Commercial real estate evaluation: The real options approach

Abstract

Investors of commercial real estate tend to sell their investment property when its price rises to a level high enough to realize capital gains, and they also consider selling the investment when its price declines to a level that triggers stop-loss selling. We assume that the investors of commercial real estate have embedded call and put options in their investment when they are engaged in the transaction of commercial real estate property. By using the real options model with given risk parameters, we derive the valuation model of commercial real estate. The model can provide more insights into the evaluation of commercial real estates by considering risk factors like vacancy rate, interest and tax rate, and transaction cost. Based on this theoretical model, further analysis can also be conducted according to the different classes of commercial real estates.