Staging option application to residential development: real options approach

Abstract

PurposeReal option valuation is capable of accounting for uncertainties in residential development projects but still lacks practical adoption due to limited evidence to support application of the theory in practice. The purpose of this paper is to use option valuation to value staging option embedded in residential projects and compare with results from DCF to determine which of the two methods delivers superior results.Design/methodology/approachThe fuzzy payoff method (FPOM), a real options model that uses scenario planning approach to generate a range of figures, from which a single-numerical value is computed for decision-making.FindingsThe results showed that the use of a range of figures was able to represent uncertainties to a higher degree of accuracy than the static DCF. As a result, the FPOM was able to capture about 3 per cent of the value of the project that was missed by the DCF. The staging option offers an opportunity to abandon unprofitable phases of a project, thereby limiting downside losses. Thus, real option models are practically applicable to cases in property sector.Practical implicationsResidential property developers must consider flexibility in financial feasibility evaluation of development because of the embedded value in uncertain property projects. It is important to account for optionality in financial evaluation of property projects for value maximisation.Originality/valueThe FPOM has been used for the first time to evaluate a horizontal phasing of a residential development project.