The Option Value of Vacant Land: Don't Build when Demand for Housing Is Booming

Tinbergen Institute Discussion Paper 2021-022/IV

41 Pages Posted: 30 Mar 2021 Last revised: 16 Sep 2021

See all articles by Rutger‐Jan Lange

Rutger‐Jan Lange

Erasmus University Rotterdam (EUR)

Coen N. Teulings

University of Amsterdam; University of Cambridge

Date Written: March 2, 2021

Abstract

Urban structures and urban growth rates are highly persistent. This has far-reaching implications for the optimal size and timing of new construction. We prove that rational developers postpone construction not because prospects are gloomy, but because they are bright. The slow mean reversion in urban growth rates for the Netherlands and the United States (estimated at 0.07 per annum) implies that a substantial share of cities should optimally postpone construction due to high growth. Observed heterogeneity in floorspace density across cities can be explained not by differences in population levels, but in growth rates.

Keywords: irreversible investment, mean-reverting growth, real-estate construction, real options, urban growth

JEL Classification: D81, G12, R14, R31, R51

Suggested Citation

Lange, Rutger‐Jan and Teulings, Coen N., The Option Value of Vacant Land: Don't Build when Demand for Housing Is Booming (March 2, 2021). Tinbergen Institute Discussion Paper 2021-022/IV, Available at SSRN: https://ssrn.com/abstract=3797199 or http://dx.doi.org/10.2139/ssrn.3797199

Rutger‐Jan Lange (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Coen N. Teulings

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

University of Cambridge ( email )

Trinity Ln
Cambridge, CB2 1TN
United Kingdom

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