Abstract
Real estate markets, for both commercial real estate and single family homes, typically respond to a large negative demand shock with a period during which the volume of transactions and liquidity of real estate declines. Explanations for these periods have focused on overly optimistic owners, imperfections in real estate markets and/or minimum down payment requirements. These are important characteristics of real estate markets, but they do not provide a satisfying explanation for the long-term declines in the number of transactions and liquidity of real estate that frequently follow negative demand shocks. This paper presents estimates, for a specific real estate market (Los Angeles single family dwellings), of the option-like value of an owner's interest in a property. Our estimates imply that when an owner has little or negative equity, the value of waiting to sell is likely to exceed the net carrying cost. Consequently, the option value of a potential seller's interest may eliminate the possibility of an otherwise mutually advantageous transaction.
Similar content being viewed by others
References
Black, F., and M. Scholes. (1973). “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, 637-659.
Brennan, M., and E. Schwartz. (1985). “Evaluating Natural Resource Investments,” Journal of Business 58, 135-157.
Cauley, S. D. (1994). “Contingent Price Contracts and the Efficiency of Housing Markets,” Journal of the American Real Estate and Urban Economics Association, Winter.
Cornell, B., F. Longstaff, and E. Schwartz. (1996). “Throwing Good Money after Bad? Cash Infusions and Distressed Real Estate,” Real Estate Economics 24(1), 23-41.
Copeland, T., R. Koller, and J. Murrin. (1991). Valuation: Measuring and Managing the Value of Companies. New York: John Wiley & Sons.
Dixit, A., and R. Pidyck. (1994). Investment Under Uncertainty. Princeton, New Jersey: Princeton University Press.
Efron, B., and R. Tibshirani. (1998). An Introduction to the Bootstrap. Boca Raton, Florida: Chapman & Hall/CRC.
Gabriel, S., J. Mattey, and W. Wascher. (1999). “House Price Differentials and Dynamics: Evidence from the Los Angeles and San Francisco Metropolitan Areas,” Federal Reserve Bank of San Francisco Economic Review 0(1), 3-22.
Geske, R. (1977). “The Valuation of Corporate Libilities as Compound Options,” Journal of Financial and Quantitative Analysis, 541-552.
Geske, R. (1979). “The Valuation of Compound Options,” Journal of Financial Economics 5, 63-81.
Hull, J. (1997). Options, Futures, and other Derivatives. Upper Saddle River, NJ: Prentice Hall.
Kallberg, J., C. Liu, and D. Greig. (1996). “The Role of Real Estate in the Portfolio Allocation Process,” Real Estate Economics, Fall.
Kau, J., and T. Kim. 1994. “Waiting to Default: The Value of Delay,” Journal of the American Real Estate and Urban Economics Association 22(3), 539-551.
Kester, C. (1984). “Today's Options for Tomorrow's Growth,” Harvard Business Review March/April, 153-160.
Liang, Y., F. Myer, and J. Webb. (1996). “The Bootstrap Efficient Frontier for Mixed-Asset Portfolios,” Real Estate Economics, Summer.
Longstaff, F., and E. Schwartz. (2001). “Valuing American Options by Simulation: A Simple Least-Squares Approach,” Review of Financial Studies 14(1), 32-39.
Mason, S., and R. Merton. (1985). “The Role of Contingent Claims Analysis in Corporate Finance.” In E. Altman and M. Subrahmanyam (eds), Recent Advances in Corporate Finance, Homewood, IL: Richard D. Irwin.
Meyer, R., and K. Wieand. (1996). “Risk and Return to Housing, Tenure Choice and the Value of Housing in an Asset Pricing Context,” Real Estate Economics, Spring.
McDonald, R., and D. Siegel. (1985). “Investment and the valuation of Firms When There is an Option to Shut Down,” International Economic Review 26 (June), 331-349.
Stein, J. (1995). “Prices and Trading Volume in the Housing Market: A Model with Down-Payment Effects.” The Quarterly Journal of Economics 110 (May): 379-406.
Tourino, O. (1979). The Valuation of Reserves of Natural Resources: An Option Pricing Approach. Unpublished Doctoral Dissertation, University of California, Berkeley.
Trigeorgis, L., and S. Manson. (1987). “Valuing Flexibility as a Complex Option,” Journal of Finance 45 (June), 594-565.
Williams, J. (1997). “Redevelopment of Real Assets,” Real Estate Economics 25, 387-407.
Winger, A. (1996). “A Layman's Approach to Risk Analysis,” Real Estate Review 25, 79-83.
Ziobrowski, B., and A. Ziobrowski. (1997). “Higher Real Estate Risk and Mixed-Asset Portfolio Performance,” Journal of Real Estate Portfolio Management 3, 107-115.
Ziobrowski, A., P. Cheng, and B. Ziobrowski. (1997). “Using a Bootstrap to measure Optimum Mixed-Asset Portfolio Composition: A Comment,” Real Estate Economics, 4.
Author information
Authors and Affiliations
Rights and permissions
About this article
Cite this article
Cauley, S.D., Pavlov, A.D. Rational Delays: The Case of Real Estate. The Journal of Real Estate Finance and Economics 24, 143–165 (2002). https://doi.org/10.1023/A:1013990523388
Issue Date:
DOI: https://doi.org/10.1023/A:1013990523388