How To Think About Real Estate

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Real estate is different than other types of investments

Here is what is meant by that: you never have to invest in a share of stock, or a barrel of oil, an ounce of gold, or 0.01 Bitcoin. Those are 100% discretionary investments. But real estate is different: we cannot sit out the real estate market. We must interact in a financial way with real estate. We may not have to buy it, but most of us who do not still stay with our parents have to rent a house or room somewhere. When you pay for a burger that costs US$25 in Hong Kong’s Central area, 40% of the cost of that burger is probably due to real estate: rental costs. In most of our shopping and retail experiences, there is an embedded real estate rental cost in it.

This is so obvious that most people should have thought about it. We are going to lease office space, or work for a company who does, if we are not the business owner. We are going to go on vacation – that means hotels or Airbnb homes.

In the framework of primary, secondary, and tertiary wealth, real estate (depending on the flavour you get) is either primary or secondary. Primary wealth might be arable land or farmland itself, as are energy resources like oil, coal, wood and charcoal – all of which are embodied energy from the sun which grow on suitable real estate. We may say that farmland has an embedded value of energy in it, because the crops harvested are possible due to the energy from sunlight. Secondary wealth in real estate terms would be the means-of-production type of real estate: commercial or the rentable property.

Because of that, real estate doesn’t operate like other asset classes. Real estate is an unavoidable investment, because it is the earth, and supply is finite in most places, at least outside of places where land is reclaimed. Rising sea levels will defeat that over time, and still lead to a shrinking supply of productive real estate.

However, not all real estate is the same. It’s not just about real estate; it’s about the person that invests in it. As it turns out, there are many different ways to invest in real estate, and many types of property. Unfortunately, the run-of-the-mill consumer has no idea, so they do the usual thing, which is leveraged purchases of residential units, either to rent out or flip. A smaller minority may go for commercial properties, for which less leverage is typically allowed: the maximum loan to value may be 80%, but this is usually decided on a case-by-case basis, depending on the type of commercial property and the bank. Some banks will not finance factories, or anything other than the ground floor of a mixed development.

A good framework to have is to have a personal investment philosophy. That is different for every person, and it is the thing that has them gravitating towards wanting to invest or own or hold property of some kind.

This is an exercise to figure out your personal investment philosophy. Once you figure out who you are as an investor, the next thing is to find a real estate market or markets, property types, demographics that you want to serve that will fulfill the personal investment philosophy of yours. For example, if you are hands-on real estate investing and you are looking for opportunities to buy stuff and add value and sell it at a profit. If you’re hands off real estate investment, then you are looking to come alongside a professional investor that can help you whether that is a syndication or a real estate investment trust or just a private placement or just a partnership.

Once you figure out a market or markets, the next thing is to find a team that can help. Unless you play only the listed space of REITs (as I do), real estate investing tends to be a team sport. If you own a physical building, operating it requires expertise. There are compliance elements, such as fire safety certificates, lift service certificates, and operating elements, such as water pumps, electrical wiring, and so on.

The people on your “team” are your broker(s), your banker, your lawyer(s). Some services, like market research, can be outsourced. You’ll need people on your team who are well-versed at that, and if there are areas you’re not great at, those folks are going to be important. Once you’ve identified your team now the final piece is the property.

I would argue that the property is the least important and most interchangeable part of the whole thing. However, what most people do is start with the property. They find a “good deal” and they buy a property. If it’s not in alignment with who they are and the kind of investor they are, such as their holding power, then there is a recipe for disaster. After one business cycle from boom to bust, you may then hear people say they tried real estate but it didn’t work. Real estate can work if it works for you.

No specific financial performance profile

One of the things that people sometimes don’t understand is that real estate doesn’t have a specific financial performance profile. It is versatile. You can do a lot of different things with a real estate portfolio. I’ve spent some of my free time studying financial planning and portfolio construction – there are some really good things that come out of the paper asset world in terms of the way you structure a portfolio to handle good times and bad times.

What a lot of people don’t understand is that pretty much anything you can do with a paper asset portfolio in terms of asset allocation and equity growth and cash flow generation and tax strategies and asset protection and estate planning, you can do with real estate. It takes a little bit of learning to do it because it’s not as commonplace to be able to know how to do it. But it’s worth the effort because you are building the portfolio that is really time-tested.

