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Case
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Reference no. 102-033-1
Published by: Asia Case Research Centre, The University of Hong Kong
Originally published in: 2002
Version: 16 July 2002
Length: 7 pages

Abstract

This case is a logical progression from ''Citic Tower II'' (201-047-1), and also addresses corporate capital budgeting decisions. Citic Pacific Limited (CPL) had to decide whether or not to purchase newly reclaimed land at the waterfront of Victoria Harbour, Hong Kong, and develop a Grade A office building for investment purposes. The decision was to be made at an approaching cyclical high point in the market for Grade A office space, in the second half of 2000, although at around 35-40% lower than the previous high point in 1997. At that time rental levels for office space were at record levels and substantial new office space was expected to come onto the market, with a consequent expected deterioration in office rentals in the medium term. CPL knew that the commercial real estate market was extremely cyclical, and that very few companies active in the market had managed to time rental cycles and investment strategies successfully. Although Citic Tower I had managed to survive the economic downturn unscathed, there was no guarantee that things would be any easier for Citic Tower II. Since the project showed a negative net present value, launching it at this point was unambiguously sub-optimal. Given the volatile nature of the market, the mark of a successful project was when the developer knew how to identify good projects and somehow also managed to time its market entry successfully. If Citic Tower II came onto the market at the right time, it might be far more promising than it appeared in mid-2000. Nobody knows when the ''right time'' is, of course, but being able to defer the decision to develop while still retaining control over the site could buy time and the option to retain what could be a very good opportunity. In other words, CPL had to value its options.

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Abstract

This case is a logical progression from ''Citic Tower II'' (201-047-1), and also addresses corporate capital budgeting decisions. Citic Pacific Limited (CPL) had to decide whether or not to purchase newly reclaimed land at the waterfront of Victoria Harbour, Hong Kong, and develop a Grade A office building for investment purposes. The decision was to be made at an approaching cyclical high point in the market for Grade A office space, in the second half of 2000, although at around 35-40% lower than the previous high point in 1997. At that time rental levels for office space were at record levels and substantial new office space was expected to come onto the market, with a consequent expected deterioration in office rentals in the medium term. CPL knew that the commercial real estate market was extremely cyclical, and that very few companies active in the market had managed to time rental cycles and investment strategies successfully. Although Citic Tower I had managed to survive the economic downturn unscathed, there was no guarantee that things would be any easier for Citic Tower II. Since the project showed a negative net present value, launching it at this point was unambiguously sub-optimal. Given the volatile nature of the market, the mark of a successful project was when the developer knew how to identify good projects and somehow also managed to time its market entry successfully. If Citic Tower II came onto the market at the right time, it might be far more promising than it appeared in mid-2000. Nobody knows when the ''right time'' is, of course, but being able to defer the decision to develop while still retaining control over the site could buy time and the option to retain what could be a very good opportunity. In other words, CPL had to value its options.

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