House Price Uncertainty, Timing of Development, and Vacant Land Prices:

Evidence for Real Options in Seattle

Christopher R. Cunningham
Department of Economics
Syracuse University
110 Eggers Hall
Syracuse, NY 13244-1020
crcunnin@maxwell.syr.edu

May, 2004



Abstract

If the future is uncertain and an investment is durable and irreversible, then the right to make a
different decision in the future can have economic value, often referred to as a real option.
Failure to account for the lost real option may cause the Net Present Value (NPV) calculation to
underestimate the true cost of an investment and to over predict investment activity.
Nevertheless, empirical evidence on the extent to which real options affect investment decisions
remains limited. In the case of land development, there are only two previous papers that offer
empirical evidence on this point. This paper adds to that small literature by testing two
fundamental predictions of how options affect urban land markets: real options delay investment,
while also raising land prices. Utilizing a rich dataset of property transactions in the Seattle
metro area, I find clear evidence in support of both predictions. If price uncertainty increases by
one standard deviation, the likelihood of development declines by 11 percent and vacant land
price increases by 1.6 percent. These finding suggest that developers account for real options
when deciding whether and when to invest.




I am grateful to Stuart Rosenthal, Gary Engelhardt, Johnny Yinger, Solveig Argeseanu and Jan
Brueckner for their helpful comments. Financial support from the Department of Housing and
Urban Development, grant number H-21367SG, is gratefully acknowledged. All errors are my
own.




1
I. INTRODUCTION
Classical economic theory states that if the net present value of an investment is non-
negative, a risk-neutral firm will choose to invest. Yet, theoretical work by Titman (1985),
McDonald and Siegel (1985, 1986), among others, suggests that if the future is uncertain and an
investment is durable and illiquid, then the ability to pursue a different investment (or to not
invest at all) in the future has economic value, often referred to as a real option. Like a
financial option that allows one to purchase a security at a fixed price in the future, a real option
allows one to make an investment at a future point in time, contingent on new information.
Furthermore, firms contemplating such an investment will require an expected net return well
above zero to justify surrendering the real option and investing in the current period. As a result,
real options should raise asset values and delay investment.
Pioneering theoretical work on investment and uncertainty includes Bertola (1988) and
Pindyck (1988).
1
Their work and others suggests that, in the presence of real options, the
expected return necessary to justify an immediate investment can be two to three times the cost
of the investment. However, only a limited number of papers have tested empirically for real
options in investment decisions. This work includes aggregate capital investment in
manufacturing (Caballero and Pindyck, 1996), natural resource extraction (Paddock, Siegel and
Smith, 1988; Moel and Tufano, 2002), and mortgage prepayment and default (Deng, 1997).
A convenient market in which to look for real options is real estate. Built structures are
both highly durable and inseparable from land without demolition and, thus, satisfy the
irreversibility condition for the presence of real options. However, only a limited number of
papers have tested empirically for real-option effects on investment, and only three have

1
In addition to models of capital investment and abandonment, real options have been incorporated into models of
investment in market entry (Shackleton, Tsekrekos and Wojakowski, 2004); entrepreneurial entry (O'Brien, Folta
and Johnson, 2003); and research and development (Weeds, 2002)

2
explored real options in real estate. Using a micro dataset, Quigg (1993) estimated a real-option
premium of 6 percent on vacant land over the deterministic (non-stochastic) price. Holland, Ott
and Riddiough (2000) used aggregate data on commercial-buildings to examine the effect of
price uncertainty on net changes in property square footage. They found that a one-standard-
deviation change in conditional volatility reduced total additional building square footage by 24
percent. Bulan, Mayer, and Somerville (2002) examined whether price volatility delayed
condominium development, using building-permit data. They determined that a one-standard-
deviation increase in conditional price volatility reduced the likelihood of development by 13
percent.
This paper adds to this small literature. In particular, it uses a new, detailed micro-level
dataset for a single metropolitan area to test the two central predictions of real options with
respect to land development: house-price uncertainty should delay home construction and raise
the value of vacant land. This is the first time that both predictions have been tested in a unified
and consistent manner.
The study area is King County, Washington (Greater Seattle). I assemble three datasets
from the County Assessors parcel and building description files, the Assessors real property
transaction files, and County GIS files of parcel location, zoning and jurisdictional boundaries.
When combined, these records yield a dataset of over 500,000 home sales, 163,000 individual
land parcels at risk of being developed, and 81,000 arms-length vacant land transactions from the
first quarter of 1984 through the second quarter of 2002.
To measure development timing, I estimate proportional hazard models in which a
building site dies when a structure is constructed. The hazard model includes time-invariant
measures of building-site quality, time-varying measures of new-housing demand, and time- and

3
location-varying measures of expected future prices and price uncertainty. To test for the
presence of real options in asset prices, vacant land sales price is regressed on similar measures
of site quality and future house price uncertainty.
Three primary findings emerge. Price uncertainty reduces land development. A one-
standard-deviation increase in price uncertainty reduces the hazard of development by 11.3
percent. This finding is similar to that found in Bulan, Mayer and Somerville (2002). At the
same time, price uncertainty raises the value of vacant land. Evaluated at the median lot price,
$91,784, a one-standard-deviation increase in price uncertainty raises real vacant land prices by
$1,446 in 2004 dollars, an increase of 1.6 percent. The evidence for real options in asset prices is
strongest in the vicinity of the urban/rural frontier (12 to 16 miles from downtown Seattle),
where a one-standard-deviation increase in price uncertainty raises vacant land prices by 9.1
percent. This finding is consistent with the theoretical work by Capozza and Helsley (1990) on
price uncertainty and the conversion of rural land to housing.
To clarify these and related results, the paper is organized as follows. Section II
describes key predictions of real option theory with respect to land markets. Section III
describes the three datasets used to estimate quality-adjusted housing prices and to examine the
timing of development and vacant land prices. Section IV describes the econometric
specifications and resulting parameter estimates for the effect of price uncertainty on
development and land price. Section V tests the robustness of these findings by conducting the
same tests on sub-samples of parcels at varying distances from downtown Seattle and using
alternative measures of price uncertainty. There is a brief conclusion.



4
II. REAL OPTIONS AND LAND DEVELOPMENT
There are two general predictions of real option theory with respect to real estate markets.
First, uncertainty about future housing prices, all else equal, should reduce the likelihood of
current-period investment, even for risk-neutral investors. This prediction is derived from the
convexity of the profit function with respect to housing prices and Jensens Inequality. These
principles were laid out in Titman (1985). The profit function for housing is convex, because, as
housing prices rise, builders can substitute capital for land by building taller or denser structures.
The less certain builders are about future prices (or the more convex the profit function), the
greater the gap between future-period profits from building at the actual price, relative to the
profit from building at the expected price. Waiting may reveal future price information, reducing
the foregone profits from building too tall or too short of a building. In the Titman (1985)
framework, waiting reduces the chance of building a suboptimal structure. In the Capozza and
Helsley (1990) model, it reduces the chance of converting agricultural land to housing
prematurely. In either case, greater future price uncertainty makes current-period investment less
desirable.
A closely related prediction is that uncertainty raises land prices above the discounted
stream of rents in its current use. This premium is conferred unto land, because, much like a
financial option that allows its owner to purchase a particular security at a predetermined price,
owners of land hold a call option that gives them the right to purchase an optimally-sized
building in the future at an exercise price equal to the cost of construction. In the Titman (1985)
model, this is the right to own a taller(shorter) building, depending on whether apartment prices
rise (fall). In the Capozza and Helsley (1990) model, this is the right to convert the land to
housing, only if prices should rise. In either case, price uncertainty raises the value of land,

5
ceteris paribus, because uncertainty increases the real option of developing land to a higher
intensity at some time in the future.
2

For example, consider a two-period problem in which a land owner can convert rural land
to urban use in period 1 or period 2. Assume that home prices in period 2 can rise or fall with
equal probability, such that the owner of housing earns zero economic profit in the current
period, and will either earn $50,000 or lose $50,000 in the second period. Finally, assume that
agricultural land earns zero economic rents in both periods. The Net Present Value (NPV) of
land converted to urban use equals the NPV of agricultural land, which equals zero. In classical
economic theory, the landowner should be indifferent between converting the land and leaving it
in agriculture. Note, however, that if the landowner keeps the land as a farm in the first period,
she then can choose to convert it in the second period only if market conditions prove favorable,
i.e., if the price of housing rises. Thus, the expected value of rural land in period 1 is $25,000
and the land owner will require a premium of this much to be willing to sell the land. The
corollary is that an expected return on housing development would need to be at least $25,000 to
warrant making an investment today rather than waiting.
3

It is important to note that if real options exist, they arise not from price volatility per se,
but from greater uncertainty about future price than current-period volatility portends. If there is
a chance future prices could be higher, then the value of vacant land, which can accommodate
many different types of structure in the future, rises relative to land that already has a structure

2
Of course, already developed land can always become vacant land through demolition, and, thus, also retains an
option premium, but because buildings are very expensive and largely sunk pieces of capital, prices must deviate
substantially from expectations to warrant tearing down a structure before it has deteriorated.
3
In the Capozza and Helsley (1990) paper, with fixed building technology, if one assumes an open-city model, real
option price and building effects are limited to rural land. If one assumes a closed city model, the delayed
conversion of land to housing at the city edge reduces the citywide housing supply and raises housing prices across
the urban area.


