Case study analysis is used to examine the application of real options in valuing a commercial real estate mall project. Comparison of valuations using traditional discounted cash flow model with Black-Scholes, Binomial and Samuelson-McKean option models brings out the relevance of real option analysis in project decisions. Real options analysis is pertinent when market prices increase the strategic value of real estate development projects by incorporating fluctuations in volatility and providing project flexibility in its operations. The developers with varied project alternatives are able to execute the most desirable alternative using real options analysis. In real estate, land held by the developer tends to have a perpetuity value and it is at the discretion of the developer to execute possible options based on prevalent market conditions. Samuelson-McKean model that values the project as a perpetual American call option has computed the premium value of the commercial project as Rs. 154.08 mn, thus giving a strategic return of 85% to the developers.

Construction is considered to be an essential component of a country's development with its linkages to various other industries like cement, steel, bricks, etc. It is considered to be the second largest economic activity next to agriculture and has generated employment to about 33 million people in India in 2008. Growth of construction has followed the trend of economic growth rate of the country and construction as a percentage of GDP has increased from 8.0% in fiscal year 2006 to 8.5% in fiscal year 2008. Construction industry in India is highly fragmented and the number of unorganized players in the industry that work on subcontracting basis is large. Construction projects can be materialized through the number of smaller contracts which mainly depend upon size of the project and diversified nature of activities to be carried out in the project and as a result, subcontracting is a common phenomenon in the construction industry (Indian Brand Equity Foundation (IBEF), 2009a).

It is classified into three sub segments namely infrastructure, industry and real estate. Infrastructure segment involves construction projects in different sectors like road, rail, port, irrigation and power. Industrial construction segment caters to expansion projects from various manufacturing sectors. Real estate construction segment involves development of vacant land and can be subdivided into residential and commercial projects such as malls and multiplexes.

Real estate has shown upheavals in its growth in the Indian economy but has appealed as an investment opportunity for domestic as well as foreign investors. Liberalized Foreign Direct Investments (FDI) of 100% in the construction business cleared the path towards foreign investment for development of commercial and residential real estate sectors and has encouraged several large financial and private equity players to launch exclusive funds targeting the Indian real estate sector (Ministry of Commerce and Industry, Government of India, 2005). Almost 80% of real estate developed in India is residential space, the rest comprising of commercial construction for offices, shopping malls, hotels and hospitals.

Infrastructure Journal, Real Options Analysis, Commercial Projects, Construction Industries, Manufacturing Sectors, Infrastructure Segments, Indian Real Estate Sector, Gross Domestic Product, GDP, Black-Scholes Model, Risk Free Rates, Development Models.