An empirical approach to measuring real options embedded within urban land values
Womack, Kiplan Shea
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The central and unifying theme of this dissertation is the value of urban land and its effect on investments in durable capital. More specifically, because structures are expensive to build, have an extensive construction time, and are long lasting, investments in durable capital entail a significant degree of uncertainty and irreversibility. Therefore, models which explicitly account for these factors directly in the estimation process may contribute to a refined measurement and better understanding of urban land values. One such model is the real options framework. Through the application of the principles of financial option pricing, this framework implies that land can be valued as the sum of the value of the land in its current use plus the value of an option to change the land to its highest and best use. Accordingly, the first chapter in this dissertation examines the estimation of the redevelopment option and explores the spatial relationship between real options and land values. Attaining the highest and best use of improved urban land often entails redevelopment of the physical capital. When a structure has depreciated to the point that the value of the existing bundle of structure and land, plus demolition costs, is less than or equal to the price of vacant land, then redevelopment occurs through teardowns (in which the existing property is demolished and a new structure is built in its place). Other times, it might not be economically (or legally) feasible to remove the structure, so partial redevelopment occurs through renovations (where the existing structure remains but the interior and/or exterior is substantially remodeled). Accordingly, the second chapter in this dissertation studies the determinants of the mutual exclusive decision to redevelop physical capital either in whole (teardowns) or in part (renovations). Overall, results from this dissertation contribute to a better understanding of urban land values by providing evidence of the true complexity of the urban spatial structure, providing new evidence that housing purchased for both teardowns and major renovations is valued only for the underlying land, and by capturing the spatial dynamics of real options as capitalized in urban land values.