The Leveraged City

Seung Dong You

Real Estate Economics, 2014, vol. 42, issue 4, 1042-1066

Abstract: type="main">

This study analyzes the effects of leverage on real estate developments. In urban growth models, a real estate developer converts land from agricultural to urban use. At the time at which such a land conversion occurs, a developer who maximizes the equity value obtains a defaultable construction loan at fair market value. By presenting a more general form of the irreversibility premium of Capozza and Helsley, I show that, with more leverage, uncertainty is less of a deterrent to the land conversion. Under uncertainty, a leveraged developer exercises the land conversion option earlier than an unleveraged developer would. Leverage expands equilibrium city size.

Date: 2014
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