Profit Allocation in Urban Renewal – A Real Option Approach

1. 19th European Real Estate Society Conference Edinburgh, Scotland, 13-16 June 2012 Profit Allocation in Urban Renewal– A Real Option Approach Department of Urban Planning National Cheng Kung University, Taiwan Oliver F. Shyr, Angel Lee, and C. F. Wang 2012.06.15

2. Background • Urban Renewal • Results in urban gentrification • Deteriorates housing affordability • Accelerates social inequality • Is an unfair game between landowners and developers • Is not a free lunch

3. Background • Urban Gentrification in Taipei

4. Background • Housing Affordability in Taipei

5. Background • Social Inequality in Taiwan - Poverty Rate

6. Background • Social Inequality in Taipei - Gini Index

7. Background • What are the public interests related to urban renewal projects? • Prevention of multiple hazards (fire, earthquake, flooding, etc.) • Provision of open spaces • Reduction of traffic accidents • Provision of walkways and bike paths • Reduction of poverty & crime rates • Aesthetic values

8. Background • Why is urban renewal an unfair game? • Proposals are often submitted by developers • Landowners don’t have complete information of local housing market • Tenants can’t participate in urban renewal • Shop owners usually can’t keep their shops after renewal

9. Background • Why urban renewal projects become free lunches for all stakeholders? • Projects are financed based on floor-area ratio (FAR) incentives • Who pays these free lunches? • High FAR justified by Transit-Oriented Development (TOD) may deteriorate the service quality of public facilities and infrastructure

10. Motivation • To estimate both the option values & intrinsic values of parcels in Taipei by taking into account urban renewal restrictions & demolition costs • To assist landowners to make the right decisions • To modify the rule of urban renewal by setting up new formula for profit allocation games

11. Research Hypotheses • FAR incentives should be a good tool to promote public interests as to prevent market failures cause by • Potential hazards • Social costs associated with poverty, crimes, and traffic accidents • FAR incentive creates debts on future renewal practices

12. Literature Review • Real Options: Theory & Estimation Approach • Black & Scholes (1973) • Merton (1973) • Quigg (1993) • Real Options: Applications • Urban Planning • Cunningham (2007) • Lee and Jou (2010) • Peng, etc. (2011) • Real Estate Valuations • Fu and Jennen (2008) • Grovenstein, etc. (2011) • Hedonic Housing Price Studies • Rosen (1974)

13. Methodology Urban Renewal Process Intrinsic Value + Real Option Value Profit Allocation Bargaining Yes Yes Proposal Submission Financial Feasibility Proposal Modification No No Abort Project Delay Project

14. Methodology • Real Option Functions • Black & Scholes, 1973 • Quigg, 1993 • C = value of the call option • S = stock price • E = value of exercise or strike price • R = risk-free rate • t= time to maturity • s= standard deviation of the return on the stock • N = CDF of normal distribution • d1 & d2 = evaluated values of normal distribution

15. Methodology • Cooperative Games • Profit imputations among landlords and developers • Bargaining Games • Sequential bargaining under asymmetric information among landlords and developers • Project Assessment on Urban Renewal Policy • Values of public interests regarding urban renewal practices

16. Methodology • Hedonic Functions • Log-linear and semi-log functions are pre-specified functions while Box-Cox functions maximize the log-likelihood of the functions within a pre-specified family of functions • It is often advisable to compare the results of different functional forms in order to identify non-robust estimates • The functional forms of our models • Double-log and Box-Cox transformation

17. Methodology • Double-log • Box-Cox P: housing price, Z: explanatory variables, D: dummy variables, β: coefficients, α: constant term, ε: random error.

18. The Data • The Data • Transaction property prices before and after urban renewal projects in Taipei from 2003 to 2011 • Makes use of sales prices rather than rents • Accounts for most transactions • Sales prices reflects future expectations • Other data • Construction (hard) and soft costs • Housing Price Index • Sources • Department of Land Administration, Ministry of Interior • Urban renewal developers • Real estate agents

19. Estimation Approaches • Expectations & Variations of Asset Values • Hedonic housing price functions • Zoning & renewal constraints • FAR incentives • Risks & Public Interests Related to Urban Renewal Projects • Costs of Negotiation (repeated games) • Scale of Development (cooperative games) • Reject & Resubmit (majority games) • Demand & Supply Analysis on Housing Market • Assessment of Multiple Hazards • Evaluation of Social Costs & Aesthetic Values

20. Final Remarks • Our Missions • To help developers & landlords make decisions on urban renewal proposals • To refine urban renewal regulations • Our Challenges • The quantification of risks and public interests associated with housing policy and urban renewal practices

21. Thank you for your attention