6
built on it. Whether developers actually incorporate these considerations into their decisions
about development and land purchase price is examined in the balance of the paper.

III. DATA AND CONSTRUCTION OF QUALITY-ADJUSTED HOUSE PRICES
The data for this analysis come from King County, Washington, a large county that is
highly urbanized in the west and uninhabited in the east. A map of the county showing the
density of existing single-family homes in 1980 is provided in Figure 1. The data come
principally from detailed records of parcel- and building-description files maintained by the
County Assessors office for the year 2002. The parcel-description file includes 70 indicator
variables for property characteristics that might affect a sites value. Similarly, the building-
description file contains over 30 measures of building size, quality of construction, existing
condition and additional features. These records are maintained for all parcels and buildings in
the county, independent of whether or not the land or the house was ever sold. The County also
maintains records of all real property transactions from 1982 through the present. These records
include transaction price, if any, type of property sold and over fifty indicators for unusual
features of the transaction. Finally, GIS files of parcel location and shape are used to measure
distance to downtown Seattle and parcel size. GIS software also is used to assign parcels to
school districts and to determine zoning status, as specified in King Countys Comprehensive
Plan of 1985.
Three new datasets are made by combining information from the raw parcel-description
file, the building-description files, the property-transaction records, and GIS shape files. The
first dataset, comprised of home characteristics and sales price, is used to construct a measure of
quality-adjusted house prices, and, in section IV, to measure future house-price uncertainty. The

7
second dataset, comprised of parcels at risk of development, is used to test whether house-price
uncertainty (estimated with the first dataset) affects the timing of land development. The third
dataset, comprised of vacant land sales, measures the contribution of price uncertainty to higher
land values. The construction of quality-adjusted house prices using the first dataset is described
in subsection A. The construction of the timing-of-development and vacant-land-prices datasets
is provided in subsections B and C, respectively. Subsection D describes other covariates
included in the timing-of-development and vacant-land-prices datasets.

A. Quality-Adjusted House Prices
To measure quality-adjusted housing prices, single-family home sales are drawn from the
real property transaction file. A total of 474,594 home sales took place without any unusual
conditions of sale.
4
These transactions were then matched to parcel, house and GIS records
using the lots identification number. Some sales did not have a corresponding lot, building, or
GIS record in 2002, yielding a total of 463,152 home sales.
5

Working with these sales, I divide the county into fifteen separate regions, based on
school district. To ensure a sufficient number of transactions to estimate time-varying house
prices, I consolidate five sparsely populated eastern districts into two larger regions and in South
King County, I attach two smaller districts to larger neighboring school districts. Finally, I
exclude Vashon Island, which had insufficient trades to assemble a consistent time series and
could not be merged readily with a neighboring district. A map of the resulting 15 districts is
provided in Figure 2.

4
Over four hundred thousand transactions do not have a price. Typically, these transactions include transfer of
property rights associated with a divorce, inheritance, foreclosure, etc.
5
Sales that occurred before the recorded year of construction are excluded because they presumably were
dilapidated structures that were subsequently torn down and replaced with the unit observed in 2002. Similarly,
sales that occurred before the year of renovation are excluded.

8
Dividing home sales by school district, separate regressions are estimated for each
quarter of sale from the first quarter of 1982 to the second quarter of 2002. Thus, a total of 1,230
separate house price regressions (82 quarters 15 school districts) are run with the following
specification:
ijt jt i jt it jt ijt
L H p + + + = ) ln( , (1)
where
it
H is a vector of housing characteristics and
i
L is a vector of lot characteristics. The
subscript i denotes house specific variables, j denotes school district, and t the quarter of sale.
By running separate regressions, the intercept
jt
and the hedonic contributions of house and lot
characteristics,
jt
and
jt
, are allowed to vary with time and by region, respectively. Table A-
1 provides the summary statistics for these variables.
The resulting time- and district-varying parameter estimates are used to predict the value
of a standard-quality home in that quarter and school district. The specification for the quality-
adjusted price series,
q
j
P is,
jt jt jt
q
jt
L H P

+ + = , (2)
where H is a vector of home characteristics and L is a vector of lot characteristics for the
average house in King County over the entire sample period. Figure 3 provides a graph of the
quality-adjusted price series for each of the school districts. While house prices generally moved
together across the county, in particular, rising in the late 1980s, there was variation in the
movement of prices over time and across school districts. Houses in Seattle (region 1)
appreciated substantially in the late 1990s, a pattern observed in other older cities. House prices
in southern King County (regions 10-15) were relatively flat during the 1990s, perhaps because

9
of layoffs at Boeing, which has a large plant in Renton. The area around and including Bellevue
(regions 3-7) had some of the most expensive housing throughout the sample period.

B. Dataset for Measuring the Timing of Land Development
To understand the effect of price uncertainty on the timing of development, the duration
of time (in years) is calculated from when a parcel enters the sample in 1984 until a structure is
built upon it. To determine when a parcel ceases to be vacant, I use the year built variable
from the King County Assessors Residential Building file (427,000 observations) and the
Commercial Building file (39,300 observations) from 2002. There were a total of 531,000 land
parcels in the county in 2002. A total of 95,805 structures were built in King County between
1985 and 2001. At the end of 2001, 67,315 land parcels remained undeveloped. Thus, a total of
163,120 parcels were eligible for development in the sample period.
A parcels duration as undeveloped land ends when the construction of a home or
building starts. Construction is assumed to start in the year preceding the recorded year of
completion in the building-description files. The lag between the initiation of construction and
the year of completion was confirmed using a subset of county building-permit records, which
have the date of permit application and date of building completion.
6
Note that this method of
inferring exposure to development pools vacant land with land that once contained dilapidated
structures.
7
Parcels with homes completed before 1985 are excluded from the analysis of the
timing of development.


6
Building permits from 1992-2003 were obtained for parcels in unincorporated King County from the Division of
Development and Environmental Services.
7
Not knowing what pre-dates a structure may be problematic, because the option to wait to redevelop an existing
built-upon site may be higher relative to that of a vacant plot, whose owner must forego all housing services until
time of construction. Demolition and permitting costs also may be different.

10
C. Dataset for Measuring Vacant Land Prices
To test whether price uncertainty raises land prices, a third dataset of arms-length vacant
land sales is extracted from the real property transactions file. A total of 102,084 vacant sales
occurred between the first quarter of 1982 and the second quarter of 2002.
8
Of these sales, 7,399
are dropped because they did not have a corresponding parcel description file. An additional
1,783 sales did not match to the GIS parcel files. Another 69 sales that included some type of
personal property are excluded, as are 2,969 sales of property on Vashon Island. To measure
conditional price uncertainty for a given quarter requires information from the preceding eight
quarters (this measure is explained in Section IV); thus, the dataset of land prices excludes sales
occurring before 1984. This leaves a total of 80,926 land sales from the first quarter of 1984 to
the second quarter of 2002.

D. Explanatory Variables
The development and land price datasets described above contain several variables that
measure site quality, drawn from the Assessors parcel description records. These files include
dummy variables for whether the parcel was at risk of erosion, flooding, a landslide or an
earthquake. Dummy variables for whether a site had difficult topography, water problems or a
restrictive shape for development are included as well. The datasets also contain the Assessors
rank of the quality of the scenic view (from 0-4.) This value was determined by taking the best
numeric score for views of two mountain ranges, two volcanic mountains, the downtown Seattle
skyline and several different bodies of water.

8
The real property transaction file identifies whether a sold lot was undeveloped at the time of sale. Therefore it
does not pool dilapidated structures and vacant land, as occurs in assembling the timing of development dataset.

11
A lots distance from the downtown is calculated in miles using the GIS parcel file. In
addition, GIS files provide the parcel size for inclusion in the land price dataset.
9
A digitized
map of King Countys 1985 Comprehensive Plan identifies the general zoning status for parcels
in unincorporated areas. Parcels deemed to be urban were allowed to develop densely, while
parcels deemed rural only were allowed a relatively low building density (typically one home
per two and a half acres). Parcels that were designated transitional were allowed an
intermediate density, but parcels in agricultural or forest lands were highly constrained.
10
Not
only do dummy variables for sub-county zoning status control for legal constraints on
development, they also proxy for availability of infrastructure such as water, sewer and road
capacity, because the 1985 comprehensive plan pledged not to extended these public services
into rural or resource areas.
The dataset for measuring the timing of development also contains one-year-ahead
expected school-district level house prices and house-price uncertainty. The method for
estimating these values is described below in subsection C of Section IV. The vacant-land-price
dataset includes price uncertainty for each quarter of sale. The timing-of-development dataset
also contains the real risk-free interest rate, measured as the interest on a 10-year U.S. Treasury
bond, and county population. Summary statistics for the timing-of-development dataset and the
land-price dataset are presented in Tables 1 and 2, respectively.



9
Parcel size is not included in the timing of development dataset. A developer must often decide how to subdivide a
large parcel into multiple building lots. The lot size observed in 2002 may be the result of a developers choice
about how intensively to use the land. However, uncertainty about how intensely to develop the land is a central
factor in raising real option value.
10
By restricting allowable densities, the technology for home construction becomes less flexible and the resulting
profit function less convex, possibly eroding real options. This question, along with a subsequent statewide growth
management act is examined in Cunningham, (2004).

