Value of waiting – option pricing as a tool for residential real estate fund divestment management

Abstract

Purpose

The value of waiting to invest has been acknowledged in management of real capital investments. Investment decision should be undertaken only if it can justify giving up the value of the option to wait; the same logic is proposed here to be applicable on divestment management of a real estate fund. The purpose of this paper is to test option pricing to quantify the option to wait in a residential real estate fund divestment. It is argued that standard industry valuation practices miss the value of active fund management that should be included when planning a fund divestment strategy.

Design/methodology/approach

Dynamic programming, specifically binomial option-pricing model is suggested to complement the current industry standard valuation approaches. The approach is tested in an embedded case study where assets of a residential real estate fund are valuated using the model.

Findings

Option pricing can provide risk-neutral quantified value whether an apartment building portfolio should be divested in a single transaction or in multiple transactions over time. In the case study, an option value of 6.6 per cent was found for a residential real estate portfolio.

Originality/value

This study is the first of its kind to propose that value of waiting to divest is an important element when planning a real estate fund divestment. The approach proposed in this study risk-neutrally calculates the value appreciation from the range of the potential values. This provides the decision-maker a deeper understanding of the implications regarding the chosen line of action.

Citation

Vimpari, J. and Junnila, S. (2014), "Value of waiting – option pricing as a tool for residential real estate fund divestment management", Property Management, Vol. 32 No. 5, pp. 400-414. https://doi.org/10.1108/PM-03-2014-0013