Real Estate Investments in Rio de Janeiro: Risk Management and Real Options

Real estate investments are characterized by high capital outflows, low liquidity and short payback together with economic uncertainties related to demand, price/m and sales speed that increase the risk perceived by investors. It is often the case when the property developer and the land owner sign an agreement where the former obtain the exclusive property rights to construct on the land for a certain period of time against an initial payment. This contract introduces in the real estate investment project the option to wait or abandon development depending on the information gathered from the market during the expiration period. We analyze a real estate investment in the city of Rio de Janeiro where the previous Real Options are identified and valued, allowing a better management of the decision process and an effective risk management for the company. We estimate the ceiling price for the exclusive property rights for several assumptions on the exchange contract of land for real estate. Exclusive property rights decrease 30 % with an increase of 10 % in the land cost. The adoption of the Real Option Strategy shows a reduction of 50 % in the Value-atRisk with respect to the traditional valuation (that does not considers the real options embedded).