Office Construction in Singapore and Hong Kong : Testing Real Option Implications

We advance the real-option-based empirical analysis of commercial real estate investment in three respects. First, we test several real option implications for real estate construction that have not been examined in the commercial real estate investment literature. In particular, we show that market volatility makes the effect of real interest rate and the expected demand growth on hurdle rent more negative, as the real option models predict. Second, we use a cointegrating vector of office employment and office stock to provide a better control of the demand for new construction than the traditional indicators based on real estate prices and vacancy rates. Third, whereas the existing studies focus on the U.S. commercial real estate markets, we study two major office markets in Asia, namely Singapore and Hong Kong. We are able to use the stock market prices in these two city states to generate forward-looking measures of office demand growth expectations and volatility