Profit Allocation in Urban Renewal– A Real Option Approach

Oliver F. Shyr, Angel Lee, and C. F. Wang

12012.06.15

19th European Real Estate Society Conference Edinburgh, Scotland, 13-16 June 2012

Department of Urban Planning National Cheng Kung University, Taiwan

Department of Urban Planning , NCKU, Taiwan

BackgroundUrban Renewal

– Results in urban gentrification– Deteriorates housing affordability– Accelerates social inequality– Is an unfair game between landowners

and developers– Is not a free lunch

2

Department of Urban Planning , NCKU, Taiwan

BackgroundUrban Gentrification in Taipei

3

Department of Urban Planning , NCKU, Taiwan

BackgroundHousing Affordability in Taipei

4

Department of Urban Planning , NCKU, Taiwan

BackgroundSocial Inequality in Taiwan - Poverty Rate

5

7.2 7.3

6.6

7.7

7.36.9

8.1

5.15.5

6.26.3

6.3 6.5 6.5

4.95.2

7.0

6.3

6.0 6.0 5.96.3 6.4

7.3

5.2

5.8

7.4

6.46.5 6.7 6.7 6.7

7.3

4

5

6

7

8

9

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009年

％ 總計 男性 女性

≈ 0

Department of Urban Planning , NCKU, Taiwan

0.303

0.3450.3400.3380.345

0.350

0.3260.324

0.3200.3170.318

0.308

0.312

0.28

0.29

0.30

0.31

0.32

0.33

0.34

0.35

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 年

％

-2

0

2

4

6

8

10

12吉尼係數 經濟成長率

≈ 0

Social Inequality in Taipei - Gini Index

6

Background

Department of Urban Planning , NCKU, Taiwan

BackgroundWhat are the public interests related

to urban renewal projects?– Prevention of multiple hazards (fire,

earthquake, flooding, etc.)• Provision of open spaces

– Reduction of traffic accidents• Provision of walkways and bike paths

– Reduction of poverty & crime rates– Aesthetic values

7

Department of Urban Planning , NCKU, Taiwan

BackgroundWhy is urban renewal an unfair game?

– Proposals are often submitted by developers– Landowners don’t have complete information

of local housing market– Tenants can’t participate in urban renewal– Shop owners usually can’t keep their shops

after renewal

8

Department of Urban Planning , NCKU, Taiwan

BackgroundWhy urban renewal projects become

free lunches for all stakeholders?– Projects are financed based on floor-area

ratio (FAR) incentivesWho pays these free lunches?

– High FAR justified by Transit-Oriented Development (TOD) may deteriorate the service quality of public facilities and infrastructure

9

Department of Urban Planning , NCKU, Taiwan

MotivationTo estimate both the option values &

intrinsic values of parcels in Taipei by taking into account urban renewal restrictions & demolition costs

To assist landowners to make the right decisions

To modify the rule of urban renewal by setting up new formula for profit allocation games

10

Department of Urban Planning , NCKU, Taiwan

FAR incentives should be a good tool to promote public interests as to prevent market failures cause by– Potential hazards– Social costs associated with poverty,

crimes, and traffic accidentsFAR incentive creates debts on future

renewal practices

11

Research Hypotheses

Department of Urban Planning , NCKU, Taiwan

Literature Review Real Options: Theory & Estimation Approach

– Black & Scholes (1973)– Merton (1973)– Quigg (1993)

Real Options: Applications– Urban Planning

• Cunningham (2007)• Lee and Jou (2010)• Peng, etc. (2011)

– Real Estate Valuations• Fu and Jennen (2008)• Grovenstein, etc. (2011)

Hedonic Housing Price Studies– Rosen (1974)

12

Department of Urban Planning , NCKU, Taiwan

Methodology

13

Financial Feasibility

Bargaining

Urban Renewal Process

Intrinsic Value + Real Option Value

Abort Project

No

Yes

Proposal Modification

Profit Allocation

Proposal Submission

Yes

Delay Project

No

Department of Urban Planning , NCKU, Taiwan

Methodology Real Option Functions

– Black & Scholes, 1973 – Quigg, 1993

14

tdd

ttRESd

dNeEdNSC Rt

12

21

11

)/(])2/()/[ln(

)()(

C = value of the call option S = stock price E = value of exercise or strike priceR = risk-free ratet = time to maturity = standard deviation of the return on the stockN = CDF of normal distributiond1 & d2 = evaluated values of normal distribution

Department of Urban Planning , NCKU, Taiwan

Methodology Cooperative Games

– Profit imputations among landlords and developers Bargaining Games

– Sequential bargaining under asymmetric information among landlords and developers

Project Assessment on Urban Renewal Policy– Values of public interests regarding urban renewal

practices

15

Department of Urban Planning , NCKU, Taiwan

MethodologyHedonic Functions

– Log-linear and semi-log functions are pre-specified functions while Box-Cox functions maximize the log-likelihood of the functions within a pre-specified family of functions

– It is often advisable to compare the results of different functional forms in order to identify non-robust estimates

The functional forms of our models– Double-log and Box-Cox transformation

16

Department of Urban Planning , NCKU, Taiwan

MethodologyDouble-log

Box-Cox

17

P: housing price,Z: explanatory variables,D: dummy variables,β: coefficients,α: constant term,ε: random error.

Department of Urban Planning , NCKU, Taiwan

The Data The Data

– Transaction property prices before and after urban renewal projects in Taipei from 2003 to 2011

– Makes use of sales prices rather than rents• Accounts for most transactions• Sales prices reflects future expectations

– Other data• Construction (hard) and soft costs• Housing Price Index

– Sources• Department of Land Administration, Ministry of Interior• Urban renewal developers• Real estate agents

18

Department of Urban Planning , NCKU, Taiwan

Estimation Approaches

19

Expectations & Variations of Asset Values– Hedonic housing price functions– Zoning & renewal constraints– FAR incentives

Risks & Public Interests Related to Urban Renewal Projects– Costs of Negotiation (repeated games)– Scale of Development (cooperative games)– Reject & Resubmit (majority games)– Demand & Supply Analysis on Housing Market– Assessment of Multiple Hazards– Evaluation of Social Costs & Aesthetic Values

Department of Urban Planning , NCKU, Taiwan

Our Missions– To help developers & landlords make

decisions on urban renewal proposals– To refine urban renewal regulations

Our Challenges– The quantification of risks and public

interests associated with housing policy and urban renewal practices

20

Final Remarks

Department of Urban Planning , NCKU, Taiwan 21

Thank you for your attention