Option Value in Presale of Real Estate Property

A common practice in real estate markets is the sale of housing development units before completion, and in some cases even before beginning of the actual construction, known as presale. Developers that choose to presell units are subject to default on the part of the buyers if market conditions become unfavorable. In recent years, court rulings in Brazil have established that developers must refund 70% to 90% of payments made if the buyer chooses to opt out of the sales contract. This configures an abandon option for the buyer and creates a contingent liability for the real estate developer. We determine the value of the option to abandon in the Brazilian real estate market and model this flexibility to opt out of the sales contract as an American type option. Our results indicate that the option value is substantial and can have important impacts on the profitability and exposure to risk of the real estate developer with potential consequences to the Brazilian real estate market. .