Redevelopment Strategies and Building Ages

Abstract

An improved real option pricing model that incorporates the depreciation effect for two-stage redevelopment projects will be demonstrated to estimate the redevelopment project values in a wide range of scenarios. Based on a stochastic differential equation, numerical analyses will focus on new factors that influence the expected exercise time, that is, depreciation rate, the annual increase in average building age, building age of the targeted property, and the average building ages in the same region. The depreciation rate is the most influential factor in this model. More importantly, this study will summarize three exercise strategies that cover all combination of the parameters. In some cases, with a low capital return rate, or high depreciation rate, or both, the traditional simultaneous exercise strategy based on the optimal demolition price-to-cost ratio is not feasible. Instead, either a sequential exercise or simultaneous exercise that is based on the optimal rebuilding price-to-cost ratio is the best choice. Detailed procedures on how to adopt the best strategy will be demonstrated. The acquisition price of the old property proved to be sensitive to the depreciation rate and the capital return rate within a certain range. To apply this model properly, the feasible time interval for the traditional simultaneous exercise strategy and the depreciation rate should be estimated accurately.