Pricing of real estate Case Study Example | Topics and Well Written Essays - 3500 words

Pricing of realistic estate - Case Study ExampleReal options have been in initiation since centuries and the earliest references are found in the story of Thales, a Greek philosopher. Thales predicted a bumper olive harvest and paid a large grant to topical anesthetic olive refiners for the right to hire their entire olive pressing facilities for a specified fee during that years harvest season.Thales however did non have the obligation to practise the facilities and had the option to let his right lapse if he chose to do so, at the cost of losing the premium he had paid al secure. The bumper crop did take place and Thales exercised his real option. He allowed other producers to use the facilities he had got at a predetermined price, but at a large additional premium. Thales is said to have profited vastly by his use of the real option.Real options in real estate are best illustrated by examples. Consider a prospective home owner who identifies a dream home available at an b enignant price. Several others too would have arrived at the same conclusion and whitethorn be ready to make competitive notchs. The first homeowner however does not have his finances tied up and needs a fortnight to get it done. wait for a fortnight may push the dream home into anothers possession, a situation that throws up the concept of a real option. The prospective owner could offer the seller a sum of money just to hold the property for the two weeks he needs to arrange the funds and buy the home at the offering price. If the funds dont come through or if he changes his mind, he loses the money paid, while the seller keeps the sum of money and can easily father another buyer from among the numerous others interested in buying the property. Just how much the sum paid should be involves putting a value on the real option. A similar situation may arise in the case of a real estate development company holding lazy land. The possession of vacant land confers a right or an opti on, but not an obligation, to develop a completed building at a upcoming date. The value of vacant land is a consequence of this right to develop an asset, the completed construction, at a price, the cost of construction. The decision to build or not and when to build if at all, are subject to several uncertainties. The forthcoming value of the constructed building may be uncertain - if property values rise, the builder is more certain of profits, while lower values at a specified time may justify delaying construction by avoiding potential losses. Delaying the construction may make more information available, allowing for a change in land utilization, nature of the project, tenant mix, funding options etc. The option to wait itself becomes valuable. Thus the misgiving by itself has value, and if that value can be quantified, the decision making process would become more accurate. Real options analysis thus assumes relevance and importance in real estate pricing by allowing a va lue to be put on uncertainty. The value of the real option increases when uncertainty about the future value of the built property increases. Thus, development of the property will take place when the value of the completed project exceeds the costs by a premium determined by a combination of uncertainty of asset value, irreversibility of the development and the choice of waiting. In many cases, projects that might have been dropped as unviable become attractive when associated real options are evaluated and quantified. In a