12

IV. ECONOMETRIC FRAMEWORK AND RESULTS
A. Model of Land Development
In addition to real option concerns, land development and house prices are affect by other
first-order determinants. The traditional urban model predicts that the physical size of the city
expands outward over time as transportation costs fall and incomes rise, causing farm-land at the
urban edge to be converted to housing. This seems a reasonable framework with which to start.
The demand for housing at a location u results from people optimizing their consumption
of housing and other goods, while minimizing travel costs. Individuals consume housing, H, and
all other goods, X, to maximize utility subject to their budget constraint: tu H u P X P Y
h x
+ + = ) ( ,
where
x
P is the price of all other goods, ) (u P
h
is the quality-adjusted price of housing, t is the
per-mile transportation cost and u is the houses distance from the individuals employment.
Simple algebra yields the price of housing:
u
H
t
H
X P Y
u P
x
h

= ) ( , (3)
which indicates that the amount the individual is willing to spend for a unit of housing depends
positively on income and negatively on the cost of other goods consumed, per-mile
transportation cost, and distance from employment.
The profit from providing housing services equals housing rent minus housing supply
cost and land rent: H u R u HC H u P u
h
) ( ) ( ) ( ) ( = . Home construction is a perfectly
competitive industry, so ) (u can be set to zero. Dividing the suppliers profit function above
by H and rearranging yields land rent:
) ( ) ( ) ( u C u P u R
h
= . (4)

13
Substituting in ) (u P
h
from the price of housing yields,
) ( ) ( u C u
H
t
H
X P Y
u R
x
|
.
|

\
|

= . (5)
Equation (5) is the bid-rent for land, per unit of housing.
If land rent from newly constructed housing at distance u exceeds rent in the current
alternative use, a new home will be built at that location. Formally, the landowners decision
rule is:
if
alt
R u R ) ( , build;
(6)
if
alt
R u R < ) ( , do not build.
For the purposes of this model,
alt
R could be the rent on agricultural land at the urban fringe, a
parking lot in the city or land rent associated with an existing structure that is ripe for real
development.
If a parcel of land contains a real-option premium, OP, then the value of OP R
alt
+ may
exceed ) (u R , delaying development. Therefore, a modified decision rule is,
if OP R u R
alt
+ ) ( , build;
(7)
if OP R u R
alt
+ < ) ( , do not build.
Thus, an increase in the option premium will reduce new construction, whereas a decline in the
option premium will yield more housing construction. However, to adequately determine the
presence of real options requires identifying or controlling for the first-order determinants of
) (u R and
alt
R .



14


B. Determinants of Bid-Rent
As I do not observe housing rents or the ongoing cost of housing supply, R(u) is re-
specified as the capitalized stream of future land rents; ) (u P
h
becomes the sale price of a quality-
adjusted house (capitalized stream of future housing rents). ) (u C is now new housing
construction cost.
In equation (5) above, the price of housing depends on income, the price of other goods,
and travel cost. Some researchers have included, publicly provided goods (schools) and local
government property taxes; still others have examined localized amenities, like access to parks or
clean air. These values in turn affect the bid-rent. Rather than include and parameterize these
determinants, I directly include forecasted one-year-ahead school-district-level, quality-adjusted
house prices, ] [
1
q
jt
P E
+
, to capture the changing demand for school-district services and location
amenities. The use of the forecasted price is appropriate, because it takes approximately one
year to build a new home in this area. Inclusion of area prices directly into the model rests on
the assumption that forecasted school-district house prices are unaffected by whether or not
individual parcel i is developed at time t. This seems a reasonable assumption, given the
relatively small share of total housing that is new construction.
I include the parcels distance from the downtown, u
i
, as dictated by equation 5. County
population level, n
t
, controls for growth of the city over time. Finally, a variable for whether a
parcel has a scenic view,
i
v , is included; it accounts for a critical location-specific amenity.
Housing is produced by combining capital and land. Thus, new-home construction cost,
) (u C , is affected by the cost of capital and the cost of preparing a building site for development.

15
I include the real interest rate on a ten-year Treasury note,
t
r , as a measure of the cost of capital
used to produce housing. Parcel characteristics that may make a site difficult for the production
of housing include whether the site was at risk of erosion, flooding, an earthquake or a landslide.
Sites that have difficult topography, water problems, or are oddly shaped also should increase the
cost of building housing there and should thus lower the land rent a housing developer would be
willing to pay.
I lack suitable measures of the returns to land in an alternative use. In place of these
variables, I include dummy variables for individual school districts, under the assumption that
rent from agriculture, forestry or as an empty lot varies by location, but is relatively unchanged
over time.
To test the existence of a real option premium, I include a measure of future house-price
uncertainty,
2

jt
, in the timing-of-development hazard model and in the hedonic regression of
undeveloped land price. The measurement of price uncertainty is discussed in the next section.

C. Measuring House Price Uncertainty
To measure the degree of price uncertainty, I begin by estimating the one-year-ahead
quality-adjusted price of housing,
q
jt
P
4 +
, as a function of an intercept and the current quality-
adjusted price,
q
jt
P :
jt
q
jt j j
q
jt
e P P + + =
4 1 0
, (8)
where t is the quarter of sale and j denotes the school district. The parameter estimates for the
regressions are presented in Table 3. While the ability to predict future prices is at odds with
efficient-market theory, there is considerable evidence that quality-adjusted housing prices can

16
be forecasted in the near term (Case and Shiller, 1989). Four quarters is the shortest time
horizon a developer might consider, given that it is the approximate construction time for a new
house in this area.
The estimate of price uncertainty,
2

jt
, then is calculated as the four-quarter moving
variance of residuals from equation (8):
) ... var(
4 1
2

=
jt jt jt
e e . (9)
This specification assumes that a would-be developers confidence in the one-year-ahead price
forecast depends on how accurate price forecasts were in the recent past.
11
Other measures of
uncertainty are described and tested in Section V to check the robustness of the initial findings.
The variance of residuals is an appealing measure because it allows for the fact that developers
may have more information than is available to the researcher. For example, one may worry that
the residuals from the forecasting model in equation (8) display positive serial correlation, to
which developers adapt their forecasts accordingly. Alternatively, one might believe that
developers simply know more about what is driving market price than, the researcher, are able to
discern. Note, however, that equation (9) can be re-written as
2
4
1
2
) (

=

=
k
jt k jt jt
e e /4, (10)
where
4

4
1

=

=
l
l jt
jt
e
e . (11)
The measure,
2

jt
, as shown in (10), accommodates these concerns by imposing the assumption
that developers know
jt
e over the coming year. Using this method, which locally de-means the

11
This is similar to ARCH, in which residuals from a forecasting equation are used to measure volatility. The
method above weights each lagged residual equally; ARCH methods solve for the likelihood maximizing weights
that predict
t
e .

17
error term, ensures that the measure of price uncertainty only increases when a price forecast for
a particular quarter deviates from the three other closest forecasts. The resulting measure of
price uncertainty is graphed for different school districts in Figure 4. There is considerable
variation in uncertainty over time and across districts.
Using
2

jt
as a measure of future price uncertainty assumes that developers confidence
in their expected price forecast hinges on how well they were able to forecast prices in the recent
past. If real options exist, and the forecasting model approximates developer thinking, then an
increase in
2

jt
should deter development and raise vacant land prices by signaling that future
price could substantially differ from predicted prices.
12


D. Price Uncertainty and the Timing of Development
To test the determinants of land development, I estimate a baseline hazard model, in
which a site dies when a home is built on it. In a hazard model, it is necessary to specify a
start time in order to measure the duration of time until failure. However, in land development, it
is unclear when a parcel is first at risk of being built upon: when the first settlers arrived, or,
perhaps, when the first car was sold? Given that I am only able to observe price uncertainty
starting in 1984, I set this as the start year for all parcel spells. As this assumption is somewhat
problematic, I estimate three different hazard models below, each of which addresses this issue
differently. In addition, the next section further checks the robustness of the findings by
estimating the model for samples of parcels that are likely to share similar start dates.

12
By measuring price uncertainty as the variance of residuals from a forecasting model, I sacrifice the first 8
quarters of vacant land price analysis and two years at risk of development. This occurs because the forecasting
model does not yield a residual until the first quarter of 1983. Taking the variance of the past four quarter residuals
means that the first measure of price uncertainty is obtained in the first quarter of 1984.

