Developers’ heterogeneity and real estate development timing options
| Pages | 472-488 |
| DOI | https://doi.org/10.1108/JPIF-07-2016-0058 |
| Date | 07 August 2017 |
| Published date | 07 August 2017 |
| Author | Zhi Dong,Tien Foo Sing |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
Developers’heterogeneity
and real estate development
timing options
Zhi Dong
Department of Property, The University of Auckland Business School,
Auckland, New Zealand, and
Tien Foo Sing
Department of Real Estate, National University of Singapore, Singapore
Abstract
Purpose –The purpose of this paper is to examine developers’optimal development timing when developers
are heterogeneous and have different marginal costs in a real estate development market.
Design/methodology/approach –This study uses a multiple-player game theoretic real option model and
provides tractable results of asymmetric development strategies from a two-stochastic-variable model.
Anecdotal evidence and market observations are presented.
Findings –Stronger developers (with low marginal costs) exercise real estate development options earlier
than weaker developers (with high marginal costs). However, the interval time between developments by
stronger and weaker developers decreases in rental volatilities. Real estate with a high positive externality are
developed earlier than real estate with a low or negative externality.
Practical implications –Weaker and smaller developers are advised to undertake projects having positive
externalities from vicinities. Government agencies are recommended to use tools of zoning and urban
planning to prioritise developments introducing positive externalities and to facilitate the growth of weaker
and smaller developers. This may subsequently help reduce incentive for land banking and oversupply in real
estate space market.
Originality/value –This research is probably the first to explicitly incorporate developers’heterogeneous
strength in real estate development timing options with multiple developers in a competitive market.
It sheds additional insights into the understanding of potential problems of development cascades,
under the interactive effects between exogenous policy changes and endogenous response from asymmetric
developers.
Keywords Externalities, Competitive real estate market, Development timing options,
Heterogeneous developers, Marginal cost on development, Urban land use
Paper type Research paper
1. Introduction
This paper relaxes unrealistic assumption of homogeneous developers in development
timing options in a competitive framework. Empirical evidence shows that developers
are heterogeneous in regard to their development experience (Dong and Sing, 2014).
More experienceddevelopers have better network connection with suppliers andclients than
less experienced developers. Their past development experience affects the marginal cost
of development in theory (Dong and Sing, 2016), practice and empirical evidence
(Coulson et al., 2015). However, the existing literature of real estate development timing
options assumesthat developers are homogeneousin regard to their developmentexperience,
especially when researchers study multiple developers in a competitive framework.
Developers’past development experience influences their development timing strategies
and they learn to reduce their marginal costs from their past experience (Spence, 1981;
Fudenberg and Tirole, 1983; Coulson et al., 2015; Dong and Sing, 2016). Real estate
purchasers incorporate developers’experience when they make purchasing decisions
because developers’experience is correlated with their development strength in the real
estate market (Shen and Pretorius, 2014).
Journal of Property Investment &
Finance
Vol. 35 No. 5, 2017
pp. 472-488
© Emerald PublishingLimited
1463-578X
DOI 10.1108/JPIF-07-2016-0058
Received 25 July 2016
Revised 31 January 2017
12 April 2017
Accepted 22 April 2017
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
472
JPIF
35,5
Business strength as indicated by reputation capital has shown important signals in an
imperfect market with asymmetric information (Boot et al., 1993). Managers are concerned
with managerial strength. Experienced managers who have established strong track
records hesitate to venture into unknown territory in emerging markets because of the fear
of losing the reputation on track records that they have built up in the past (Ong, 1997).
Ong and Cheng (1996) show that signals on business strength can be sent through a variety
of aspects of developers in uncertain real estate markets.
Anecdotal evidence signals that strong and large developers have better capability than
weak and small developers to undertake projects of large scale or with high idiosyncratic
risk, when the volatility on the demand of real estate is high. The demand and supply in real
estate markets are cyclical with fluctuated levels of volatility. Uncertainty kicks into
markets when there are signals of potential market crisis, market failure or sudden
regulation changes. Small developers are likely to be disadvantaged in volatile space, asset
and development markets because of their smaller capacity of undertaking risk and
development than that of large developers. Small developers tend to wait for signals and
information in a high volatile market with low demand of real estate space. Large developers
are able to pre-empt into development markets when the demand of real estate space is low
but may catch up in the future.
It is important to understand the best development timing and strategies in-between
large and small developers because of the following three reasons. Their asymmetric supply
and market power (Dong and Sing, 2016) could influence the cyclical pattern of the
performance of real estate markets (Grover and Grover, 2013). The findings of development
timing decisions will assist researchers in understanding the phenomena of development
cascades as mentioned in Grenadier (1996). The implications on results will provide
additional insights into researchers’and practitioners’understanding of endogenous
response in relation to exogenous effects in real estate space and development markets.
The present study answers the question of whether developers’development strength
influences their development timing strategies. It extends the application of real option
theory because the theory allows us to integrate stochastic shocks and uncertainty into
analyses. The literature on real options application has increasingly accounted for the
importance of development option value (Williams, 1991; Grenadier, 1995a; Grenadier, 1996;
Lucius, 2001; Sing, 2001; Jou and Lee, 2009; Amédée-Manesme et al., 2013; Li et al., 2014) and
taken into account asymmetric effects of developers on the optimal development timing
options (Grenadier, 1996; Wang and Zhou, 2006; Chu and Sing, 2007). The literature shows
that the optimal option exercising behaviour of developers is influenced by demand and
supply side asymmetry that drives the option exercising decisions.
The present paper incorporates differential revenue and marginal cost functions in
multiple-developer real option models. The inter-project externality effects from
neighbouring projects are included in the models, when more than one project are
involved. In addition, this study expands the duopoly market structure used in the literature
into a multiple-player market structure. This multiple-player model allows optimal
development timing decision to be evaluated under competitive market conditions.
Developers’different levels of development strength are expected to significantly affect the
development timing option simultaneously with the externality of development projects.
This research provides theoretical and analytical results and observed market phenomena.
The paper contributes to the literature on the following aspects. First, it provides
analytical and comparative results on development timing that is different between large
and small developers. Second, it explains how the effect of exogenous shocks in markets
may affect the lapse of time between large and small developers’commencement of
developments. Third, it guides small developers in respect to increasing their competitive
advantage by taking up projects that receive complementary benefits from other real estate
473
Real estate
development
timing options
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