Irreversible Investment, Real Options, and Competition: Evidence From Real-Estate Development

We examine 1,214 condominium developments in Vancouver, Canada between 1979-1998 to identify the extent to which uncertainty delays investment. We find that increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments. Empirically, a one-standard deviation increase in the return volatility reduces the probability of investment by 13 percent, equivalent to a 9 percent decline in real prices. Increases in the number of potential competitors located near a project negates the negative relationship between idiosyncratic risk and development. These results support the argument that competition erodes option values and provide clear evidence for the real options model of investment under uncertainty over alternatives such as simple risk aversion.