DP16023 The option value of vacant land: Don't build when demand for housing is booming

Author(s): Rutger-Jan Lange, Coen N Teulings
Publication Date: April 2021
Keyword(s): Irreversible investment, mean-reverting growth, real options, real-estate construction, urban growth
JEL(s): D81, G12, R14, R31, R51
Programme Areas: Financial Economics, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16023

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 â?¼0.07 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.