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The paper examines the risk-and-return characteristics of a popular development strategy, the presale system (or sale before completion), used in many Asian cities. We model a presale decision in a real-options framework and suggest that the use of presale is primarily for a risk-sharing purpose. That is, developers can reduce bankruptcy and marketing risks by selling (or leasing) their projects before their completion dates. Our model also indicates that, because of the presale system, there is a barrier for new developers to enter into a market, which helps explain the anecdotal observation that most real estate markets in Asian cities are oligopolistic in nature and dominated by large developers. Copyright 2004 by the American Real Estate and Urban Economics Association

This article derives a closed-form solution for an equilibrium real options exercise model with stochastic revenues and costs for monopoly, duopoly, oligopoly and competitive markets. Our model also allows one option holder to have a greater production capacity than others. Under a monopolistic environment we find that the optimal option exercise strategy in real estate markets is dramatically opposite to that in a financial (warrant) market, indicating the importance of paying attention to the institutional details of the underlying market when analyzing option exercise strategies. Our model can be generalized to the pricing of convertible securities and capital investment decisions involving both stochastic revenues and costs under different types of market structures.The option framework developed in the finance field has been used extensively for analyzing investment decisions related to nonfinancial assets. For example, Brennan and Schwartz (1985) and Paddock, Siegel and Smith (1988) use an option approach to evaluate natural resource investments and offshore petroleum leases. McDonald and Siegel (1986), Majd and Pindyck (1987) and Ingersoll and Ross (1992) explicitly analyze the impact of option value on capital investment decisions. McDonald and Siegel (1985) and Berger, Ofek and Swary (1996) address the termination option of an investment project. Childs, Ott and Triantis (1998) use the option valuation framework for analyzing the capital budgeting decisions of interrelated projects. Grenadier (1995) and Grenadier and Weiss (1997) apply the real options concept to value lease contracts and technological innovations. Schwartz and Zozaya-Gorostiza (2000) design a real options approach for evaluating information technology investments. However, it might be fair to say that, among all the areas embracing the application of the real options concept, real estate markets seem to draw the most attention from researchers. This is probably due to the large size of real estate markets and the availability of empirical data, which make it easier for researchers to