A Real Options Analysis of Urban Regeneration; The option of when to invest and its effect on providing utilities infrastructure

Regeneration projects are essentially large scale refurbishment interventions aimed at improving the land-value/rents of a private development and associated public space. The typical method of valuing these property developments is the net present value (NPV) approach, which can undervalue the flexibility of investment decisions. This is particularly germane with regard to the role of utilities infrastructure in regeneration projects, where future uncertainty surrounding expected income plays a role in their business case. Real option theory, well known but seldom used by practitioners, is used here to assess the value of the option to defer investment in a district heating network due to future uncertainties surrounding the price at which gas will be sold at by competitors. This paper is a first try at demonstrating the functionality of real options as imagined to be used by property developers when considering heating infrastructure provision. In the example provided 200 two-bedroom flats will be built during a regeneration, and with the assumptions of real option theory intact, it is shown that the option of deferring investment in a district heating project is worth more than investing at current heat sale prices. There is an increase in the overall project‟s marginal profit on gross development costs in the upside case (in the event of the option being called). Taken as a whole, this paper fills a gap in the use of real options in regeneration projects for considering applications of sustainable heating networks. There are many issues highlighted by this paper, such as the need for empirical validation of the results, as well as the continued development of a mathematical modelling framework.