18
Utilizing the timing-of-development dataset described in subsection B of Section III, the
following proportional hazard is specified:
) exp( ) ( ) (
0
X t h t h = , (12)

where the baseline hazard, ) (
0
t h , is shifted by changes in a vector of covariates, X , (discussed
in subsection B). The covariates along with controls for sub-county zoning,
i
FE
Z , are presented
below in equation (13):
j i
FE FE i t t i i jt
q
jt
S Z C r n v u P E X + + + + + + + + =
+ 2 4 3 2
2
1 1 1
] [ ' . (13)

Note that expected school-district housing prices, ] [
1
q
jt
P E
+
, and price uncertainty,
2

jt
, vary by
year t and by school district j. Interest rates, r, and population level, n, only vary by year t.
Thus, the effect of price uncertainty on the timing of development is identified by inter-temporal
and inter-temporal-cross-sectional variation. The contributions of the site-quality measures to
the likelihood of development only are identified by within-school-district variation.
If real options are present, then an increase in price uncertainty will lower the hazard of
development. Formally, the null hypothesis is that price uncertainty does not affect the timing of
land development: 0 :
1 0
= H ; and the alternative hypothesis is that price uncertainty delays the
timing of land development: 0 :
1
<
a
H .
In the presence of real options, interest rates have an ambiguous effect on the timing of
development. On the one hand, a higher interest rate raises the cost of capital to a firm and, thus,
pushes up the threshold return necessary to justify an immediate investment. At the same time,
however, higher interest rates lower the discounted present value of future profits, making short-
run profits relatively more valuable than any forgone future rents from a suboptimal

19
development. This latter effect lowers the hurdle-price necessary to justify an immediate
investment.
Developers often construct multiple homes at once. Thus, there may be strong spatial
correlation in the timing of development. To correct for this, I cluster the standard errors by
subdivision plat.
13
For larger parcels that were not platted in 2002, I cluster the standard errors
using the assessors one-quarter square mile reference grid identifier.
The results from three different timing of development specifications are presented in the
first three columns of Table 4. The parameter estimates presented in column 1 result from
assuming an exponential distribution, which imposes a constant and, thus, memoryless,
proportional hazard: = ) (
0
t h . The advantage of the exponential hazard is that, if this is the true
model, it does not require measuring the start of the spell correctly, because the hazard is the
same at all spell lengths.
The parameter estimate of price uncertainty,
1
, is negative and significant at all standard
significance levels. Thus, I can reject the null hypothesis that price uncertainty does not affect
the hazard development, in favor of the alternative that price uncertainty lowers the likelihood of
development. This finding is consistent with the presence of real options. A one-standard-
deviation increase in price uncertainty lowers the instantaneous hazard of development by 10.7
percent.
14

The parameter estimates on the other covariates conform to theoretical predictions
reasonably well. The estimate on the coefficient for future expected prices is positive, though
insignificant. Higher interest rates are, on net, a deterrent to investment. The parameter estimate

13
A plat is a map filed by a developer with the local planning office that divides a large parcel of land into
individual building lots.
14
The percentage shift in the hazard was calculated as 1 )] [exp(
2
1
.

20
for county population size is positive and statistically significant, but the parameter estimate for
parcel distance from the CBD is insignificant, perhaps because of the inclusion of school-district
and zoning dummy variables. Furthermore, most measures of site quality have the expected
sign, though parcels at risk of erosion, flooding, earthquakes or landslide were not statistically
significantly less likely to develop.
The exponential distribution is a restrictive parameterization. The true hazard of
development may increase or decrease with duration. For example, as time progresses, there
may be fewer developable sites left, and it increasingly will be likely that a house will be built on
any surviving parcels. On the other hand, sites that remain vacant up to time t may be
unattractive based on unobservable characteristics, such that they will increasingly be less likely
to develop as t increases. A baseline hazard with a Weibull distribution, which has the functional
form
1
0
) ( ) (

=

t t h , allows the hazard of development to increase or decrease monotonically
with time. In fact, the exponential hazard specified in column 1 is a special type of Weibull,
where 1 = .
The results from the Weibull hazard are presented in column 2. Price uncertainty appears
to be an even greater deterrent to construction when compared to the exponential
parameterization. A one-standard-deviation increase in the price uncertainty term lowers the
hazard of development by 26 percent. The Weibull parameter estimate, , is 5.1, indicating a
strongly increasing hazard of development over time. It is statistically different from 1 at all
standard significance levels, suggesting that the null hypothesis that, 1 = , can be rejected, in
favor of the alternative that 1 > . Interestingly, the Weibull specification reverses the sign of
the coefficient estimates for the interest rate and county population level. Higher interest rates
increase the probability of development and greater population lowers the probability of

21
development. While the finding that higher interest rates raise the likelihood of development is
consistent with the presence of real options, it seems harder to reconcile with general investment
theory and observed aggregate trends in home construction.
The large Weibull parameter estimate and the reversed coefficient signs for these
variables may result from how spell time is measured. As discussed above, only the year a
building was constructed is observed, in these data not the month or day a developer broke
ground. All duration spells begin in 1984 and end when the site is developed or observed to be
right-censored at the end of 2000. Thus, it is possible, that the more flexible Weibull baseline
hazard is capturing the effect of high interest rates in the eighties and/or a larger county
population in the nineties. County population, in particular, increases monotonically throughout
the sample period.
As an alternative, I use a third estimator that estimates the effect of duration non-
parametrically using the proportional hazard model of Prentice and Glockler (1978) and Meyer,
(1990). This estimator controls for the baseline hazard by including dummy variables for failure
in spell year t and thus sweeps out all purely inter-temporal variation, whether it is duration time,
interest rates, or population, used in the estimation of covariate parameters.
By including dummy variables for year, (and thus for spell duration), this specification
absorbs the mean inter-temporal variation in the likelihood of development and is a discrete-time
analogue of a Cox-proportional hazard in which the baseline hazard is partialled out of the
likelihood function. However, because I only observe failure annually, these dummy variables
are perfectly collinear with interest rates and county population, excluding them from the hazard.
Column 3 provides the parameter estimates from using the semi-parametric (the
covariates retain the proportionality assumption) hazard specification. Now, a one-standard-

22
deviation increase in price uncertainty reduces the probability of development by 11.3 percent, a
result surprisingly close to that from assuming an exponential distribution.

D. Price Uncertainty and Land Prices
To estimate the effect of house-price uncertainty on land values, I specify a hedonic
model of vacant land prices, using the dataset on vacant land transactions described in Section
III. If there is greater uncertainty about the most desirable structure to own in the future, then
vacant land that allows one to build a different type of structure at a future date will trade at a
premium above its discounted stream of future rents in its current, low-capital use,
alt
R .
In a world without real options, but with steadily rising house prices, vacant land is worth
the discounted stream of future rents in the alternate use plus future rents when the land is
converted to housing. From Capozza and Helsley (1989):

(

+ =

) ( | ) (
*
*
*
0
u R dt Ce dt e u R dt e R E P
rt rt
t
rt
t
alt land
, (14)
where t* is the optimum time in expectation to convert land to housing and C is the cost of new
home construction. Given this relationship, I include in the hedonic model many of the
determinants of the bid-rent function discussed in Section B. I expect the sign on the parameter
estimates for these variables to be the same as in the hazard model above.
15
The hedonic model
omits forecasted housing price which is clearly endogenous with respect to land prices. In lieu
of county population and the risk-free interest rate I include a full set of year and season dummy
variables. The hedonic also contains parcel size in square feet.
If real options exist, then greater uncertainty about future prices should raise the option
premium and result in higher observed sale prices. If the parameter estimate of price uncertainty,

15
Recall that, in the simple model it is an increase in the bid-rent function at distance u that induces development.

23
2

jt
, is significantly greater than zero, we can reject the null that price uncertainty does not
affect land values in favor of the alternative.
The results from the OLS estimate of the hedonic model are presented in column 4 of
Table 4. The coefficient estimate for the price uncertainty term is positive with a p-value of
.0039, suggesting the presence of a real option premium. When evaluated at the median lot
value, a one-standard-deviation increase in price uncertainty results in a modest increase in lot
price of $1446 in 2004 dollars.
16
This change in value is equivalent to a 1.6 percent increase in
land price. The coefficient estimates for other parcel characteristics are the expected sign with
the exception of erosion danger, which is positive. Erosion may be correlated with omitted
measures of site quality, perhaps proximity to water.

V. ROBUSTNESS OF FINDINGS
A. Price Uncertainty by Distance Bands from the CBD
As was discussed in part B of the previous section, it may be problematic to assume that
all parcels became eligible for development in 1984. To check for possible bias from assuming a
start time of 1984, the previous section forced the baseline hazard to be constant (exponential),
let it increase monotonically (Weibull), or let the data dictate the effect of each spell duration
(non-parametric). All of these parameterizations assumed that the effect of duration time was
constant across parcels. However, land throughout the county may become eligible for
development at different times. For example, land near downtown Seattle has been at risk of

16
The slope coefficient estimate for a log dependent variable, linear covariate specification, is recovered by
multiplying the parameter estimate by the dependent variable. At the mean lot value of $90,784 the change in price
for a change in uncertainty is ) (
2
slope or 446 , 1 $ 008 . ) 784 , 90 $ 991 . 1 ( = .

24
development since the nineteenth century, while land on the Sammamish Plateau (east of
Bellevue) probably was not at risk of development until the 1970s.
A general pattern in urban economics is that cities expand outward over time.
17
If a
parcel becomes eligible for development as the city expands, then grouping parcels of similar
distances from the downtown may ensure that these parcels have similar development start dates.
Therefore to check the robustness of the earlier findings, I stratify the original timing-of-
development dataset (discussed in part B of Section III) into six sub-samples based on a parcels
distance from the downtown. The six distance bands are: 0-4 miles, 4-8 miles, 8-12 miles, 12-16
miles, 16-20 miles and beyond 20 miles. As is illustrated in Figure 5, with the exception of the
innermost distance band, 0-4 miles, which lies entirely within the City of Seattle school district,
all other distance bands cross five or more school districts, ensuring cross-sectional and inter-
temporal variation in forecasted prices and price uncertainty.
I specify the exponential distribution for the baseline hazard, because the parameter
estimate on the full sample was similar to the parameter estimate from the non-parametric model.
In addition, the exponential allows one to utilize inter-temporal variation in price uncertainty to
identify the parameter. To ensure sufficient cross-sectional variation in price and price
uncertainty, I omit school district and sub-county zoning fixed effects.
While I expect the estimated parameter signs to remain the same across distance bands, I
have few expectations a priori with respect to the relative magnitudes of the true coefficients.
Parcels near the center of the CBD may have the largest value of
1
, because housing prices are
high enough to justify multi-story structures, introducing greater convexity into the profit
function. For example, determining optimum building height is a critical and difficult decision,

17
Causes of outward expansion of cities include falling commuting costs, rising taste for space, and rising house
prices. See Brueckner and Fansler (1983) for a theoretical explanation and empirical evidence.

