Commercial Investment Real Estate November/December 2018 | Page 17

A first step in determining the value of real options is simply knowing what they are. Understanding the nature of real options helps in understanding whether they are likely to have value, and whether traditional DCF is likely to underprice that value. Real Options Illustrated Consider two investments — one in a piece of undeveloped land and another in an existing factory. In the case of raw land, the investor has many real options: the timing of when the land will be developed, based on how demand evolves; developing the land for residential or commer- cial use; developing the land all at once or in phases; and whether to develop the land or abandon the project. At the time the land was purchased, the investor was buying a bundle of real options to exercise at some point. Similarly, the investor in a factory can decide when to increase or decrease production; expand or reduce the capacity of the fac- tory; shut the factory down, and the conditions under which it would be restarted; and retool or even abandon the factory should demand for its product not meet expectations. The most common real option and one of the most valuable is the option-to-delay. This option affords the investor flexibility to delay making a decision up to the point when an irreversible decision is made. With real options, an investor has flexibility in responding to future uncertainty, and this flexibility (the option) itself has value. Option-to-delay has critical value because it gives time to collect more information about the decision, and it gives any uncertainty surrounding the decision time to resolve. In short, this and all of the other real options available to investors have real value, and should be reflected in the valuation of the entire investment. Murray C. Grenville is CEO of Sterling Valuation Group in New York, which values alternative, non-liquid assets for hedge funds, private equity firms, banks, and other financial institutions. Richard J. Buttimer, Jr., Ph.D., is director of the Childress Klein Center for Real Estate and John S. Crosland, Sr., distinguished professor in the Belk College of Business at the University of North Carolina at Charlotte. Contact Grenville at mgrenville@sterlingvaluationgroup. com and Buttimer at [email protected]. STAY ON THE PATH Your membership in CCIM means unlocking the secret of commercial real estate opportunity through empowering education, a worldwide network of role models and peers, and a methodology to transition assignments into more lucrative opportunities or even equity participation. Continue the journey by renewing today at www.ccim.com/renew CCIM.COM November | December 2018 15