This MIT OpenCourseWare site is based on the materials from Professor de Neufville's and Professor Geltner's Web site.
Course Meeting Times
Lectures: 2 sessions / week for 7 weeks, 1.5 hours / session
Recitations: 1 session / week, 1 hour / session
The course builds upon the reality that "the forecast is always wrong", that is, that the future cannot be known accurately. This fact is especially true for real estate and infrastructure projects, whose up-front costs are huge and whose benefits extend far into the future. The fundamental question, for both designers and developers, is: "How do we most effectively manage our inability to forecast the future accurately?"
We argue that it is best to deal with project uncertainty proactively, by deliberately building flexibility into the project, which enables the owners or operators to take advantage of new opportunities while protecting the project from bad outcomes. From the perspective of finance, this consists of creating "real options" that provide "calls" on favorable developments and "puts" on failures. From the perspective of design, the flexibility consists of features that, like options, enable the project owners to reconfigure the project in useful ways – to expand it, to change its function, to alter its operating characteristics.
The course is intended for all those with a serious interest in the design, development and management of real estate or infrastructure projects. In addition to real estate professionals, the instructors expect to serve architects and urban planners, business managers, civil and other engineers concerned with construction.
The course will cover all the mathematics and technical aspects required. It assumes that participants are familiar with and comfortable with:
- quantitative analysis, such as used in spreadsheets;
- discounted cash flow concepts; and
- basic elements of probability and statistics
Background in real estate is a plus, but is not essential to benefiting from the course.
The course intends to develop the understanding and skills useful in developing flexible designs. Specifically, it presents methods for valuing this flexibility, so that developers and others can determine what level and kinds of flexibility are desirable in specific circumstances. These include:
- The understanding of uncertainty in practice;
- Jensen's inequality; valuation or design around average values leads to erroneous results;
- The intuition of why flexibility is valuable in the context of uncertainty, and why the greater the uncertainty, the greater the value of flexibility;
- "Calls" to take advantage of opportunities, and "puts" to exit unfavorable circumstances;
- The assumptions underlying the financial valuation of options;
- Insights and lessons from the economic analysis of options: effect of payout yield and volatility (uncertainty) on the value and exercise decision for real options;
- The reality of real estate markets, and the consequent desirability of alternative methods of valuation; and
- GIGO and other problems with using the economic model.
- The practical characterization of uncertainties;
- Certainty Equivalence Valuation;
- DSM – Design Structure Matrix as a means to understand system and thus to identify opportunities for flexibility; and
- Valuation of options via Monte Carlo simulation.
The class can also provide the basis for a thesis or similar project. The research and analysis done for the class project may provide students, individually or in teams, with the basis for a thesis topic. The instructors are certainly open to discussions along these lines and will assist students trying to develop thesis proposals.
Approach to Learning
We base the course on:
- "Learning by doing". Specifically, we expect students to engage with practical projects, and to explore how the concepts and techniques apply to individual situations.
- Multidisciplinary, team learning – students will work in groups of individuals with different backgrounds and skills.
Students will work on actual projects of their choosing, subject to approval by the instructors.
They will develop an in-depth understanding of their case by applying the course concepts and techniques to it. This engagement will give them a basis for appreciating the relative merits and applicability of the concepts and techniques presented in class.
To make the best use of the limited time available to us, the instructors have organized the class in advance of the first meeting:
- We have divided the class into interdisciplinary teams of students.
- Each group will select a real estate or infrastructure development projects that they wish to examine in detail over the balance of the semester. They will then investigate and analyze it, write up the case for archival use, and will present it to the class for discussion.
The instructors will grade based on both individual participation and the group write-up and presentation.