25
making developers more sensitive to any given level of price uncertainty.
18
Moving away from
the CBD, there may be significant zoning regulations that restrict the height of buildings or the
number of units, but, even here, developers may have discretion over lot size or over whether to
build town-homes or low-rise apartments. At the same time, greater regulation may reduce
house price uncertainty by limiting the threat of negative externalities from development.
Parcels at the urban-rural frontier confront a different, but related, problem. While
developers in the city center must struggle to determine optimum building scale, their real option
is at least in the money. There is a structure of some size they can build that will sell for more
than its exercise price, which is the cost of construction. On the other hand, rural land near the
urban edge may or may not be more profitably used as housing. In other words, the real option
in the current period could be in or out of the money. Greater price uncertainty in this region
should raise the value of agricultural land, because even if it is not more profitable as housing
presently, it could be in the near future, and vice versa. If one were to exclude a change in
development scale and limit the developers decision to build or not to build, then the intuition
from the finance literature (in which the analogue is to own or to not own a security), is that
option premiums are largest when the exercise price is nearest the market price. If house prices
are well above construction cost (and building technology is fixed), then the option will be priced
equal to the difference between the market price of housing and construction cost. If, on the
other hand, housing prices are well below zero, and there is no chance of them rising above
construction cost, then land is simply worth the discounted future agricultural rents.
The parameter estimates for the timing of development hazards by distance band are
presented in columns 2 to 8 of Table 5. The parameter estimate for the effect of price

18
For example, by law, buildings taller than four stories (five in the city of Seattle) must be constructed out of
reinforced concrete or steel, instead of wood, substantially increasing the cost of construction.

26
uncertainty,
1
, is negative and significant for all distance bands. The coefficient estimate on
uncertainty is largest nearest downtown and at 8-12 miles from the CBD, a distance band that
includes the high land value (and tall buildings) office cluster of Bellevue and the fast growing
technology center in Redmond. These findings suggest that real option effects may increase with
feasible building height.
19

Pricing vacant land confronts similar problems as measuring the start date of a duration
spell. Parcels far from the downtown may not reasonably be expected to be converted to housing
for decades, if ever, but generate considerable unobserved earnings in the alternative use, as
timber or farm land. Land near the CBD may simply be vacant lots, yielding no rents, but
retaining a sizable option premium that justifies keeping the land undeveloped in the near term.
Following the structure of Table 5, the coefficient estimates for the vacant land
transaction price regression are allowed to vary by distance from the CBD. Dividing the vacant
land transactions into the same six distance bands and running the hedonic model separately
reveals that higher price uncertainty only raises land prices 12-20 miles from the CBD. The
coefficient estimates from the regressions by distance bands are provided in columns 2 to 8 of
Table 6. House-price uncertainty actually has a negative effect on land prices 4-12 miles from
the CBD, an outcome that does not conform to theory. This pattern in land prices suggests that
that price volatility may be a greater concern to landowners confronting the irreversible
conversion of agricultural land to urban use, a finding consistent with the work by Capozza and
Helsley (1990).



19
Whether this is a result of higher land values or more flexible zoning in commercial clusters will be the focus of
future work.

27
B. Alternative Measures of Uncertainty
As a further test of the robustness of the findings presented above, I create four additional
measures of price uncertainty. The measures are presented below in increasing order of
conservativeness. The finding that price uncertainty delays the likelihood of construction is
consistent across all measures. The finding that price uncertainty raises land price is consistent
for three of the five measures.
Should house prices not be forecastable (efficient-market theory), current observed
volatility of prices may be the best measure of future price uncertainty. To test this, I take the
four-quarter moving variance of quality-adjusted prices:
4 / ) (
2
4
1
2

=
=

k
q q
jt
jt k jt
P P , (15)
where:
4
4
1

=

=
l
q
q
l jt
jt
P
p . (16)
The parameter estimates for an exponential hazard model with the above measure of price
uncertainty are included in column 1 of Table 7. Note that greater price volatility appears to
delay the timing of development. Column 1 of Table 8 provides the parameter estimates from
the vacant land price regression. Price uncertainty using this measure appears to raise land
prices.
As was discussed in Section III, there is little evidence as to how far back in time
developers look when assessing future price uncertainty. To test the robustness of my
assumption that they only consider the previous four-quarters, I take the variance over the past
eight quarters:
8 / ) (
2
8
1
2

=
=

k
q q
jt
jt k jt
P P , (17)

28
where
8
8
1

=

=
l
q
q
l jt
jt
P
p . (18)
Column 2 of Table 7 provides the parameter estimates for an exponential hazard model with the
above measure of price uncertainty. Note that greater price volatility appears to delay the timing
of development by a magnitude similar to the four-quarters price variance. Column 2 of Table 8
provides the parameter estimates from the vacant-land-price regression. Greater price volatility
appears to raise land prices by even more when volatility is measured over eight quarters.
In creating my preferred measure, I relaxed the assumption of unforecastable prices and
created a simple model in which current price predicts future price four quarters ahead. I then
took the variance of the residuals over the previous four quarters. This allowed for the fact that
developers may know more than we the researchers do. Perhaps, this control for forecast model
misspecification is too conservative. Therefore, as a third robustness check, I simply take the
sum of squared residuals from the price forecasting model presented in equation (8):
4 / ) (
2
4
1
2

=
=
k
jt
e . (19)
This measure is analogous to the predicted error from an ARCH(4), in which each lagged
residual is given the same weight. The parameter estimates for the hazard model and the land
price regression are provided in column 3 of Tables 7 and 8, respectively. Note that price
uncertainty significantly reduces the hazard of development but does not significantly affect land
prices.
In a final robustness check, I estimate a GARCH(1,1) measure of price uncertainty.
GARCH models, like the ARCH models from which they are derived, jointly estimate a forecast
model and the conditional heteroscedasticity of the error term. To obtain the GARCH(1,1)
estimate of conditional volatility, I estimate a similar forecast model as before, but predict

29
conditional volatility with a one-quarter-lagged residual, and a one-quarter-lagged conditional
volatility estimate:
jt
q
jt j j
q
jt
e P P + + =
4 1 0
(20)
and
2
1 1
2
1 1 0
2

+ + =
jt j jt j j jt
e . (21)
The four-quarters-ahead predicted price and the estimated conditional heteroscedasticity are then
included in an exponential hazard on the timing of development and a hedonic regression of land
price, respectively.
The parameter estimates from the hazard model and land price regressions using the
above measure of future price uncertainty are provided in columns 4 of Tables 7 and 8,
respectively. The parameter estimate of the GARCH(1,1) conditional volatility on the likelihood
of development is negative and significant, consistent with the presence of real options.
However, the parameter estimate for the contribution of price uncertainty to land prices is
insignificant.
In summary, the finding that price uncertainty deters the likelihood of development is
highly robust. The parameter estimate associated with price uncertainty is negative and
significant for all distances from the downtown and for various measures of price uncertainty.
However, the contribution of price uncertainty to land prices is somewhat less robust. Price
uncertainty only contributes to higher land prices 12-20 miles from the CBD and to higher land
prices in the whole county when using the least conservative measures (conditional variance) or
the most conservative measure (variance of residuals).



30
CONCLUSION
The weight of the evidence in this paper suggests there are real options in real estate
markets. Uncertainty about future prices reduces the hazard of current-period development and,
at the same time, raises land prices. These findings are robust to various parameterizations and
to a well specified hedonic regression on vacant land sales. Allowing parameter estimates to
vary by distance from the CBD reveals that price uncertainty delays the timing of development,
but is greatest where particularly capital-intensive projects are viable. Real-option effects only
appear to raise land prices in the vicinity of the urban-rural frontier, 12-20 miles from the CBD,
perhaps reflecting a premium for an at-the-money real option to convert agricultural land to
housing.
Only a limited number of papers have looked for evidence of real options in investment
decisions, and only a few have examined real estate markets. My finding for the effect of price
uncertainty on the timing of development is very similar to that of Bulan, Mayer and Somerville
(2002), whereas the finding that price uncertainty modestly raises vacant land prices is consistent
with the work by Quigg (1993). These results suggest that real estate investors do account for
real options, even in competitive and economically important sectors, like new home
construction. The presence of real options in land markets is further evidence for the necessary
inclusion of real options in models of capital investment and has broader implications for the
importance of price stability and consistent government policy in stimulating fixed investment.

