Decision analysis approach to real estate valuation

You Yiran

Abstract

Real Estate Investment has long been a hot choice among investors because of its potential huge returns. Thus, an accurate valuation of a real estate development project will be crucial in aiding the investor in his decision making process.

The problem with the existing valuation methods is that they are not capable of estimating the Investment Value of the project for a particular investor because the investor's risk preference has not been included in the valuation process. Since in reality, people do hold different risk preferences and that will affect the value of the project perceived in different eyes, therefore a new valuation method which is capable of modeling investor's risk preferences is needed to improve on the valuation accuracy. A Decision Analysis Approach to real estate valuation has been proposed to specifically model investor's risk preferences through his utility function. The method improved on the existing method such as Option Pricing Theory where risk preference has been commonly assumed as neutral. At the same time, it is also capable of valuating multiple options embedded in a single project.

With the application of the method to Hong Kong Disney Land, it can be concluded that different risk preferences do affect the value perceived by the investor on the same project. The difference of the perceived value is affected by both the type of risk preferences as well as the initial wealth level of the investor. Therefore, it is shown that the value of risk preference in real estate valuation should not be simply neglected and it is recommended to take this dimension into account whenever a valuation is done for a particular investor.