Real estate is time-proven

If you go back 50 years, 100 years or even 1,000 years ago, the wealthiest people owned and controlled real estate. Wealth that is very scalable in the digital manner, such as equity in Mastercard or Microsoft, are a feature of only the last 50 years: a function of the fossil fuel age. The owners of equity in those companies might make their wealth someplace else, but lots of wealth gets stored for protective purposes in real estate, as is the case with Bill Gates.

Physical real estate investing, as opposed to REITs, has one problem for young investors: ticket size. To invest in a commercial shoplot in the Klang Valley which costs RM3 million, you will need RM600,000 cash as a downpayment.

Syndication is the ability to put people together to do a bigger deal. Someone who has worked for 3 or 5 years might not have enough savings (or leverage ceiling) to personally invest in a piece of property that he or she might like, but if three or four friends band together and each put in S$50,000 or S$100,000, now there are more possibilities. This is one way to get around the ticket size issue: a simple syndication. Needless to say, you have to pick partners you know you can work with, with a similar investment framework, holding period, and thinking. But many of the bigger real estate transactions today like hotels, big commercial office buildings are almost always done as a syndication, a group of investors that come together.

Tax aspects of real estate

This concerns not just the tax-deductibility of interest on real-estate loans in some jurisdictions. With-holding taxes for foreign investors in some jurisdictions is an important thing to look out for, as that can dilute returns.

Overseas investors in US or Australian real estate will face with-holding taxes and capital gains taxes on disposals of those properties in the future. However, in the REIT space, the right structure may be able to provide a shield against (say) US with-holding taxes, as with Keppel-KBS US REIT. This REIT provides a tax-efficient means for investors to participate in the US commercial real estate market, as its properties are held under a structure which provides a shield for investors against US withholding taxes.

Another example is Manulife US REIT, which was restructured as a Singapore-Barbados-US-based entity in January 2018 in order to manage the tax leakage from revisions to the US tax code in December 2017.

If you study a country’s tax code, you can tell (most of the time) where they would like to see you put your investments, if the tax code is well-thought-out. In the US and lots of places around the world, there are tax benefits given to people who will endeavour to provide clean, safe affordable housing, office space, and productive farmland to other folks. The idea is that we have a multitude of benefits that we can derive from real estate: recurring income, long-term growth over time, and amortization of the loan, which puts more of the real estate on your side of the balance sheet (equity).

Tax benefits can be immense. Sometimes, people actually choose the specific vehicle in real estate based on the tax result they are trying to achieve in life. If they have a lot of earned income and they want to offset that, there are ways to do that with real estate. Tax credits allow you to take a property you own and then push all of the gain and equity forward, and not pay tax today. This can be termed a tax deferred exchange, where you are exchanging for another property. Warren Buffett is the king of deferred tax benefits, which explains a not-insignificant part of his wealth pie.

One of the greatest tax breaks possible in real estate is depreciation. The way depreciation works to take the value of the structure (not the dirt beneath it, or value of the land per se) and depreciate it over time: the building is deemed by Inland Revenue to be deteriorating over time. In the real world, many buildings can have a 40- or 80-year life if maintained well, so it can go up in value in the interim. But for tax purposes it is going down in value and you are suffering a “loss.” But it’s a “phantom loss” because you are not really putting any money out and you are able to take that write-off against money you have coming in, and so that creates a huge tax benefit.

Depending on the type of property, you can have accelerated depreciation for certain components like the personal property or the fixtures (wiring, pipes, water pumps, etc). So there are schedules you can work with on your accountant to do that. It is a way to pull in a lot of capital by pulling tax breaks into the current and not having to pay current income tax against the money you are bringing in today. This is not complicated, and worth a few hours of reading to understand if you want to be a serious real estate investor.

Why are you interested in real estate investing?

Is it for passive cash flow? Is it because you want to expand your balance sheet over time? Is it for tax breaks? Based on what your answers are to those questions, you are going to select real estate types and markets that are going to give you the best advantage you can.

The role of debt in real estate investing

For most investors, they are thinking of a mortgage loan when they buy residential real estate. In some jurisdictions, debt is useful for the reason that interest payments are tax-deductible. Leverage is also useful because it can multiply your return on investment, if you buy at the right time and prices do indeed end up going up.

If you have a property that you expect to generate cash flow at 10% yield per year, and you can borrow money at 5% to purchase it, you should borrow as much as you can and own as many of those properties as you possibly can, because you make a profit on the debt and that is just on the cash flow. The tax breaks (in some jurisdictions, perhaps no in Malaysia and Singapore) and the amortization and the long term appreciation have to be thrown in too.

