The Question:

Real Estate Investment Corporation (REIC) is a firm that is principally engaged in the purchase, development, management, and sale of real estate properties, particularly residential properties. It is currently evaluating whether or not to purchase the old ABC Community Hospital, located in the East ABC of Singapore in a neighbourhood undergoing rapid growth and rejuvenation. The ABC Community Hospital operated unprofitably until 2021 when it closed and filed for bankruptcy. Real Estate is considering purchasing the building, converting it to apartment units, and operating it as an apartment complex. The hospital and its property are currently being offered for sale. Real Estate has performed an extensive evaluation of the site and neighbourhood, and has projected the value of the property to be $5 million. After considering its size and location, Real Estate thinks that this is an attractive price and is considering offering to purchase the property at this price. David is in charge of the hospital project for Real Estate. David has thought that this property could be converted into "low-income" apartments. The location seems ideal for such a conversion, and with the potential subsidy from government housing agency, the remodelling could be quite a profitable investment. The Singapore Housing and Development Agency (SGHDA) has been administering the Low- Income Housing plan (LIH) for many years, in an effort to accommodate families in need of affordable housing. Because of the high demand for housing in Singapore, rents have been increasing at rates higher than 10% per year in many neighbourhoods, leaving large numbers of families without affordable housing. For this reason, the SGHDA started the LIH plan, which provides financial incentives for real-estate developers to become involved in the rehabilitation of properties for low-income families. Under normal circumstances such projects might not be appealing to developers, since other investments might yield a higher return (with similar risk). With LIH financial incentives, which represent large subsidies to the developer from the SGHDA, these projects become attractive enough to warrant investment. The SGHDA takes many things into consideration before approving any project under the LIH plan, and all applications are carefully reviewed by different area specialists. The LIH plan subsidies represent long term investments of large amounts of money. Therefore, the SGHDA takes great efforts to ensure that all projects are fully completed and that they serve their original purpose of providing housing for low-income families. For companies which apply for government LIH plan, the completed application process may cost about $50,000. David needs to decide whether his company should offer to purchase the hospital or not; however, the decision process is more complex than this, since there are many factors that are uncertain. One of the key issues is whether the 96-unit renovation plan would be granted approval by the SGHDA (with subsidy). In some instance when a developer applies for SGHDA subsidies under the LIH plan, the SGHDA evaluation process can take as long as five months. Unfortunately, Real Estate has to make some decisions quite soon. According to David, some of the uncertainty concerning the approval of a potential application for the hospital property could be resolved if he could postpone his decision for at least one month, until after the coming November housing policy revision under Ministry of Housing. One of the two listed proposals is fully supportive of the LIH plan, and encourages more low- income housing for such developments. The other proposal has not been supportive of the low- income housing concept or the LIH plan of subsidizing private development. Obviously, the

chances of approval of an application for the hospital property to qualify for LIH plan subsidies would increase or decrease according to the outcome of the policy revision. David thought that if he were to wait until after November to make a decision on the property, he would have a better idea of whether his LIH plan application was going to be approved. Unfortunately, there is always the risk that the property would be purchased by some other buyer if Real Estate waited until after the policy revision. David therefore needs to decide whether to make an offer now or to wait until after the policy revision and risk that the property would already be sold. If and when Real Estate were to offer to purchase the hospital, they must also offer a non- refundable deposit of 15% of the purchase offer (in this case, $750,000). Once Real Estate has made an offer to purchase the hospital, Real Estate can then apply for the LIH plan subsidies. After 60 days from the date that the offer and deposit are drawn up, Real Estate must either complete the offer to buy the property, in which case the remaining 85% of the value of the property is paid, or withdraw the offer, forfeiting their 15% deposit. There is no guarantee that Real Estate's LIH subsidy application would be processed and decided upon within the 60-day period Real Estate has before making a final decision. (In the past, the SGHDA approval process has taken anywhere from one month to five months.) If the SGHDA were to decide on Real Estate's application within the 60-day time period, then this would make Real Estate's evaluation process easier. However, there is a distinct possibility that if Real Estate were to offer to purchase the hospital (to develop if for low-income housing), they would not hear from SGHDA regarding the status of their application before the 60-day limit that the hospital trustees have. Real Estate would have to decide either to withdraw their offer (and lose their 15% deposit) or to purchase the property without knowing whether their application for LIH plan subsidies is going to be accepted. Initially, David thought that the hospital renovation project would be profitable only if it received the LIH plan subsidies from the SGHDA. Renovation as well as maintenance costs on the property were projected to be quite high, and consequently higher rents would ordinarily have to be charged to tenants to cover these costs. However, because of all of the new development and construction that has been going on in the neighbourhood, David thought that medium-income families might find the renovated apartments attractive and be willing to pay the higher rents. This might make the renovation project cost-effective even if it were not approved for LIH development (and subsidies). So there is an alternative choice of developing non-subsidized commercial apartments for high income families.

Question 2

Reviewing the past history of LIH applications, David estimated the probability that the application decision would be delayed beyond 60 days to be 20%. David then estimated that the probability that the outcome of the new proposal is favourable is 70%. Given that the outcome of the new proposal were favourable, David estimate that the probability of the LIH plan to be approved is 75%; if the outcome were unfavourable, the probability of approval is 30%. Finally, David estimated the probability that the property would still be available for purchase after the policy revision (if Real Estate took no action) to be 80%.

David next went to work on the financial analysis of the development project. The estimated profit of the new development project under the LIH plan would be $850,000. This value includes the purchase cost of the property, the cost of renovations, annual maintenance costs, annual rental incomes, and applicable tax shelters.

If LIH plan approval were not granted for the project, Real Estate would lose some of the attractive subsidies and tax shelters offered by SGHDA. On the other hand, if Real Estate develop non-subsidized commercial apartments instead (without LIH plan), the estimated profit would be $250,000.

You are expected to quantitatively evaluate the value of this project and give your recommendations. You may provide:

A decision tree analysis model for this problem;

Solve the optimal decision strategy and give your overall recommendation.