Application Of OPT In Real Estate Development Investment Decision

Option pricing theory (OPT) is one of the most important achievements in thefield of modern economics, which mainly discusses the method of confirming optionvalue. Two American economists, Merton and Scholes, have won the Nobel Prize forcontributing to option pricing. At the beginning, this paper introduces the development of China's real estate.By using internal and external research achievements for reference and combiningwith a case study, this paper provides an insight into the application of OPT in realestate development investment decision. Option, also called selection right, is one of the rights that have property ofunequal rights and obligations. According to different benchmarks, option can beclassified as call option and put option, American option and European option,financial option and real option. As a realistic selection right, real option is widelyused in investment decision, Mergers and Acquisitions (M&A) and project evaluation.Because it is unfamiliar to Chinese, and it consists of many complicated mathematicsmodels, real option theory has been seldom used by us. But in fact, real option hasmuch important value for being applicable to investment decision of the items thathave long term, high risk and huge sum. After analyzing the uncertain factors that will influence the investment decisionof real estate development, this paper indicates that Discounted-cash-flow (DCF) is incommon use to make real estate investment decision, which comprises Net PresentValue (NPV) and Internal Rate of Return (IRR). As the most widely used method,NPV has two basic hypotheses, which say that investment is retrievable and incapableof postponement. But in the most situations, real estate investment is beyond retrieval,and it can be postponed. The developers can divide the item into two steps. Beforedeciding whether to develop the second part or not, they can make the choice ofinvestment occasion more flexible. As NPV ignores the value of flexibility in realestate investment, so this paper is helpful to developers to make more correct iABSTRACTinvestment decision by using binomial tree methods. To connect theory with practice, this paper especially makes Zi Zhu Lin Gardenas a case study. After collecting the basic data of this item, this paper gives aquantitative analysis of the item from NPV and binomial trees angle of view. As far as real estate development investment decision is concerned, there aremany uncertain factors in it. On the basis of reserving the reasonable part of thetraditional method, OPT takes uncertainty and flexibility of the investment intoaccount, and it puts forward a new method for developers, which will benefit realestate investment.