Real option valuation of retail properties in South Africa

This study focused on real option valuation (ROV) as a complementary methodto the popular income-capitalization method (ICM) when valuing retail propertiesin South Africa.The ICM may be approached in two ways viz. the direct capitalization method(DCM) and the discounted cash-flow (DCF) approach. In South Africa theformer is primarily employed to determine the ‘fair-value’ of a retail property. Acombination of the two approaches yields the most accurate valuation butrequires a higher dependency on input variables.Retail centre transactions qualified as suitable case studies if they allowed foradditional ‘bulk’ to be developed (option to expand) and the purchaser paid apremium above a calculated theoretical ‘fair value’. A ROV framework based onthe binomial (financial) option pricing model was developed to value theexpansion option for each case study. The value of this real option accounts forany premium paid over-and-above the theoretical ‘fair-value’.In all four case studies the premium paid was captured by the ROV framework,albeit at differing holding-periods. Although the result is not statisticallysignificant it bestows credibility on ROV as a complementary tool to the ICM. Insummary, ROV quantified the ‘gut-feel’ or intuition-based motives by investorswhen paying premiums for expandable retail properties in South Africa.