School of Property, Construction & Project Management
TITLE: IS THERE VALUE IN WAITING? AN EMPIRICAL STUDY OF REAL OPTIONS APPLICATION TO PROPERTY DEVELOPMENTS.
Several evaluation methods are employed by property practitioners in determining the financial viability of proposed property developments. One method widely used in Australia by practitioners is the discounted cash flow technique (DCF). However, the use of the DCF has witnessed several criticisms due to its approach to risks and uncertainties and prominent among them is the inability of the DCF to evaluate strategic flexible managerial decisions that add value to project returns. Due to these shortcomings of DCF, an alternative method that captures the value embedded in flexible managerial decisions can’t be overemphasised. Hence, real options valuation was developed as a complement to DCF.
Real options analysis functions with future decision rights embedded in property developments. The concept hinges on the premise that, adjusting financial variables such as the discount rate could result in myopic decisions. Therefore, there is the need to manage investments actively until its final termination point rather than merely adjusting rates to reflect uncertainties and risks. There is also the need to evaluate real estate projects based on a range of values to capture all possible future values of a development in order to make better decisions. However, the real option method has also not been widely adopted in practice after its proposition by academics. Hence, there is the need for practical application to real life cases in order to expand knowledge of the method.
The study uses a mixed method approach (quantitative with an embedded case study and qualitative) to evaluate property development cases in real life to determine whether case studies of proposed property developments support real options theory as opposed to standard project evaluation methods. This will deliver new evidence that has the potential to drive the adoption of the method in practice or otherwise. Through the development of a conceptual framework, academia will benefit from the new knowledge. Practitioners will also benefit from this study due to the new evidence in support of the use of real options in practice.