Flexibility is an inherent part of real estate project developments, and the value asso­ciated with flexibility is an integral part of the value of undeveloped sites.

The standard rule of thumb is that development should take place when the residual value is positive and left undone if negative. However, if it is possible to postpone the development decision, then this can actually lead to premature development and an underassessment of land value, by ignoring other possibilities that may arise.

Real options theory may offer an alternative approach, in that it treats explicitly the flexibility that is inherent in any project development and offers an attractive complement to standard valuation approaches.

Real life studies on real options in development are in short supply, and a way to assess the content of the theory and its applicability is to compare valuations undertaken using a real options approach with observed transaction prices. However this requires market data which is in short supply.

In this research, funded by the RICS Education Trust, Norman Hutchison and Rainer Schulz of the University of Aberdeen, Scotland, set out the case for adopting a real option approach to valuing development land and provide an illustration of the technique.

The key requirement, though, is to be able to take this research to the next stage, by testing the methodology on real development data, and the researchers call for collaboration with the development industry to fully explore the benefits that this approach would bring.

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