Risk mitigation with buy‐back guarantees and guaranteed appreciation plans
| Pages | 239-253 |
| DOI | https://doi.org/10.1108/14635780010324547 |
| Published date | 01 April 2000 |
| Date | 01 April 2000 |
| Author | Seow‐Eng Ong,Shawn Hong Guan Lim |
| Subject Matter | Property management & built environment |
Academic papers:
Appreciation
plans
239
Journal of Property Investment &
Finance, Vol. 18 No. 2, 2000,
pp. 239-253. #MCB University
Press, 1463-578X
Received August 24
1998
Revised February 14
1999
ACADEMIC PAPERS
Risk mitigation with buy-back
guarantees and guaranteed
appreciation plans
Seow-Eng Ong and Shawn Hong Guan Lim
School of Building and Real Estate, National University of Singapore,
Singapore
Keywords Financial planning, Marketing, Risk
Abstract Two marketing schemes that provide protection against downside price risk are
examined. The buy-back guarantee allows the property purchaser to sell the property back to the
developer at the original purchase price, while the guaranteed appreciation plan assures the
buyers of a minimum price appreciation at the end of a specified period. Both plans essentially
provide the property purchaser with put options with contingent payoffs that differ in terms of the
strike price. This paper examines the value of the buy-back guarantee and the guaranteed
appreciation plan as well as providing a framework for evaluating the put options. The key
finding is that the time value of such put options is extremely low if they are too deep in-the-money
and if expected volatility is low. If so, a careful examination of the terms offered suggests that the
buy-back guarantee is expensive. In contrast, the guaranteed appreciation plan can be regarded as
a free option because it provides a strike price that is above the purchase price. Hence, property
purchasers react favorably to the guaranteed appreciation plan. Finally, implications for
marketing and pricing strategies are examined.
1. Introduction
The residential property market in Singapore witnessed unprecedented price
increases from 1993 through 1996. Over this period, the benchmark residential
property price index[1] compiled by the Urban Redevelopment Authority
(URA) of Singapore increased by 122 percent. Amidst concerns that the
property market was increasingly speculative, the anti-speculation package
introduced in May 1996 sought to increase transaction and financing costs. An
increasing supply of private residential properties ± initiated during the boom
years ± continued to come on-stream in 1997 and 1998, creating an imbalance in
the demand and supply. The indigestion created by the demand-supply
imbalance, abetted by the Asian regional economic crisis of 1997, resulted in
lower private property prices. The benchmark URA price index shed 12.5
percent for 1997. Over the first half of 1998, prices for residential properties
registered a further decline of 11.1 percent.
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The authors wish to thank Gerald Brown and Kanak Patel for their insightful comments during
the initial stages of this research. In addition, we wish to thank Nick French and an anonymous
referee for their insightful comments. All other errors are solely the responsibility of the
authors'. Please direct all comments and queries to seong@nus.edu.sg.
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