We analyze the effects of leverage on the timing of real estate developments that involve conversion of land from agricultural to urban use. We assume that a developer who maximizes the equity value obtains a defaultable mortgage loan. At the time the land conversion occurs, furthermore, a lender originates the mortgage loan at fair market value. We show that, under uncertainty, the leveraged developer moves the exercise of the land conversion option forward with the mortgage loan. Seeking to lower the uncertainty premium, the developer who can make a strategic default decision lowers the level of land conversion triggers. In urban growth models with irre-versible development, lower levels of the triggers expand equilibrium city size.
Keywords: leverage; mortgage default; real estate development; real option
