Is there Super-normal Profit in Real Estate Development?

40 Pages Posted: 5 Sep 2019 Last revised: 4 Aug 2021

See all articles by David Geltner

David Geltner

Massachusetts Institute of Technology (MIT); MIT Center for Real Estate

Anil Kumar

Aarhus University, Department of Economics & Business Economics; Danish Finance Institute

Alex Van de Minne

University of Connecticut - School of Business

Date Written: August 3, 2021

Abstract

This paper explores the question of whether real estate development (RED) projects systematically present positive net present value (NPV) and therefore, provide super-normal profit. Such projects are the products of a business operation that governs the exercise of the real call option on development that is represented by developable land. We present a framework for considering super-normal profit in the RED industry, and then in light of that framework we examine RED projects produced by publicly-traded equity real estate investment trusts (REITs). We find strong evidence of positive correlation between REITs' Tobin-Q ratios, indicative of positive NPV, and the ratio of development assets to total assets in the firm, controlling for other factors. The nature of the firm's Tobin's-Q metric is such that the implied added firm value is net of land cost and net of overhead and search costs associated with the RED business operation. While our findings do not prove a direction of causality between REITs' RED activity and positive NPV, the robust positive correlation controlling for other factors raises interesting implications which are discussed in the paper.

Keywords: Real Estate Development, REITs, Super-normal Profit, Positive NPV, Real Option

JEL Classification: G10, G32, R30

Suggested Citation

Geltner, David and Kumar, Anil and Van de Minne, Alex, Is there Super-normal Profit in Real Estate Development? (August 3, 2021). University of Connecticut School of Business Research Paper No. 19-14, MIT Center for Real Estate Research Paper No. 3, Available at SSRN: https://ssrn.com/abstract=3444309 or http://dx.doi.org/10.2139/ssrn.3444309

David Geltner

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139
United States

MIT Center for Real Estate ( email )

77 Massachusetts Avenue
Cambridge, MA 02139
United States

Anil Kumar (Contact Author)

Aarhus University, Department of Economics & Business Economics ( email )

Fuglesangs Alle 4
Aarhus V, 8210
Denmark

Danish Finance Institute ( email )

Alex Van de Minne

University of Connecticut - School of Business ( email )

368 Fairfield Road
Storrs, CT 06269-2041
United States

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