Real option premium in Hong Kong land prices

Abstract

Purpose

This paper aims to identify the imbedded option value in price of auctioned land in Hong Kong, and to propose a more accurate valuation method in predicting land price.

Design/methodology/approach

Based on records of land auctions and property transactions during two periods of very different market conditions, land prices are estimated using the traditional hedonic pricing method as well as the option model modified from Quigg. The results are compared to deduce whether there is any imbedded option value, thus concluding whether the option model facilitates a more accurate valuation of land prices.

Findings

This study concludes that land auction prices have embedded option value in waiting to develop land. Option premiums increase with implied volatilities, which go up during market downturns, suggesting that developers place higher value on the option to develop during recessions.

Research limitations/implications

The accuracy of the analysis may have been compromised by the limited number of land auctions conducted and the difficulties in inferring the value of multi‐ownership residential buildings from sample transactions of their constituent individual units. Future research will benefit from a larger sample of transactions.

Practical implications

This paper illustrates that real option models provide the property industry with a valuation tool that addresses the concern arising from the irreversibility of investment decisions.

Originality/value

The study finds out the option premiums of vacant land in Hong Kong, lending empirical support to the application of option‐based models for more accurate land valuation under different market conditions.

Citation

Chiang, Y., Joinkey So, C. and Stanley Yeung, C. (2006), "Real option premium in Hong Kong land prices", Journal of Property Investment & Finance, Vol. 24 No. 3, pp. 239-258. https://doi.org/10.1108/14635780610659946