Real options theory and the pricing of residential land-use rights in Shanghai

Abstract

China's shift away from the welfare housing scheme has generated tremendous demand for private home ownership since the early 1990's. The resulting growth in the housing market fueled the country's transformation towards a market economy. However, the transition has not been without problems. One of the main issues the government has been grappling with is the dispute between developers and residents over low rates of resettlement compensation. This thesis offers a compound option model to analyze the existing land disposal system in China. Assuming Shanghai's land market is efficient and the market values of land-use rights converge to the option values of land, the model identifies the maximum values of tenants' resettlement and infrastructure components of the total land values developers can rationally pay to avoid negative-NPV investment decisions. The model suggests a compensation cost function of about 51 percent of total land value (conveyance fee plus resettlement and infrastructure cost), or 26 percent of the underlying asset value upon sales of the residential development. It is the recommendation of this thesis that the Chinese government reexamines the existing land conveyance system to formally include tenants' resettlement compensation and infrastructural fees as part of the land-use rights bidding package. This thesis further recommends legal recognitions of tenants' 'invisible leasehold interests' to strengthen their rights to the land on which they reside.