Real Options for Risk Analysis in Estimating the Capitalization Rate

Abstract

A suitable cap-rate is generally determined through an analogical process in order to estimate the value of any real estate through the capitalization of the incomes. The analogy relates to the risk and duration of similar investments. There are numerous methods to rationalize the valuation of the cap-rate. Appraisals have a certain degree of uncertainty in all these methods. This paper proposes a methodology which removes any uncertainty when evaluating the cap-rate. This is achieved through the combination of the formal logic of the Ellwood’s model and the Real Options Analysis.