Option pricing for real estate development: Hong Kong Disneyland

It is well known that the traditional net present value (NPV) approach fails to take account of the multiple effects arising from the interactions of the operating and strategic flexibility during the course of a project. Option pricing theory (OPT) has been successfully applied in the valuation of both financial and real investments in the last two decades. However, it is still a relatively new approach in the valuation of real estate investments. This paper thus attempts to extend the application of OPT to the valuation of real estate development projects, providing insights into rectifying the limitations of traditional approaches. The paper starts with an overview of the development of OPT relating to real estate investments. It then examines the appraisal method adopted by the Government for Hong Kong Disneyland and explores the real options that may create added value to the project. A binomial option pricing model is proposed that estimates the potential values of the project with those options available. The study concludes that OPT is superior to NPV approach on the valuation of real estate investments in that it enhances upside potential as well as reducing downside risk.