Analysis of the Viability of an Urban Renewal Project under a Risk-Based Option Pricing Framework

Abstract

Under real option theory, property developers are able to determine the optimal timing of executing their investment projects on a risk-neutral basis. The writers adopted the Samuelson-McKean model to value the embedded option of the largest urban redevelopment project in Hong Kong—Kwun Tong Town Center—for its feasibility study. Then housing prices were simulated by using the Monte Carlo simulation. This paper has made a contribution to the real estate investment literature in tracing the plausible optima and adverse outcomes, particularly in situations in which perfect information is not available. The estimated mean value of the project is approximately $31.14 billion, which is around 15% lower than the required value, i.e., the hurdle value of $36.65 billion. The finding has revealed that immediate implementation of the Kwun Tong redevelopment project is unfavorable from a financial standpoint because the expected return is insufficient to offset the cost of uncertainties.