Optimizing supply and portfolio selection decisions in real estate development

Abstract

Real estate sector is one of the major drivers of the economy. Its direct connection to the banking sector, impact on economy and its capital intensiveness make it an important research topic. From an operations research perspective, risk management in the real estate and construction industry is a vital topic for all stakeholders in this industry, but most importantly for the developer and the contractor because the investment decisions made during the initial phases are critical to the continuity of the business. The literature shows that risks inherent in the industry are numerous. The major risks are delay risks (delay of finishing a project at time), quality risks (inadequate or poor execution of projects) and budget risks (the risks of increased costs or of a project running beyond the planned budget). For the developer, the major concern is cash flow throughout the horizon which is partially generated through sales of constructed and pre constructed units and from capital raised through equity and debt. This study addresses the problem of a developer who has an initial total capital and has the option to invest in several projects to maximize his net present value (NPV). The problem is how to choose the projects to invest in from a set of possible projects and to decide on the number of units of each project that should be supplied in the market during each time period. The problem is dealt with by formulating and optimally solving a mathematical program, for given price values that vary each year throughout the time horizon over which the projects are completed, and uncertain market demand for the constructed units.