Unfortunately, not enough property investors in Malaysia and Singapore make these considerations in the residential case. You can be killed if you have leveraged investments that all drop 30% in capital value in a recession, even if the cashflows on some of those assets are maintained, i.e. tenants are able to maintain payments and honour contracts signed (even so, you may have to lower rents for a while for goodwill). This is because in some cases, banks can make a margin call if your property dips into negative equity. But this is not always true, you would have to check for your jurisdiction. If not, and if you have the cash to sustain a 1.5 year recession, then all should be fine. Such calculations should be made accordingly.

Therefore, we have to accept that leverage is a double-edged sword, although I would love to have a no-lose scenario in leverage real estate plays. If you are very sure about capital gains in the timeframe of your investment, you can have a higher debt level. The more certain you are, the higher the debt level you can take on, subject to the bank’s (or your alternative financer’s) discretion.

These days, easier debt access (and cheaper debt!) is the tail that wags the dog of capital gains, especially in residential markets: there is a positive feedback loop between gains in real estate prices and lower interest rates / easier availability of credit to the population at large. We have to be careful not to get caught high and dry when the credit spigot is frozen, although my thinking is that central banks are not likely to let residential property prices fall more than 30-40% from today’s prices.


Real estate investment trusts (REITs) are required to abide by a certain set of rules in order to be considered a REIT. That includes paying out at least 90% of their distributable income to unitholders. In exchange, REITs enjoy tax benefits and are only taxed on retained income that is not distributed. In essence, distributable income is not taxed at the corporate level as long as it is distributed to unitholders.

In Malaysia and Singapore, investors are not taxed on personal dividends, either. In the case of Malaysia, this is as long as the dividends are not your primary source of income, i.e. that you as an individual hold a job and pay income tax on that salary. This means that, effectively, nearly all of the income earned from a REIT at the corporate level goes directly into the unitholders’ pockets. There are few other good opportunities in life to avoid the taxman.

Singapore is the most liquid listed REIT market in the region, with 40 listed REITs to choose from. Malaysia has around 15 at pixel time, if I recall correctly.

REITs in many cases are levered, with many in Singapore maintaining gearing ratios between 30% and 45%. Those with a higher gearing tend to be riskier; those with a gearing closer to 30% can easily afford to acquire more properties to be injected into the REIT.

The important metric for REITs is the dividend yield, which are benchmarked to risk-free government bond yields. The higher the spread between REIT dividend yields and government bond yields, the better – the latter is considered risk-free, while REITs are risky and allow capital value losses, which is why they should pay a higher yield in the first place.

Our financial education system (which doesn’t seem to exist in Malaysia/Singapore!) is a marketing system that feeds the banks, developers, and agents (both real estate and insurance, some of whom create value, and some of whom don’t).  If you want to get out of that system and stop feeding those parties and keep more of your own money, real estate can be a vehicle to do it with, if done the right way.

The first thing to do is to understand, to get educated about real estate investing. There are many options to do this in the age of the internet. It doesn’t have to go to a real estate broker or salesperson who wants to sell you a house or a property – there are great books and audio courses and podcasts.

If you find a seller that really wants out, you can negotiate a great deal for them that you can’t do in other types of markets. So the thing about real estate is that you don’t want to be overwhelmed by it.

There should always be a way to get involved with real estate that speaks to you whether it is providing clean, affordable housing for folks who can’t afford to buy their own property. Or it could be about getting people involved in sustainable agriculture (which I what I’m interested in) and seeing why we are going to have a food/biodiversity crisis at some point, and how we can benefit from that.

Right price, right time

The game is to figure out how you can do something with real estate that feeds your passion. There should be no hurry: I believe that in real estate, there is always a right price for an asset. The value of beachfront property, for example, should trend to zero in 50 years due to rising sea levels, so you might want to think about that. As for the right piece of urban real estate or agricultural plots, they can still preserve capital and even provide cash flow, but you may have to put your own time into operations. You don’t have to jump in tomorrow if you think market prices are still high.

If you are really good and you know how to find value, you have a chance.

Guest Contributor, Aidan Chan.

Aidan Chan is a mentor to CEOs, a tutor in physics, mathematics, economics, and also works at a sovereign wealth fund as a day job. He trades in the stock market as a side hobby. He graduated with a B.A. (Hons) Mathematics from Cambridge University in 2012. In his spare time he reads books, mostly on history, philosophy, economics, finance, nutrition, physics, and chemistry. He also does Paleo exercises.

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