Optimal Phasing and Inventory Decisions for Large-Scale Residential Development Projects

Land developers in select economic environments have been found to build in large increments and hold substantial amounts of inventory despite their ability to mitigate risk by phasing the production of residential lots. Such behavior was observed in numerous metropolitan areas throughout the southeastern and southwestern United States in the years leading up to financial crises, resulting in inventories of tens of thousands of lots in cities such as Atlanta, Las Vegas and Orlando, just to name a few. The model presented in this paper explores the rationale behind the choices made by developers in these markets and others by extending the real options framework to concurrently estimate optimal phasing and inventory decisions for large-scale residential development projects. Modeled interactions between several variables indicate that full development, smooth phased development and lumpy development can all be optimal under different market conditions, with each pattern feeding back into inventory levels and lot pricing.