Real Estate – Is It A Business Or Investment?

I read from newspapers the other day that McDonald’s Corp put 20-year franchise rights in Malaysia and Singapore on sale for at least USD400mil. In United States, the fast food giant’s revenue in 2015 alone was USD8.5bil and it earns one fifth of its revenue from rental payments from his franchisees. Amazing!

Then, I was pondering about the real meaning of real estate investment. These few years, everyone in town talks about the property and spontaneously they concluded that it is arguably the most investable product compared to stocks, bond or commodity. Investors, regardless of keeper or flipper, make money from buy low and sell high. In the Malaysia property history, the real estate price will always go up in long term without fail. Some properties price even doubled in less than 3 years. In addition, investors can leverage on bank loan a.k.a. other people’s money to invest. As time goes by, the property price increased whereas the balance of loan principle reduced.

Nah, it is indeed a dull topic! I will not cover this topic further before you flip to the next article.

On the other hand, there are so many conventional or creative ways to make money from property other than owning it. Businessmen look at property in a totally different perspective. First of all, property investment takes time to reap the fruit, usually 5 to 10 years or more. Inevitably, there are many pitfalls throughout the span of 10 years investment, e.g. tax, legal, tenant management, physical defects, to name a few. In contrast, Businessmen use property as a tool to run their business, make money in shorter time frame and bypass all the hassle without holding that property for a long term.

The most common way amongst all will be the fix-and-flip, or in layman term that means investors buy, overhaul and sell it at a premium. Some even go for auction properties to fetch a higher margin. I have an investor friend in my network who specialise in acquiring bungalows in Penang island, design, renovate and furnish it and sell at a 10% profit, i.e. usually RM300k or more. However, with the raise of Real Property Gain Tax (RPGT) to 30% for first 3 years of property disposal on October 2013, many businessmen have to make some special arrangement to avoid the tax.

Naturally, we perceive business as something we need to incur a lot of capital to start with. Worse still, we need to put in a lot of time and effort to make profit and most of the time it is risky. However, in property business, these are not always the case. For easier explanation, pls see the examples of some business model in property below.

Entrepreneurs have different characteristic among each other. Some are conservative and cautious that they only go for business that generates safest returns. Some are aggressive and they have much largest risk appetite. Some are cash flow sensitive that they are especially particular in managing their cash flow. In fact, there are many businesses that the more we put in our time, the lesser capital we need to inject in it. Moreover, it is relatively safer compare to investing a property.

Let’s have a look at the strategies my investor friends used to make profit through real estates. 

ACTIVE BUSINESS MODEL

(more time needed to involve in the business):

Introducer

As a businessman, network is our networth. To become a good introducer, we need to have a network of all-time ready buyers and some experienced real estate negotiators who can bring us great deals. We make money by selling the deal to potential investor. You will understand this if you are familiar with Cashflow Game 101. The key is to make the deal owner look for you first before approaching other investors.

Deal Matcher

One investor may faced constraint in investing property due to insufficient fund, whereas another investor do not have borrowing capacity due to age or other reasons. Just like introducer, we match the two investors who can share their resources to form a JV partnership. Then, we make profit by owning a portion of the property share or make monetary commision for our effort to bridge the 2 investors as agreed by both parties.

Demand Creator

Property investment is all about supply and demand. In some newly developed area, businessmen start up businesses as pioneer in that area to draw the crowd. When the area is mature after several years, they will sell off their business to other investors, keeping the property for rental collection.

Paper Investor

There are investors who invest real estate without really acquiring the property. They will look for distress sellers who are no longer afford to pay the monthly installment. Then they come out with a legal agreement to settle the monthly instalment on behalf of the seller with the option to buy the said property at fixed price in the future, usually lower than market value. When the next buyer purchase the property, this investor will make the profit from the selling price less fixed price stated in the agreement.

Tenants Manager

Managing tenants is a difficult tasks for most people who are not a full-time investor. One can actually help the investors to manage the property by searching for good-profile tenants, collecting rental, solving problems and arranging repair/maintenance jobs for their properties. In return, he will be paid 5 – 10% of the monthly rental payments.

PASSIVE BUSINESS MODEL

(no time needed to involve in the business)

Real Estate Investment Trust (REITs)

There are many types of REITs in Malaysia. The 2 most common type of REITs are retail REITs and residential REITs. The main source of income for retail REITs is the rent collected by tenants of their shopping malls. Residential REITs on the other hand invests in residential buildings such as apartments, condominiums, high-end and luxury high-rise residentials. This type of investment is particularly popular in the difficult time as investors do not need huge capital to own the expensive properties and yet they can enjoy the benefit of investing in it.

JOINT-VENTURE (RAW LAND)

Some individuals have a piece of raw undeveloped land (commercial or residential title) and they do not have the capability to develop it. They can joint-venture (JV) with a developer to add value to the plot of land by planning and developing it. In return, they will own a portion of the project which will eventually make more money for them than just selling the land.

JOINT-DEVELOPMENT

This is a unique way of investing in a property development business which is popular in many European countries for more than a decade. Investors will fund the development project through a specially arranged legal structure within a specified time frame, usually 2 – 3 years. Upon exit, investors will make a fixed return as stated in the agreement. Investors will be protected by a corporate term note and/or land charge as security. Generally, the capital outlay is minimal and the return is attractive.

In a nutshell, the property market could be vulnerable in a prolonged economic slump. With all sort of options available, we can now choose the right investment and business model that best suited our financial portfolio. Diversification is always a good solution to reduce the risks, be it an investment or a business.

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By : Roy Ong