Content area
Full Text
Real Estate Valuation II
Introduction
[17] Opera (2010) outlined the importance of feasibility studies in investment and development analysis. In particular, she highlighted the need to question the assumptions that underpinned the analysis, as these are the key indicators of uncertainty pertaining to a given project. The thesis of this paper is that uncertainty is an integral part of the development process and it needs to be reflected in the development appraisal. The appraisal model will determine a residual (normally land value or profit) based upon a belief of a particular outcome of the development. But the future outcome is unknown and the actual outcome could be one of a multitude of possible outcomes. It is therefore important to know which variables have the largest effect on the change of outcomes and, thus, where the risk is the highest. In doing this it is then possible to try to decrease the risks that are seen to be too high.
Historically, developers have relied upon static single point development appraisal models. A developer would determine, say, the land value today based upon predetermined and fixed inputs into a residual valuation model. A simple scenario analysis may then be used to "test" the single point estimates for each variable to produce an "at best" and "at worst" result of the same calculation.
These models have been enhanced and modified to allow the developer to look at the uncertainty that is in the situation they are modelling and try to quantify it, this means moving away from the idea of a best and worst estimate, to a range of outcomes and a distribution ([28] Byrne, 1995). Using "Monte Carlo simulation", it is argued that the developer can easily move away from fixed-point analysis and include the uncertainty they face in their models. This has become and accepted form of analysis with computer programmes such as Crystal Ball or @Risk utilising the "Monte Carlo simulation" to allow the developer to model the uncertainties pertaining to each variable. For a full discussion on this approach see [7] French and Gabrielli (2006).
In terms of decision theory, the static point model would be considered to be normative in approach as it suggests, within the context of a rational model, what...