31
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Employment under Uncertainty, (Massachusetts Institute of Technology).
Brueckner, Jan K., and David A. Fansler, 1983, The Economics of Urban Sprawl: Theory and
Evidence on the Spatial Sizes of Cities, Review of Economics and Statistics 65, 479-82.
Bulan, Larrni, Christopher Mayer, and Tsur Somerville, 2002, Irreversible Investment, Real
Options, and Competition: Evidence from Real Estate Development, Working Paper.
Caballero, Ricardo J., and Robert S. Pindyck, 1996, Uncertainty, Investment, and Industry
Evolution, International Economic Review 37, 641-62.
Capozza, Dennis, and Robert W. Helsley, 1989, The Fundamentals of Land Prices and Urban
Growth, Journal of Urban Economics 26, 295-306.
Capozza, Dennis R., and Robert W. Helsley, 1990, The Stochastic City, Journal of Urban
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Case, Karl E., and Robert J. Shiller, 1989, The Efficiency of the Market for Single-Family
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Cunningham, Christopher, 2004, Urban Growth Boundaries and Real Options: Evidence from
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Deng, Yongheng, 1997, Mortgage Termination: An Empirical Hazard Model with a Stochastic
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Dixit, Avinash K., and Robert S. Pindyck, 1994. Investment under uncertainty (Princeton
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Investment: An Examination of Competing Investment Models Using Commercial Real
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There Is an Option to Shut Down, International Economic Review 26, 331-49.
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of Economics 101, 707-27.
Meyer, Bruce D., 1990, Unemployment Insurance and Unemployment Spells, Econometrica:
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Perspective on Entrepreneurial Entry in the Face of Uncertainty, Managerial and
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621-40.

32
Shackleton, Mark B., Andrianos E. Tsekrekos, and Rafal Wojakowski, 2004, Strategic Entry and
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Table 1 Summary Statistics for Variables Used
to Test Determinants of Land Development


Variable
Mean Median
Standard
Deviation
Dummy if site developed 0.050
in that year

Anticipated 1 year Ahead 11.444 11.422 0.247
Quality Adjusted Housing
Price
1
(in logs)
Price uncertainty
2
0.006 0.002 0.007
Interest Rates 7.979 7.670 1.920
(10-year US Treasury %)
Population 15.197 15.073 1.316
(100,000)
Distance to CBD 15.148 14.466 8.313
(miles)
Scenic View 0.342 0 0.932
(rank 0-4)
High Erosion Danger 0.008
High Flood Danger 0.009
High Seismic Danger 0.008
High Risk of Landslide 0.007
Difficult Topography 0.095
Water Problems 0.052
Odd Shaped Lot 0.083
Sub-County Zoning
Incorporated 33.44
Urban 41.89
Transitional 6.63
Rural 11.36
Agricultural/Forest 6.68

Parcels 163,120

Failures 95,805

Years-at-risk 1,956,547


1
Log predicted quality-adjusted house price four quarters ahead from model
jt
q
jt j j
q
jt
e P P + + =
4 1 0


2
Moving variance of residuals,
) ... var(
4 1 jt jt
e e
from forecasting model above.

Table 2 Summary Statistics for Variables Used
to Test Determinants of Land Price


Variable Mean Median
Standard
Deviation
Vacant land 431,343 90,784 1,289,140
transaction price
Price uncertainty
1
0.005 0.002 0.008
Lot Size 9.935 9.470 1.411
(square feet)
Distance to CBD 15.466 14.881 7.323
(miles)
Scenic View 0.427 0 1.023
(rank 0-4)
High Erosion Danger 0.009
High Flood Danger 0.008
High Seismic Danger 0.010
High Risk of Landslide 0.008
Difficult Topography 0.097
Water Problems 0.042
Odd Shaped Lot 0.049
Sub-County Zoning
Incorporated 29.56
Urban 44.58
Transitional 8.9
Rural 12.83
Agricultural/Forest 4.14
Observations 80,926

1
Moving variance of residuals,
) ... var(
4 1 jt jt
e e
from forecasting model:
jt
q
jt j j
q
jt
e P P + + =
4 1 0



Table 3
Price Forecasting Parameter Estimates by Region
1

1
jt
q
jt j j
q
jt
e P P + + =
4 1 0
, quality-adjusted prices four quarters ago
predicts current price. Quarterly, quality-adjusted price
q
jt
P , is
constructed by predicting the price of a synthetic home with mean house
and lot characteristics (for that school district) using time and district
varying hedonic coefficient estimates derived from 1230 (82 quarters
15 districts) individual regressions of log sales price on parcel and lot
characteristics drawn from 554,906 homes sales.

Intercept
Lagged quality-adjusted
price (4 quarters)
Region
Parameter
Estimate
Standard
Errors
Parameter
Estimate
Standard
Errors
1 -0.129 (0.397) 1.015 (0.035)
2 1.322 (0.798) 0.886 (0.070)
3 0.819 (0.638) 0.932 (0.055)
4 0.633 (0.580) 0.948 (0.050)
5 0.916 (0.583) 0.924 (0.050)
6 2.223 (0.823) 0.818 (0.069)
7 1.235 (0.678) 0.897 (0.058)
8 1.54 (0.695) 0.868 (0.061)
9 8.483 (1.027) 0.247 (0.091)
10 2.047 (0.804) 0.823 (0.070)
11 0.471 (0.562) 0.96 (0.050)
12 0.296 (0.633) 0.976 (0.056)
13 1.701 (0.787) 0.85 (0.070)
14 1.538 (0.831) 0.864 (0.074)
15 0.454 (0.589) 0.962 (0.052)
Table 4 The Effect of Price Uncertainty on Timing of Development and Land Prices
(Clustered standard errors in parentheses-development
1
; robust standard errors-land prices)
Proportional Hazard Models-Timing of Development Land Prices
Explanatory
(1) (2) (3) (4)
Variable Baseline Hazard OLS
(Parameter) Exponential Weibull Nonparametric
Anticipated 1 year Ahead 0.109 3.332 0.839 --
Quality Adjusted Housing Price
2
(0.193) (0.267) (0.258)
Price uncertainty
3
-16.098 -42.920 -17.160 1.991
(3.167) (3.742) (3.656) (0.748)
Interest Rates -0.034 0.692 -- --
(0.012) (0.018)
Population 0.072 -2.158 -- --
(0.028) (0.083)
Distance to CBD 0.009 0.008 0.009 -0.010
(0.006) (0.006) (0.006) (0.002)
Scenic View 0.061 0.060 0.064 0.073
(0.010) (0.010) (0.010) (0.005)
High Erosion Danger -0.089 -0.090 -0.095 0.268
(0.126) (0.127) (0.129) (0.058)
High Flood Danger -0.059 -0.047 -0.065 -0.262
(0.137) (0.140) (0.140) (0.059)
High Seismic Danger 0.117 0.132 0.110 0.002
(0.113) (0.116) (0.116) (0.059)
High Risk of -0.054 -0.044 -0.061 -0.148
Landslide (0.120) (0.119) (0.122) (0.060)
Difficult Topography -0.751 -0.743 -0.777 -0.299
(0.036) (0.036) (0.037) (0.019)
Water Problems -1.422 -1.398 -1.454 -0.775
(0.107) (0.105) (0.106) (0.029)
Oddly Shaped Lot -1.751 -1.734 -1.790 -1.123

(0.050) (0.050) (0.051)
(0.043)
Constant -5.062 -18.960 -- 0.089
(1.854) (2.595) (0.007)
Weibull Parameter -- 5.052 -- --
(0.148)
Lot Size -- -- -- 0.089
(0.007)
School District Fixed Effect Yes Yes Yes Yes
Sub-County Zoning F.E. Yes Yes Yes Yes
Year Fixed Effects No No Yes Yes
Season Fixed Effects -- -- -- Yes
Log-Likelihood -187518.8 -175848.7 -364,866.7
2
R : 0.20
N 163,120 163,120 163,120 80,926
1
Errors clustered by subdivision plat.
2
Predicted quality adjusted house price four quarters ahead from model:
jt jt jt
e p p + + =
+ 2 1 4
) ln(
.
3
Moving variance of residuals, from forecasting model above.
) ... var(
4 1 jt jt
e e
Table 5
Uncertainty and Land Development by Distance from CBD
Hazard Model of Development

Exponential Distribution All Parcels
(Clustered standard errors in parentheses)
1
1
Errors clustered by subdivision plat.
2
Average of school district quarterly predicted quality adjusted house prices in the
next calendar year, from regression model:
jt
q
jt j j
q
jt
e P P + + =
4 1 0

3
Previous years four-quarter moving
variance of residuals from forecasting model above: ) ... var(
4 1 jt jt
e e .
Explanatory
Variable (Parameter)
(1)
All
Parcels
(2)
Distance
Band
0-4 Miles
(3)
Distance
Band
4-8 Miles
(4)
Distance
Band
8-12 Miles
(5)
Distance
Band
12-16
Miles
(6)
Distance
Band
16-20
Miles
(7)
Distance
Band
>20
Miles
Anticipated 1 year 0.109 0.769 1.319 0.952 0.567 -0.503 -0.600
Ahead Quality Adjusted
House Price
2

