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The option pricing theory in the evaluation of real estate projects: The waiting option

Abstract:

This paper shows an application of the Option Pricing Theory in the evaluation of real estate projects. Particularly, valuation methods of binomial trees and the Black & Scholes model are reviewed, adopting the latter for the valuation of a real estate project with a presale stage. This characteristic aligns to the waiting option, as financial literature describes. The project with the presale stage, analyzed with the Black & Scholes model, obtained a valuation of $570,859, while the project in a non-presale scenario obtained a value of $393,951. Comparing these values, the waiting option added value to the project for $ 176,908, due to the reduction of the failure risk. This paper contributes to the scarce literature about the evaluation of real estate projects, with embedded real options.