Real estate 101

Business model

The main variations in the business model of a real estate company is typically that of:

  1. Acquiring to sell (i.e. developer): A typical example would be property developers bidding for land and selling a finished product (e.g.: residential units) to end consumer.
  2. Acquiring to rent (i.e. landlord): In the context of Singapore, property companies holding assets for the long term and leased the units out for rental income. Typical examples include office buildings, industrial buildings and hotels.

Drivers of real estate business

The dynamics of real estate business is affected by factors which are often out of control of the companies. In most instances, real estate companies are largely price-takers in the market which they operate in. Below are some broad factors which have implications to a real estate company.

  1. Government policy: In a highly government controlled real estate market such as Singapore, the demand and supply forces are often controlled by government policies. Singapore government master plan, release of land parcels, property cooling measures and immigration policy are some of the examples which could significantly impact the demand and supply forces of the property market which would in turn have a significant bearing on the performance of real estate companies.
  2. Cost of funds: Funding to real estate companies is as important as water is to fishes. To undertake a new property acquisition, real estate companies often have to either tap into the debt or equity market. Hence, maintaining a competitive cost of funding and access to multiple avenues to the debt and equity market is essential for a real estate companies to operate.
  3. Sentiments: An important and yet often difficult to quantify factor which impact the real estate companies’ business is overall market sentiments. This impact developers more than landlords due to the shorter business cycle of a developer. In a situation whereby a developer is able to ride on a cycle of positive market sentiments, it will be able to turn around a piece of land into a finished product while booking in a handsome return of equity over the development cycle which typically last three years. Conversely, if the sentiments turn bearish during the property development cycle, property developers will face with significant losses. On the other hand, real estate companies which are landlords, will not have their rents increased or decreased significantly arising from the positive sentiments as rents are typically locked in for a period of 2 years to as long as 10 years for certain industries. The only exception is probably hotel business whereby room rates are charged by days.

A mixed and match is usually the case

Typical real estate companies are a mixed and match on the above (i.e. a portion of the business doing development while another portion of the business doing leasing) due to the natural manner which real estate companies evolve. Real estate companies typically begin their trade as property developer and invest their returns into being a landlord which will provide them with a stable recurring income.

To add into the confusion, a significant number Singapore real estate companies have expanded to foreign land to replicate the business model which will subject themselves with the respective drivers of the real estate market in that particular country such as government policy surrounding land ownership restriction by foreign companies.

Economic moats

Developer: I would say there is hardly any economic moat amongst property developers as the pricing of the development is usually driven by the attributes of the specific projects such as location and market sentiments. As a result, significant profits are usually earned by companies during a positive market cycle.

Landlords: Real estate landlords typically have greater means to create economic moats through better asset management strategies.

One example would be mall management strategy undertaken by more successful mall operators in Singapore such as CapitaLand and Frasers Property. It is not difficult to see greater foot traffic well-run malls which will directly translate to higher rental return.

Another example would be the hotel at Marina Bay Sands which is an iconic must stay places in Singapore. This in turn allow the hotel operators at Marina Bay Sands to charge a premium rate.

Summary

The above presents readers a high-level understanding on real estate companies’ business and what are some of the key drivers to their business. Before you invest your dollar in a real estate companies, it is probably useful to ask yourself these questions:

  • Is the company primarily a developer or a landlord?
  • Is the company investing in countries outside Singapore?
  • Are there any government policies which will impact the company?
  • How is the company funding its real estate investment?
  • What degree of economic moat is the company able to create?
  • How is the market sentiments impacting the companies’ business?

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