Uncertainty, Flexibility, Valuation and Design: How 21st Century Information and Knowledge Can Improve 21st Century Urban Development – Part II of II

Abstract The 21st century presents humankind with perhaps its greatest challenge since our species almost went extinct some 70,000 years ago in Africa. A big part of meeting that challenge lies in how the urbanization of three billion additional people (equal to the entire world population in 1960) will be accomplished between now and mid-century, on top of necessary renewal and renovation of the earth’s existing cities. China alone will urbanize 300 million more people between now and 2030, equal to the entire population of the U.S., the world’s third most populous country, in just 20 years. This is development on a scale and pace that is an order of magnitude greater than the past century, in a world resource and climate environment that is near the breaking point, in a context of greater technological, financial, and economic uncertainty than ever before. To meet this challenge will require that we use the best tools in our kit, including ones that have become available to us only in this new knowledge and information-based century. Technology got us here, and technology will be key to getting us through. In this paper we will review and synthesize two important methodological developments in our profession that can help infrastructure and real estate physical development (i.e., urban development) to be accomplished more effectively and efficiently in a world of uncertainty. The first methodological development is the honing of real options theory and methodology for practical application to identify and evaluate sources of flexibility in the design and operation of capital projects. The second development is the marriage of digital data compilation of property transactions records with the honing of econometric analysis methodology to allow the practical quantification of real estate and infrastructure asset price dynamics. We argue that this latter development provides the key input to the former development, enabling a much more complete and rigorous treatment of design and evaluation problems for urban development. We also argue that an engineering systems approach to option modelling is likely to find better traction in actual professional practice than the economic theoretical models that have dominated the academic literature. We provide a concrete example by applying the suggested approach to the Songdo New City development in Korea. The result can be better informed design and valuation and more efficient urban development laced with greater flexibility to avoid the worst down-side outcomes and to take advantage of the best up-side opportunities, saving vital resources of capital, land, raw materials, and energy.