Real Option Pricing in Mixed-use Development Projects

The application of real options theory to commercial real estate has developed rapidly during the last 15 Years. In particular, several pricing models have been applied to value real options embedded in development projects. In this study we use a case study of a mixed-use development scheme and identify the major implied and explicit real options available to the developer. Moreover, we offer the perspective of a real market application by providing a decision framework in order to price the main real options through a binomial approach with a combined set of measures to quantify development risk and resolve uncertainty, timing, irreversibility and pricing. We identify an approach to ascertaining appropriate volatility inputs for the model. Finally we suggest our framework can be used for risk assessment purposes, both ex-ante and ex-post.