Theory of valuing building life-cycle investments

Abstract

The physical adaptability of buildings is very important in today's fast-changing business environment. The actors who invest in long-term adaptability are positioned better to the changes during the life cycle of a building. This conceptual paper argues that the current dominating real estate (property) investment analysis theories do not accommodate enough building design-related information (i.e. physical asset characteristics), which results in long-term loss of competitiveness and unsustainable use of built environment resources. It is demonstrated that physical asset characteristics can create valuable real options that should be acknowledged in real estate investment analysis and management. The real estate investment literature has not so far been able to produce a widely accepted financial model for justifying life-cycle investments. A theory is proposed here that can be used to value life-cycle investments in buildings. This new theory combines of real options valuation, investment analysis and building component life-cycle design. These themes are used to formulate a conceptual framework for valuing life-cycle investments. The framework is intuitive and transparent, and it can be easily added to current spreadsheet investment analysis tools.

Redefining the impact assessment of buildings: an uncertainty-based approach to rating codes

“…For example, as mentioned above, ventilation strategies can be impacted by changes in layout over the lifetime of buildings (Montazami et al, 2015). The perceived economic value of office buildings can be strictly related to its flexibility of spaces and systems upgrading (Vimpari and Junnila, 2016).…”

Pricing lease agreements incorporating tenant’s downscaling option

“…For example, if the cash flows of an investment have large volatility, option pricing can often provide best valuation results. Application of real options in real estate has been recognized in many subtopics; however, it seems that they are not widely used in practice (Vimpari and Junnila, 2016).…”

“…Fawcett et al (2012) and Cardin et al (2013) have also proposed the use of real options in designing more flexibility into buildings and enhancing the lifecycles of the physical assets. Recently, Vimpari and Junnila (2016) noted that “it appears that major real estate investment journals have not discussed the role of PACs”, i.e. physical asset characteristics, “in real estate investment analysis.…”

International Real Estate Review

“…develop a model capable of justifying the expenses of the flexible design of a property that could be renovated into an office block at a future specified cost. Recently, Vimpari and Junnila (2016) argue that the physical adaptability of buildings is important but current investment analyses that use DCF do not incorporate enough information on the characteristics of the physical assets, which leads to the long term loss of competitiveness and imprudent use of built environment resources. evaluate the flexibility of converting a naturally ventilated building into a mechanically ventilated building.…”