(0.193) (0.382) (0.154) (0.142) (0.171) (0.250) (0.263)
Price uncertainty
3
-16.098 -52.716 -27.868 -35.273 -24.305 -19.319 -22.131
(3.167) (15.378) (3.830) (5.842) (7.139) (6.962) (6.159)
Interest Rates -0.034 0.057 0.047 0.013 -0.067 0.001 -0.098
(0.012) (0.029) (0.016) (0.023) (0.027) (0.030) (0.027)
Population 0.072 0.191 -0.004 0.047 -0.093 0.146 0.024
(0.028) (0.080) (0.033) (0.038) (0.046) (0.051) (0.046)
Distance to CBD 0.009 0.171 0.088 -0.022 0.063 0.020 -0.067
(0.006) (0.037) (0.021) (0.025) (0.029) (0.035) (0.008)
Scenic View 0.061 0.265 0.090 0.075 -0.033 0.028 0.047
(0.010) (0.030) (0.014) (0.017) (0.030) (0.024) (0.025)
High Erosion -0.089 -8.689 -1.765 -1.902 -1.110 -0.417 0.091
Danger (0.126) (1.009) (0.738) (0.334) (0.259) (0.349) (0.164)
High Flood -0.059 -8.557 -0.146 -7.260 -0.303 -0.667 0.297
Danger (0.137) (1.008) (0.938) (0.998) (0.700) (0.282) (0.117)
High Seismic 0.117 -0.457 -0.711 -1.881 -0.734 0.034 -0.086
Danger (0.113) (0.735) (0.611) (0.577) (0.313) (0.165) (0.186)
High Risk of -0.054 -1.229 -0.970 -0.669 -0.589 -0.633 -0.822
Landslide (0.120) (0.117) (0.077) (0.063) (0.095) (0.077) (0.072)
Difficult -0.751 -0.754 -0.976 -1.276 -1.750 -1.413 -1.476
Topography (0.036) (0.486) (0.182) (0.304) (0.107) (0.102) (0.189)
Water Problems -1.422 -1.216 -1.842 -1.771 -1.678 -1.738 -2.064
(0.107) (0.158) (0.091) (0.116) (0.100) (0.128) (0.115)
Oddly Shaped Lot -1.751 -- 1.521 0.910 -0.785 -0.318 -0.326
(0.050) (0.108) (0.368) (0.363) (0.182) (0.190)
Constant -5.062 -15.890 -18.701 -14.149 -8.260 0.434 5.592
(1.854) (3.435) (1.519) (1.512) (1.833) (2.762) (2.854)
School District F.E. Yes No No No No No No
Sub-County Zoning F.E. Yes No No No No No No
Log-Likelihood -187518 -8494.7 -22010.2 -36633.5 -45998.6 -29671.4 -44765.0
N 163,120 9,634 19,551 31,220 24,580 15,126 21,403
Table 6
Uncertainty and Vacant Land Prices by Distance from CBD
(Robust standard errors in parentheses)

1
Moving variance of residuals, ) ... var(
4 1 jt jt
e e from forecasting model of quality adjusted house prices by school
district:
jt
q
jt j j
q
jt
e P P + + =
4 1 0

.

Explanatory
Variable (Parameter)
(1)
All
Parcels
(2)
Distance
Band
0-4 Miles
(3)
Distance
Band
4-8 Miles
(4)
Distance
Band
8-12 Miles
(5)
Distance
Band
12-16
Miles
(6)
Distance
Band
16-20
Miles
(7)
Distance
Band
>20
Miles
Price uncertainty
1
1.991 -0.237 -7.812 -5.462 19.652 11.076 0.626
(0.748) (19.870) (3.408) (3.519) (3.282) (2.026) (0.905)
Distance to CBD -0.010 -0.315 -0.068 0.122 0.103 0.047 -0.044
(0.002) (0.027) (0.015) (0.013) (0.013) (0.015) (0.003)
Lot size 0.089 0.725 0.478 0.293 0.016 -0.069 0.225
(0.007) (0.039) (0.032) (0.020) (0.014) (0.014) (0.010)
Scenic View 0.073 0.087 0.156 0.073 -0.020 0.096 0.093
(0.005) (0.020) (0.013) (0.009) (0.012) (0.012) (0.010)
High Erosion 0.268 0.000 -0.167 -0.825 -0.219 0.458 0.048
Danger (0.058) (0.000) (0.176) (0.988) (0.258) (0.077) (0.090)
High Flood -0.262 0.000 -1.008 -0.788 -0.624 -0.452 -0.072
Danger (0.059) (0.000) (0.341) (0.376) (0.215) (0.185) (0.065)
High Seismic 0.002 -2.804 -2.868 0.000 0.175 -0.401 -0.062
Danger (0.059) (0.373) (1.095) (0.000) (0.327) (0.221) (0.060)
High Risk of -0.148 0.164 -0.080 -0.034 -0.176 0.028 -0.542
Landslide (0.060) (0.231) (0.621) (0.400) (0.251) (0.093) (0.092)
Difficult -0.299 -0.237 -0.373 -0.464 -0.460 -0.140 -0.344
Topography (0.019) (0.055) (0.048) (0.041) (0.048) (0.049) (0.036)
Water Problems -0.775 0.939 -0.523 -0.645 -0.869 -0.540 -0.934
(0.029) (0.403) (0.132) (0.079) (0.060) (0.070) (0.042)
Oddly Shaped Lot -1.123 -0.145 -0.560 -0.620 -0.367 -2.429 -0.760
(0.043) (0.092) (0.103) (0.081) (0.113) (0.101) (0.089)
Constant 10.031 5.287 6.980 7.103 9.023 11.353 9.266

(0.063) (0.349) (0.293) (0.216) (0.266) (0.347) (0.152)
Year Fixed Effects Yes Yes Yes Yes Yes Yes Yes
Season Fixed Effects Yes Yes Yes Yes Yes Yes Yes
School District F.E. Yes Yes Yes Yes Yes Yes Yes
Sub-County Zoning F.E. Yes Yes Yes Yes Yes Yes Yes
2
R
0.20 0.24 0.21 0.22 0.23 0.41 0.25
N 80,926 3,863 8,295 15,608 17,217 12,809 23,134
Table 7 - Alternative Measures of Future Price Uncertainty
Uncertainty and Timing of Development

Exponential Distribution All Parcels
(Clustered standard errors in parentheses)
1
Variance of quality adjusted prices over past four quarters:
) ... var(
4 1
q
jt
q
jt
P P

.
2
Variance of quality adjusted prices over
eight quarters: ) ... var(
8 1
q
jt
q
jt
P P

.
3
Sum of squared residuals sum ) ... (
4 1 jt jt
e e from house price forecasting model.
4
Variance estimate from Generalized Autoregressive Conditional Heteroskedasticity model:
2
1 1
2
1 1 0
2

+ + =
jt j jt j j jt
e .
5
Moving variance of residuals,
) ... var(
4 1 jt jt
e e
from forecasting model of quality
adjusted house prices by school district:
jt
q
jt j j
q
jt
e P P + + =
4 1 0

.

Explanatory
Variable (Parameter)
(1)
Variance of
Quality-
Adjusted
Prices
(4 quarters)
1

(2)
Variance of
Quality
Adjusted
Prices
(8 quarters)
2

(3)
Sum of
Squared
Residuals
(4 quarters)
3

(4)
GARCH(1,1)
4

(5)
Variance of
Residuals
(Preferred
Measure)
5

Anticipated 1 year Ahead 0.123 0.362 0.809 0.397 0.109
Quality Adjusted Housing
Price
(0.198) (0.237) (0.228) (0.232) (0.193)
Price uncertainty -15.781 -11.759 -3.043 -7.943 -16.098
(3.157) (3.016) (0.364) (1.386) (3.167)
Interest Rates -0.044 -0.043 -0.049 -0.057 -0.034
(0.012) (0.013) (0.012) (0.013) (0.012)
Population 0.065 0.040 -0.036 0.020 0.072
(0.031) (0.036) (0.034) (0.037) (0.028)
Distance to CBD 0.009 0.009 0.009 0.009 0.009
(0.006) (0.006) (0.006) (0.006) (0.006)
Scenic View 0.061 0.062 0.062 0.061 0.061
(0.010) (0.010) (0.010) (0.010) (0.010)
High Erosion Danger -0.089 -0.089 -0.091 -0.088 -0.089
(0.126) (0.126) (0.126) (0.126) (0.126)
High Flood Danger -0.059 -0.060 -0.058 -0.060 -0.059
(0.137) (0.136) (0.137) (0.136) (0.137)
High Seismic Danger 0.117 0.116 0.118 0.114 0.117
(0.112) (0.112) (0.113) (0.111) (0.113)
High Risk of -0.053 -0.053 -0.053 -0.053 -0.054
Landslide (0.119) (0.119) (0.120) (0.119) (0.120)
Difficult Topography -0.751 -0.752 -0.753 -0.751 -0.751
(0.036) (0.036) (0.036) (0.036) (0.036)
Water Problems -1.421 -1.421 -1.419 -1.421 -1.422
(0.106) (0.106) (0.106) (0.106) (0.107)
Oddly Shaped Lot -1.751 -1.752 -1.753 -1.752 -1.751
(0.050) (0.050) (0.050) (0.050) (0.050)
Constant -5.047 -7.339 -11.061 -7.307 -5.062
(1.856) (2.175) (2.114) (2.106) (1.854)
School District F.E. Yes Yes Yes Yes Yes
Sub-County Zoning F.E. Yes Yes Yes Yes Yes
Log-Likelihood -187622.7 -187597.8 -187267.3 -187580.9 -187518.8
N 163,120 163,120 163,120 163,120 163,120
Table 8 - Alternative Measures of Price Uncertainty
Uncertainty and Vacant Land Prices All Parcels
(Robust standard errors in parentheses)

1
Variance of quality adjusted prices over past four quarters: ) ... var(
4 1
q
jt
q
jt
P P

.
2
Variance of quality adjusted prices
over eight quarters: ) ... var(
8 1
q
jt
q
jt
P P

.
3
Sum of squared residuals sum( ) ...
2
4
2
1 jt jt
e e ) from quality adjusted house
price forecasting model.
4
Variance estimate from Generalized Autoregressive Conditional Heteroskedasticity model:
2
1 1
2
1 1 0
2

+ + =
jt j jt j j jt
e .
5
Moving variance of residuals, ) ... var(
4 1 jt jt
e e from forecasting model of
quality adjusted house prices by school district:
jt
q
jt j j
q
jt
e P P + + =
4 1 0

.

