Time to build options in construction processes

Tien Foo Sing

Construction Management and Economics, 2002, vol. 20, issue 2, 119-130

Abstract: Time to build is a very important factor in a real estate development venture. Delay in completion of a project not only affects the financing costs and the rental revenue but also it may, on a more strategic note, determine the success or failure of a project. A time to build option model consisting of a stochastic rate of completion and a stochastic net project payoff is applied to the sequential construction process of a large scale construction project. The results of the sensitivity analysis show that the optimal payoff value, that triggers the exercise of the option to invest at a maximum rate, increases positively with the increases in cash flow volatility, input cost uncertainty, excess asset return per unit risk and maximum rate of investment. However, it has a negative relationship with the rental yield. In a case study involving a commercial project, the premium for hedging the payoff risks by pre-leasing a project was estimated at 11.29%, whereas the additional cost incurred for shielding a project against input cost risks in a design and build contract was estimated at 7.80%, where each is given as a percentage of the total construction costs.

Keywords: Time To Build Option; Project Payoff Uncertainty; Input Cost Uncertainty; Sequential Investment; Option Premium (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1080/0144619011010209

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