Real option analysis. The viability of real estate projects

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Traditional methods used for real estate project valuation, such as the static Net Present Value, have some limitations, as these methods do not consider the possibility of a change in the initial conditions of the project or during its development. On the other hand, the real options approach allows for flexibility in evaluating a real estate project, improving the decision-making process as it helps identify the optimal strategy and timing for the construction phases. The paper deals with evaluating an actual real estate project in La Rioja (Spain) using different options to estimate its final Net Present Value. The results show that the real estate project would be profitable under several scenarios, although the valuations can vary significantly among the different types of options. This is because some options add more value to the project than others, depending on their cost and the uncertainty they eliminate. In contrast, the results obtained using the traditional static method would have led a real estate developer to discard the project completely, as its Net Present Value would have been negative. This confirms that the introduction of flexibility in real estate developments creates additional value by allowing developers and investors to dynamically react to changes in the market, thus making better investment decisions and finding real estate investment opportunities that otherwise would not be considered at all.

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    • Figure 1. Tree 1 option to expand
    • Figure 2. Tree 2 option to expand
    • Figure 3. Tree 1 option to contract
    • Figure 4. Tree 2 option to contract
    • Figure 5. Tree 2 option to choose
    • Figure 6. Option to choose. Tree with chosen options in each node
    • Figure 7. Tree 1 option to wait
    • Figure 8. Tree 2 option to wait without barrier
    • Figure 9. Tree 2 option to wait with barrier
    • Conceptualization
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Formal Analysis
      Alberto Munoz Cabanes, Arturo Romero
    • Investigation
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Methodology
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Project administration
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Software
      Alberto Munoz Cabanes, Arturo Romero
    • Supervision
      Alberto Munoz Cabanes, Alfonso Herrero de Egana
    • Validation
      Alberto Munoz Cabanes, Arturo Romero
    • Visualization
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Writing – original draft
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Writing – review & editing
      Alberto Munoz Cabanes, Alfonso Herrero de Egana, Arturo Romero
    • Data curation
      Arturo Romero
    • Resources
      Arturo Romero