VALUING REAL ESTATE AS DIVIDEND PAYING STOCK WITH A PUT-OPTION

Option pricing theory is familiar in the property market with studies that consider the methodology for the pricing of mortgages, development land, idle time, property stocks, lease options and other optionality with regards to design or use. It has not, to date, been generally considered as an alternative pricing method for income producing property as a financial investment. This study conceptualises investment property as a dividend paying stock with a put-option at reversion. It provides the possibility to identify the risks in property investment with regards to different types of tenants and lease terms, thereby enabling the distinction between the contribution of the lease and the vacant possession to the total value of the property with a view to more accurate pricing. This potentially enables hedging within a single property against certain lease attributes or market activities. The paper is structured in three parts. The first part contains the literature survey, which considers the different aspects of existing property valuation techniques, option pricing techniques and literature that specifically deals with option pricing within the property context. The second part deals with a theoretical explanation of the use of option pricing to value real estate, with an analysis of the required information in order to apply such techniques. The last part is an empirical testing, which is based on a portfolio of properties with varying weighted average lease expiry periods.