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Sustainable Value of Investment in Real Estate: Real Options Approach

Marek Durica (), Danuse Guttenova (), Ludovit Pinda () and Lucia Svabova ()
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Marek Durica: Department of Quantitative Methods and Economic Informatics, Faculty of Operation and Economics of Transport and Communications, University of Zilina, Univerzitna 1, 010 26 Zilina, Slovakia
Danuse Guttenova: Department of Quantitative Methods and Economic Informatics, Faculty of Operation and Economics of Transport and Communications, University of Zilina, Univerzitna 1, 010 26 Zilina, Slovakia
Ludovit Pinda: Department of Mathematics and Actuarial Science, Faculty of Economics Informatics, University of Economics in Bratislava, Dolnozemska cesta 1, 852 35 Bratislava, Slovakia
Lucia Svabova: Department of Economics, Faculty of Operation and Economics of Transport and Communications, University of Zilina, Univerzitna 1, 010 26 Zilina, Slovakia

Sustainability, 2018, vol. 10, issue 12, 1-18

Abstract: The issue of application of real option valuation approach in the valuation of investment project is presented in the article in a way in which the flexibility of the project could be included in the process of its valuation. The authors apply the valuation approach in case of a specific investment project in the real estate in the capital city of the Czech Republic—Prague, using the option to expand, to contract, and to abandon the project. The main aim of this case study is to present a practical application of the investment valuation and to construct an option pricing model for real estate investment which considers and integrates as many aspects of the investment and market environment as possible to describe the best situation of the real estate market and its development. The valuation of the investment is carried out using a universally applicable numerical method of binomial trees. The results obtained are subjected to the sensitivity analysis with respect to the discount rate, value of the most influential parameter of the volatility and the input option parameters. The results of the valuation of the project obtained using the real option approach are important mainly for the management of the company in the process of quantification of the present value of future investments. Implementation of managerial interventions enables for optimizing the value of the project not only in case of favourable development of the real estate market, but particularly in case of unfavourable development. Therefore, they are important in order to protect an investor from potential high losses. Finally, the valuation of these interventions increases the present value of the project, contributing to the decision of the corporate management regarding its implementation.

Keywords: real option; real estate investment; binomial tree; net present value; volatility; discount rate; discounted cash flows; project evaluation; flexibility (search for similar items in EconPapers)
JEL-codes: Q Q0 Q2 Q3 Q5 Q56 O13 (search for similar items in EconPapers)
Date: 2018
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