The value of expanding commercial rental space : a real options framework
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- Master Thesis 
In this thesis, we develop a real options framework to value options to expand a commercial property. We consider the investment in a development project under uncertainty in future rental rates and in the presence of regulatory uncertainty. We have consulted with industry experts to model the framework as realistic as possible without losing analytical tractability. Our framework contributes to the accurate valuation of real estate as well as the real options literature related to real estate, by adjusting and combining existing frameworks and applying them to the real estate industry. First, we consider a simple investment in the expansion of a property under uncertainty in future rental rates, but in the absence of regulatory uncertainty. We proceed to introduce the presence of a regulatory process in the form of a mandatory fixed approval lag, prior to the firm receiving the investment opportunity. Finally, we introduce uncertainty in the length of the regulatory process. For each model, we are able to obtain optimal investment thresholds and option values, and in most cases these results are closed form analytical solutions. We find that an option to expand an existing property has significant value under the right conditions, even when the immediate expansion is not profitable. We also show that the presence of a regulatory process alters the option value, and that a stochastic regulatory process implies a higher cost to the firm than a fixed regulatory process.