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The Journal of Real Estate Finance and Economics

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01.10.2009

How Does a Development Moratorium Affect Development Timing Choices and Land Values?

verfasst von: Jyh-Bang Jou, Tan (Charlene) Lee

Erschienen in: The Journal of Real Estate Finance and Economics | Ausgabe 3/2009

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Abstract

This paper investigates how a development moratorium affects choices of development timing and land values in a framework where both the value of developed property evolves stochastically and the development costs are fully irreversible. We assume that a regulator initially announces that land is not allowed to be developed during a finite period of time in the future. A developer, thus, must decide whether to develop land before the timing ordinance is imposed, or after it expires. The development moratorium reduces the developer’s option value from waiting and, thus, accelerates development. We also use simulation analysis to demonstrate how the other factors that relate to the demand and supply conditions of the real estate market affect this accelerating effect.

Vorheriger Artikel The Effect of House Prices on Household Consumption in Italy

Nächster Artikel Mean Reversion and Momentum: Another Look at the Price-Volume Correlation in the Real Estate Market

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See Juergensmeyer and Roberts (2003), which provides a thorough review of the literature on growth controls.

Geske and Johnson (1984) have provided the pricing formula for the American put option with a finite maturity. Moreover, our model assumes that the value of the post-development option is conditional on the pre-moratorium option not being exercised. This contrasts with the standard compound-option literature, such as that addressed in Bar-Ilan and Strange (1998), Childs et al. (1998), and Paxson (2007), which assume that the later option can be only exercised after the earlier option has been exercised.

McFarlane (1999) argues that investment in land development is fully irreversible if demolition costs are extremely high. Similarly, Riddiough (1997) suggests that irreversibility is a reasonable assumption for real estate when the physical asset is long-lived and switching costs to alternative uses are sufficiently high. Turnbull (2005a) argues that the irreversibility assumption may not be realistic, but provides analytically tractable solutions.

Consider V(t) as an asset value. Those who purchase this asset should require a compensation equal to (r − α)V(t), given that V(t) is expected to grow at a rate equal to α. Consequently, the term r − α replaces the asset yield in the formula developed in Barone-Adesi and Whalley (1987).

As Barone-Adesi and Whalley (1987) indicate, the convenience yield for agricultural commodities such as grain and livestock may be negative. It is also possible for us to consider a negative convenience yield for holding developed property when calculating the American call option with a finite maturity, i.e., C _i(V ₁(τ₁),T _i − τ₁). Nevertheless, we must restrict the convenience yield to positive values when calculating the perpetual American call option value F(V ₂(t)).

We use Eq. 11 to calculate C _i(V ₁(τ₁),T _i − τ₁). The quadratic approximation of Barone-Adesi and Whalley (1987) is not as accurate as the confined exponential approximation with maximization method addressed in Lee and Paxson (2003). Our qualitative results, however, will not be affected by whichever approximation method we choose to calculate C _i(V ₁(τ₁),T _i − τ₁).

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Titel: How Does a Development Moratorium Affect Development Timing Choices and Land Values?
verfasst von: Jyh-Bang Jou
Tan (Charlene) Lee
Publikationsdatum: 01.10.2009
Verlag: Springer US
Erschienen in: The Journal of Real Estate Finance and Economics / Ausgabe 3/2009
Print ISSN: 0895-5638
Elektronische ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-009-9184-0

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