Research On Valuing Commercial Real Estate With Real Option Approach

Recent years, the development of China still remains rapidly growth under thesituation that the world economic is not optimistic. Real estate industry has played animportant role in this development, and commercial real estate is also developing rapidly,which provides investors many investment opportunities.The first step of the investment is to value the project for determining whether it isprofitable to invest in this project. The most commonly method is NPV, the traditionalNPV method is the discounted cash flow (DCF), but the DCF method has some drawbacks.One hand, it is used under a static process, so ignoring the managers’ flexibility in theinvestment process, on the other hand, too many parameters which are needed to evaluateaffect the accuracy of valuation, so the real option (RO) is introduced in this article, whichcan overcome some problems of DCF method when dealing with cash flow, and valuingby real option are better able to reveal the real value of the commercial real estate ininvestment projects.Just as we discussed above, this article mainly consists of several aspects which arebelow:Firstly, the article shows the development status of the commercial real estate inChina. By comparing the development history of commercial real estate in variouscountries, the article also shows that commercial real estate industry has developmentpotential and investment value.Moreover, the article takes the credit default risk into consideration, by combiningwith the real option method, develops a new pricing model; relax the traditional valuingmethods which ignore the default risk of bankrupt, and find that the model with the creditdefault risk is better than the traditional model in valuing the commercial real estate.Lastly, by a specific commercial real estate project in our research, the article takesoption natures of the lease agreement into valuing the project by using real option andDCF methods, compares and analysises the results of the different methods.Through this research, the target is finding an effective way to reveal the value ofcommercial real estate for guiding investors’ investment. This study also shows that there are many differences between the traditional DCF method and real options method,especially in flexibility. Real option method seems more reality than DCF under the realinvestment environment, but the calculation of DCF is easier to be understood and done.Both of the methods are effective tools for dealing with cash flow in commercial realestate valuation.