A2 Real Estate Analysis PDF

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Real Estate Development: Select a New Project

Yao Pan Metropolitan College, Boston University AD 715: Quantitative and Qualitative Decision Making Dr. Zlatev October 10, 2020

Real Estate Development 2 Table of Contents Executive Summary ..................................................................................................... 3 Introduction .................................................................................................................. 4 Payoff Table and Decision Tree Sketch ..................................................................... 4 EMV Results ................................................................................................................. 5 Sensitivity Analysis ...................................................................................................... 6 Recommendation ......................................................................................................... 6 Appendices ................................................................................................................... 8

Real Estate Development 3 Executive Summary Our company currently faces three project options: invest in an apartment building or an office building or a warehouse. We can also hire a business analyst to help us make the final decision. Based on these two premises, a quantitative analysis, using the payoff table, the decision tree, calculations of expected monetary values, and sensitivity analysis, is explained in my report. Questions addressed are 1. Which one of the development projects should be selected? 2. Should the company hire a business analyst? Proceeded from the decision tree (Appendix 4) and the payoff table (Appendix 2), Expected Monetary Values (EMV) of all three project options, and of whether to hire an analyst are calculated. •

EMV without an analyst is 304,800.

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EMV with an analyst could be as high as 314,400 only if the survey results are positive. However, the probability of positive results is 58% when we need a 96% certainty of positive results.

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The results will be negative is 42%, and the EMV could be as low as 59,000.

Although future economic conditions, optimistic, realistic, or pessimistic, are unknown for the company, investing in an office building without hiring any analyst has the highest EMV and a higher chance of succeeding.

Real Estate Development 4 Introduction Our real estate company is considering the development of one of the following three possible projects: (1) an apartment building; (2) an office building; (3) a warehouse. The amount of payoff earned by selling the estate depends on the economic conditions: optimistic, realistic, and pessimistic. We can hire an analyst to survey before making the final decision. However, there is an upfront payment of $14,000 for the survey. The probabilities of the survey results to be positive or negative are 0.58 and 0.42. All known data is revealed in Appendix 1. Payoff Table and Decision Tree Sketch The payoff table, Appendix 2, identifies the profit under each economic scenario with or without survey results. The decision tree’s sketch, Appendix 3, visualizes each alternative with its payoff under different scenarios. We should choose a project among alternatives, constructing an apartment, office, or warehouse with or without an analyst’s survey and interpretation. The states of nature are the uncontrollable, external environment (optimistic/realistic/pessimistic) surrounding our company. Our company first needs to decide whether we should hire a business analyst to assist in decision making. The analyst will charge $14,000 for a market survey whose result may be positive or negative. The probability of a positive survey result is 58%. Our company must then determine the optimum real estate project by analyzing individual alternatives under each state of nature. Data from the payoff table, and the Expected Monetary Value (EMV) of different alternatives, are added to the decision tree. Hence, a complete decision tree with payoffs, probabilities, and

Real Estate Development 5 EMVs is attached in Appendix 4. The calculation of EMVs will be demonstrated in the next section. EMV Results 1 •

Hire an analyst and survey results are positive: o Apartment EMV: 309,700 o Office Building EMV: 314,400 o Warehouse EMV: 258,700

In this case, we should hire an analyst and construct an office building. •

Hire an analyst and survey results are negative: o Apartment EMV: 59,000 o Office Building EMV: 82,000 o Warehouse EMV: 77,000

In this case, we should hire an analyst and construct an office building. ▪

Do not hire an analyst: o Apartment EMV: 286,400 o Office Building EMV: 304,800 o Warehouse EMV: 250,400

In this case, we do not hire an analyst and construct an office building. Hence, the development of an office building gives us three possible decisions: 1. Hire a business analyst and receive positive results EMV: 314,400 2. Hire a business analyst and receive negative results EMV: 82,000 3. Do not hire a business analyst EMV: 304,800

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For a complete analysis, see Appendix 5.

Real Estate Development 6 Although the EMV of hiring an analyst and receiving positive survey results is the highest in office building development, the EMV for hiring an analyst 216,792 is lower than not hiring 304,800. ▪

Hire an analyst EMV: 216,792

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Do not hire an analyst: 304,800

In conclusion, our company should not hire an analyst and develop an office building project. Sensitivity Analysis2 Let p represents the probability of positive survey results, while (1-p) is the probability of negative results, the EMVof hiring an analyst then is 314400p+82000*(1-p). 3 We are indifferent when the EMV(hire) is the same as the EMV of not hiring an analyst, 304,800. A detailed calculation to find the value of p is showing below: EMV(hire)=EMV(not hire) 314400p+82000*(1-p)=304800 232400p+82000=304800 p=0.96 In our case, the probability of positive results 0.58 is smaller than 0.96 (0.58...