Real Options Valuation of Phased Investments in Commercial Energy Retrofits under Building Performance Risks

Abstract

Although the importance of energy efficiency investments has grown substantially in recent years, there has been very little about reliable valuation methods specifically aimed for commercial building energy retrofits under building performance risks. To fill this gap, the key objective of this study is to develop and exemplify a real options valuation framework that can be used to evaluate the financial impact of phased investments in a building portfolio. This study proposes a rigorous theoretical decision-support framework: Phased Investment for Energy Retrofits (PIER). PIER blends real options and net present value (NPV) analysis techniques together to valuate managerial flexibility associated with the phased investment strategy. The research results revealed that use of PIER would lead to a favorable NPV while performance risks could serve as a crucial factor that determines the level of government subsidy. The valuation framework of this study will help project owners and decision-makers better assess the impact of performance risks on commercial energy retrofit investments, which will serve as a solid foundation for them to make further better-informed project decisions.

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