Download A Real Options Theory

A Real Options Theory:
Quantifying and valuing the possibility of a lease renewal
José Antonio Roodhof
MSc Real Estate Science
Introduction
The problem:
- The possibility that a tenant will renew his lease contract
is currently based upon intuitive aspects and is not
quantified in a scientific and objective manner
- In which way is it possible to quantify the possibility of a
lease renewal?
- To what extent is it possible to assign a value to this
possibility?
Introduction
- Distribution of uncertainties and/or possibilities
Introduction
- It is not possible to quantify and value uncertainties and
possibilities with the traditional methods
- A lease renewal = a possibility and therefore uncertain
- To renew or not to renew
- Same as a financial option
- To exercise or not to exercise
Introduction
- Therefore, the real option theory!
- Derived from the financial option theory
Real Options
- The Real Option theory assumes that a company is
capable of changing the normal distribution to an
asymmetrical distribution by hedging the downside and
exploiting the possible upside in the future
Real Options
Real Options
- Real options v.s. Financial options
Financial option
Spot price
Variable
S
Strike price
K
Time to expiration
Volatility
t
σ
Risk free rate
rf
Real option
Discounted future cash flow of
the asset
Costs to buy the asset
(investment)
Option term
Risk of the asset (difference
worst case, best case)
Risk free interest rate (time
value of money)
The Model
- Based upon Black – Scholes
The Model
- Translation to real estate lease contracts
Variable
S
K
t
σ
rf
Real option
Discounted future cash flow of the asset
Costs to buy the asset (investment)
Option term
Risk of the asset (difference worst case, best case)
Risk free interest rate (time value of money)
The Model
- Market price is the only incentive
- Only to demonstrate
- Input of more (subjective) variables is possible
- Also, other option models can be used
Conclusion
- It is possible to quantify the possibility of a lease renewal
- Also, it is possible to assign a value to this possibility
- Results of the model ‘not important’
Conclusion
- Importancy of this thesis is in:
- The translation of the financial option theory to options in
real estate lease contracts
- It shows that it is possible to quantify and value
uncertainty (options) in real estate
Application in practice
- A ‘new’ method in real estate to quantify and value
uncertainty
- Helpful tool next to the traditional methods
Application in practice
- But, follow-up research is needed!