Fair Value and Risk Profile for Presale Contracts of Condominiums

Jin Choi, Henning Rasmussen and Matt Davison

Online First™, 12 April 2010

Abstract

Developers usually presell new condominiums, requiring purchasers to make down payments on a contract that allows them to purchase, at a fixed price, the finished condominiums on a later date. This presale contract is akin to a financial call option sold by the builder to the purchaser of the condo. In this paper, we value the presale contract from both the purchaser’s and the developer’s points of view. We examine the influence of various opt-out clauses, different interest rates and other factors on the value of presale contracts. We discuss the extent of risk sharing between the purchasers and the developers according to varying levels of down payments. We conclude that developers enjoy a reduction in risk without a corresponding reduction in expected profits by holding a presale.

Keywords  Presale – Down payment – Profit – Risk

H. Rasmussen (deceased).
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