Explanatory
Variable (Parameter)
(1)
Variance of
Quality-
Adjusted
Prices
(4 quarters)
1

(2)
Variance of
Quality
Adjusted
Prices
(8 quarters)
2

(3)
Sum of
Squared
Residuals
(4 quarters)
3

(4)
GARCH(1,1)
4

(5)
Variance of
Residuals
(Preferred
Measure)
5

Price uncertainty 0.478 1.177 0.068 -0.153 1.991
(0.164) (0.324) (0.101) (0.380) (0.748)
Distance to CBD -0.011 -0.010 -0.010 -0.011 -0.010
(0.002) (0.002) (0.002) (0.002) (0.002)
Lot Size 0.097 0.089 0.089 0.087 0.089
(0.007) (0.007) (0.007) (0.007) (0.007)
Scenic View 0.074 0.073 0.073 0.072 0.073
(0.005) (0.005) (0.005) (0.005) (0.005)
High Erosion Danger 0.278 0.269 0.269 0.261 0.268
(0.054) (0.058) (0.058) (0.058) (0.058)
High Flood Danger -0.251 -0.263 -0.263 -0.265 -0.262
(0.057) (0.059) (0.059) (0.059) (0.059)
High Seismic Danger -0.004 0.003 0.003 -0.001 0.002
(0.056) (0.059) (0.059) (0.059) (0.059)
High Risk of -0.150 -0.146 -0.147 -0.147 -0.148
Landslide (0.058) (0.060) (0.060) (0.060) (0.060)
Difficult Topography -0.297 -0.299 -0.299 -0.304 -0.299
(0.018) (0.019) (0.019) (0.019) (0.019)
Water Problems -0.761 -0.775 -0.775 -0.776 -0.775
(0.028) (0.029) (0.029) (0.028) (0.029)
Oddly Shaped Lot -1.081 -1.124 -1.124 -1.129 -1.123
(0.042) (0.043) (0.043)
(0.043)
(0.043)
Constant 9.954 10.026 10.039 10.069 10.031
(0.060) (0.063) (0.063) (0.063) (0.063)
Year Fixed Effects Yes Yes Yes Yes Yes
Season Fixed Effects Yes Yes Yes Yes Yes
School District F.E. Yes Yes Yes Yes Yes
Sub-County Zoning F.E. Yes Yes Yes Yes Yes
2
R
0.20 0.20 0.20 0.20 0.20
N 85,864 80,926 80,926 81,759 80,926
Number of Single Family Homes Per Quarter Mile
250 to 1,100 (472)
70 to 250 (627)
30 to 70 (370)
10 to 30 (649)
5 to 10 (345)
1 to 5 (463)
all others (759)
0 5 10
Miles
Seattle
Renton
Bellevue
Figure 1. Number of Single Family Homes in
King County in 1980
Figure 2. Regions of Analysis from School Districts
400
406
888
412
417
407
404
001
414
410
001
405
411
403
401
402
409
415
210
216
408
0 5 10
Miles
1
3
4
2
5
6
7
8
9
10
11
12
13
14 15
Figure 3. Time Varying Quality-Adjusted Prices by Region
(in logs)
10.5
10.7
10.9
11.1
11.3
11.5
11.7
11.9
12.1
12.3
12.5
1
9
8
2
-
1
1
9
8
3
-
1
1
9
8
4
-
1
1
9
8
5
-
1
1
9
8
6
-
1
1
9
8
7
-
1
1
9
8
8
-
1
1
9
8
9
-
1
1
9
9
0
-
1
1
9
9
1
-
1
1
9
9
2
-
1
1
9
9
3
-
1
1
9
9
4
-
1
1
9
9
5
-
1
1
9
9
6
-
1
1
9
9
7
-
1
1
9
9
8
-
1
1
9
9
9
-
1
2
0
0
0
-
1
Region-1
Region-2
Region-3
Region-4
10.5
11
11.5
12
12.5
13
1
9
8
2
-
1
1
9
8
3
-
1
1
9
8
4
-
1
1
9
8
5
-
1
1
9
8
6
-
1
1
9
8
7
-
1
1
9
8
8
-
1
1
9
8
9
-
1
1
9
9
0
-
1
1
9
9
1
-
1
1
9
9
2
-
1
1
9
9
3
-
1
1
9
9
4
-
1
1
9
9
5
-
1
1
9
9
6
-
1
1
9
9
7
-
1
1
9
9
8
-
1
1
9
9
9
-
1
2
0
0
0
-
1
Region-9
Region-10
Region-11
Region-12
10.5
11
11.5
12
12.5
13
1
9
8
2
-
1
1
9
8
3
-
1
1
9
8
4
-
1
1
9
8
5
-
1
1
9
8
6
-
1
1
9
8
7
-
1
1
9
8
8
-
1
1
9
8
9
-
1
1
9
9
0
-
1
1
9
9
1
-
1
1
9
9
2
-
1
1
9
9
3
-
1
1
9
9
4
-
1
1
9
9
5
-
1
1
9
9
6
-
1
1
9
9
7
-
1
1
9
9
8
-
1
1
9
9
9
-
1
2
0
0
0
-
1
Region-5
Region-6
Region-7
Region-8
10.5
10.7
10.9
11.1
11.3
11.5
11.7
11.9
1
9
8
2
-
1
1
9
8
3
-
1
1
9
8
4
-
1
1
9
8
5
-
1
1
9
8
6
-
1
1
9
8
7
-
1
1
9
8
8
-
1
1
9
8
9
-
1
1
9
9
0
-
1
1
9
9
1
-
1
1
9
9
2
-
1
1
9
9
3
-
1
1
9
9
4
-
1
1
9
9
5
-
1
1
9
9
6
-
1
1
9
9
7
-
1
1
9
9
8
-
1
1
9
9
9
-
1
2
0
0
0
-
1
Region-13
Region-14
Region-15
Figure 4. Time Varying Measures of Uncertainty by School District
(Variance of Previous four Quarter Residuals)
0
0.005
0.01
0.015
0.02
0.025
0.03
0.035
1
9
8
4
-
1
1
9
8
5
-
1
1
9
8
6
-
1
1
9
8
7
-
1
1
9
8
8
-
1
1
9
8
9
-
1
1
9
9
0
-
1
1
9
9
1
-
1
1
9
9
2
-
1
1
9
9
3
-
1
1
9
9
4
-
1
1
9
9
5
-
1
1
9
9
6
-
1
1
9
9
7
-
1
1
9
9
8
-
1
1
9
9
9
-
1
2
0
0
0
-
1
2
0
0
1
-
1
2
0
0
2
-
1
Region-1
Region-2
Region-3
Region-4
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
1
9
8
4
-
1
1
9
8
5
-
1
1
9
8
6
-
1
1
9
8
7
-
1
1
9
8
8
-
1
1
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8
9
-
1
1
9
9
0
-
1
1
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9
1
-
1
1
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9
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-
1
1
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9
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-
1
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1
1
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9
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2
0
0
0
-
1
2
0
0
1
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1
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0
0
2
-
1
Region-9
Region-10
Region-11
Region-12
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
1
9
8
4
-
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0
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Region-5
Region-6
Region-7
Region-8
0
0.005
0.01
0.015
0.02
0.025
1
9
8
4
-
1
1
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8
5
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2
0
0
0
-
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2
0
0
1
-
1
2
0
0
2
-
1
Region-13
Region-14
Region-15
Figure 5. Distance Bands used in Robustness Analysis
Miles from CBD
0-4 4-8 8-12 12-16 12-16 20+
incorporated area (in 2002)
regions of analysis from
school districts (Fig. 3)
Appendix Table 1
Summary Statistics for Variables Used to Construct Quality-Adjusted House Prices
[Median Values in Brackets], (Standard Errors in Parentheses)
Used in house price regression:
ijt jt ijt jt ijt jt ijt
L H p + + + =
0
) ln(

Variables
(1)
All Sales
(2)
Region with
Fewest Sales-9
(3)
Region with
Most Sales-1
Log(Real Sale Price) 11.61 11.37 11.57
[11.56] [11.39] [11.54]
(0.52) (0.44) (0.55)
New Construction 0.15 0.17 0.04
House Square Footage 1617 1561 1350
[1440] [1490] [1230]
(700.1) (559.3) (558.8)
Stories 1.36 1.34 1.33

Age 29.4 27.8 53.6
[24] [18] [56]
(25.8) (27.6) (24.9)
Bathrooms 1.85 1.71 1.56
[1.75] [1.75] [1.5]

Fire place 0.81 0.64 0.71
Finished Basement 2.30 0.81 2.74
(Grade: 0, 2-8)
Percent Brick 4.01 2.19 9.79

(18.00) (13.34) (27.92)
Quality of construction:
cabin-substandard
0.005 0.026 0.004
Quality of construction:
good-very good
0.370 0.189 0.248
Quality of construction:
excellent-mansion
0.017

0.001 0.008
House is in good to very
good Condition
0.31

0.369

0.434

Distance to downtown 11.57 30.48 5.02
Seattle [10.36] [31.47] [5.11]
(6.39) (2.56) (1.79)
Scenic View 0.127 0.245 0.186
Waterfront 0.013 0.016 0.006
Site Dangers 0.009 0.018 0.004
Difficult Topography 0.030 0.027 0.034

Observations 463,152 5,969 135,162