Abstract
The real estate market of EU countries has undergone a severe global financial crisis 2008–2009, recovered successfully later, and now experiencing significant uncertainty due to the COVID-19 pandemic event. Significant volatility of the real estate business is once again evident, just as it was following the global financial crisis. The paper aims to provide a case study of a real estate project by giving insight into the Latvian real estate project that had been experiencing similar economic uncertainty, to demonstrate hybrid real options valuation (ROV) method to adapt real estate investments to changing circumstances and to develop the decision-making solution to similar EU real estate problems during the pandemic. The paper provides the “step-by-step” ROV application’s methodology in real estate development projects. The presented methodology is a powerful managerial risk management tool for the executives of similar real estate development projects in the EU countries struggling to make investment decisions in the pandemic and post-pandemic period. Since any estimation includes assumptions, ROV results should be interpreted and perceived as approximations only. The future works can provide robust ROV analyses and interpretations regarding the demand for real estate, showing quantitatively how competition can impact strategic investment decisions.
Highlights
2008–2009, recovered successfully later, and experiencing significant uncertainty due to the COVID-19 pandemic event
This paper aims to test empirically the real options valuation (ROV) application for real estate development projects as a financial risk management tool
(2007) argue that there are several constraints in Black-Scholes approach usage for real options valuation as they may often differ from simple financial calls in the following ways: exercise price may be directly correlated with the value of a project instead of being a fixed amount; there might be carrying costs of holding the option open, and with financial calls, a time to maturity is a standard amount it may be difficult to identify in strategy context
Summary
In EU the real estate business experiences a high level of uncertainty. “Covid-19 is a game-changer to the property industry like the global financial crisis was, but even more disruptive” (PwC and the Urban Land Institute 2021, p. 4). During the Covid-19 pandemic, many real estate investors opt to wait, observe, and only in case of positive development invest in the project. Having the land in their hands, the investors had got a real option—to construct the residential complex to sell the unfinished residential complex immediately, or to wait and develop the project later. In such uncertain circumstances, there was a strong call for real options application by the real estate players. To demonstrate how financial options theory can be adopted to value real investment projects, three ROV methods as Black-Scholes option pricing model (BSOP), binominal option pricing lattices (BOPM), Monte Carlo simulation (MCS), and their appropriateness for the valuation of real estate projects are further discussed
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