Editorial

Citation

Brown, G.R. (1999), "Editorial", Journal of Property Investment & Finance, Vol. 17 No. 5. https://doi.org/10.1108/jpif.1999.11217eaa.001

Editorial

The papers in this issue of the journal illustrate the wide range of topics that can influence property. You will see that there are papers on property investment vehicles in Germany, the effect of drinking water quality on prices, the determinants of capital structure and redevelopment of Brownfield land. Although these may appear to be very different, what they all share in common is an understanding of valuation. Valuation is the key to making investment decisions.

It is at this point that you need to consider the role of traditional valuation models when valuing different types of property investment. Whatever model is used in practice, valuation models can generally be regarded as embodying the concept of present value. Even the common capitalisation model is just a present value model that makes simplifying assumptions concerning the growth in expected cash flows. So, as long as you have an estimate of the current expected cash flow together with a capitalisation rate you can arrive at a value for a property. If you were considering an investment you would estimate the costs involved and calculate the net present value (NPV). If this were positive, implying that it is worth more than its cost, you would accept the project and if it were negative you would reject it.

This is a simple decision rule, but it also assumes that if you reject a project then the investment opportunity no longer exists. The NPV rule is an all or nothing decision. However, in many cases this is not the case. In a property development situation, for example, you may decide not to invest today but to wait until conditions are more favourable. As events resolve themselves you may find that the project becomes profitable. The project has not disappeared, you have recognised that the decision to invest depends on future uncertainties. You may, for example, decide to wait for 12 months because you believe that there is a strong chance that you could get planning consent for a larger project. You therefore have an option to develop now or to wait. What is interesting about this is that the greater the uncertainty associated with the future the greater the value of the option. NPV models would view uncertainty differently.

Traditional present value models do not therefore adequately take the value of options into consideration. Options are, however, an important aspect of many investment projects and offer an explanation for some investment decisions that have been made. Fortunately the economic basis and mathematics for estimating option values is well known. So far, however, it has had little impact on traditional valuation practice. Herein lies a challenge. Traditional valuation has concerned itself with yields and concepts such as years' purchase. These are still common currency and the technology of valuation, apart from more fully embracing discounted cash flow concepts, has changed very little over the last 20 years. Property valuation is still largely treated and taught as though it is separate from mainstream finance. If valuation theory is to advance then it needs to adapt and embrace modern financial concepts such as option pricing theory. The reason is not to give an impression of sophistication but to arrive at valuations that are a better reflection of how the market behaves.

Fortunately some work is being done in this area and during next year the Journal of Property Investment & Finance is planning a special issue dealing with the application of real options in property. Hopefully, this will stimulate some interesting research in valuation theory.

Gerald R. BrownNational University of Singapore