Korea Real Estate Investing - Part 2: Oceanview Apartment for $10,000
Welcome to Part 2 of our Series on investing in Sokcho, Korea. If you missed Part 1, click here. The series follows a group of Seoul Real Estate Investing Members whirlwind 19 hour day as we traveled to Sokcho (located near Mt Saraksan) to check out the properties of two of our investors and explore unique Korea-focused real estate buying strategies using Key Money deposits.
One thing is apparent from our conversations with the Sokcho Investors: their search for "desirability."
What is desirability? A quality of the real estate property that people will always be attracted to. Some common desirable factors might be:
* Proximity to a great school
* Beautiful ocean views
* Beautiful mountain views
In fact the investors' choice of Sokcho to invest is in large part driven by what they see as Sokcho’s inherent desirability as a location (ex: proximity to Mt. Sarkasan, beautiful oceans, and more - we’ll discuss that more in the next email).
As we drive to Property #2, we can see right away that one of its big desirability factor is its clear, unobstructed ocean views.
From the rooftop of Property #2. Prices may go up or down, but ocean views will never change.
Of course, finding a desirable property is only part of the process. There are countless, beautiful, desirable properties located throughout Korea and the world. As a real estate entrepreneur, you need to go one step further - buy these desirable properties at a discount to what their 'worth.'
You saw with Property #1 how our Sokcho Investors were able to turn KRW 3,000,000 into KRW 16,000,000 (or KRW 13,000,000 in profit) right from the outset of their purchase.
A property is only valuable to a real estate investor if it’s selling at the right price. A really nice home selling for an exhorbinant amount might be fine for the homeowner who’s blinded by thoughts of raising kids there and showing off a new bbq grill. But of for a real estate entrepreneur, whose goal is to make money, and more importantly, not lose money, price is ALL IMPORTANT.
The difference between what you PAY FOR A PROPERTY and what a PROPERTY IS WORTH is what Warren Buffett would call - "your margin of safety."
Every investment you buy should come with an adequate "margin of safety" that takes into consideration:
* Potential upside (how much you can make)
* Amount of effort needed
* Risk (usually measured in 'how much you are paying')
The higher the risk and effort, the more 'margin of safety' you'd like built into the deal.
RULE OF INTELLIGENT INVESTING
1. Do no speculate in real estate and hope for prices to go up. Buy at a price that guarantees a profit.
How is this done?
By searching out mispriced assets - Assets (property) that is being sold for less than what it's worth.
Let's take a look at how our Sokcho Investors apply Intelligent Investing rules to Property #2.
Original Asking Price: KRW 150,000,000
After Negotiations: KRW 100,000,000 + 10,000,000 for all the furniture
Key Money deposit from new tenant: KRW 100,000,000
Out of Pocket Price for our investor: KRW 10,000,000
For KRW 10,000,000 our investors were able to get a room full of very nice furniture (in fact, one regret they had was leaving the nice furniture in there and not replacing it with sturdier, furniture) and control of an apartment in this building:
Here's an important point to consider: The negotiation down to KRW 110,000,000 wasn't simply an arbitrary number to 'buy low' - but it was based on understanding the market and knowing what the current key money rate for the apartment was. By knowing that information ahead of time, they could make a calculated purchase based on Risk vs Reward. By having this knowledge ahead of time, they could negotiate and explain their reasoning while also knowing how much margin of safety they were comfortable with purchasing at.
KRW 150,000,000 represented a fair price for the property
But at KRW 110,000,000 (plus furniture) our investors were severely limiting their downside risk.
They tenant would provide most of the upfront cost. And in the worst case scenario, they could sell their property for KRW 110,000,000 rather easily and have a net profit of a room full of nice furniture!
Sound easy? In theory, it is. But in practice, it takes a lot of research, a lot of study, and an understanding of the market and risk.
What do you think? Do you think they got a good deal? I'd love to hear your feedback.
Comments (3)
Hey Jessica...Great question! I had the same questions when I first learned about this.
The strategy is not a rental income cashflow strategy. In fact, we ran the numbers (IRR) for both rental income vs the key money strategy and found that the key money strategy returns far exceed rental income.
I'll go into more details but in a nutshell, this is a networth building strategy (or you can think of it as an appreciation play). If you're looking to get passive income through rental income, then this strategy may not apply, unless you have many, many properties, which I'll explain.
First off, before trying this strategy, an investor must find these things:
1. A steady market - Seoul, with its big swings up and down, is too volatile (or adds more risk).
2. A market where the Key Money is 85% or higher, relative to the purchase price. This reduces the amount of cash needed to make the purchase.
3. A discount at the purchase. As with all investments, you want to make sure you made money at the purchase.
So how does this work?
So let's say you're able to find a discounted property in a steady market (we'll use Sokcho for this example, but other markets exist).
The owner wants $150,000 for the purchase. You know tenants are willing to put around $95,000 in Key Money to live in the area, rent free. You're able to negotiate down to $100,000.
Once you have an agreement, you put down earnest money of $5,000. You market the property for a tenant and find someone to agree to the $95,000 Key money. You schedule a "double closing." Tenant will move in the same day you take possession. $95,000 goes to the owner + the $5,000 you put down for your deposit. Tenant gets a place to live. You now own the unit.
You have, in essence, received a 0% interest loan from your tenant.
But so what? You're not 'making money' off of rent? So what's the point?
Here's where factor #1 comes into play - a steadily increasing market.
In two years, when the contract is up, if the market has appreciated to say $105,000 for key money deposits, you can either: a) ask for more key money or b) find a new tenant.
Let's say your tenant wants to leave and you find someone else who wants to pay $105,000 in Key money to live there.
You take the $105,000 from the new tenant, give back $95,000 to the old tenant. That person leaves and finds a new place to live.
The new tenant moves into the property.
And you pocket the difference - $10,000 - between what the new tenant gave you and your repayment to the old tenant.
You pay yourself back $5,000. And you have a $5,000 profit.
So in two years, you've managed to double the money you paid to 'purchase' this property.
What if the market doesn't go up?
Of course, people will naturally ask - what if the market doesn't go up? What if there's a downturn?
There's certainly that risk.
That's why Factor 1 is important - steady market. But now Factor 2 also comes into play.
What did you risk to take ownership of this apartment? Your out of pocket payment has to be 'small enough' so that you limit your downside risk.
If, worst case scenario, the market takes a severe downturn and the key money rate drops dramatically. Let's say it drops to $50,000 - highly unlikely, but let's just say.
Now you don't have enough to pay back your tenant. What happens?
The property becomes their property. And you lose your initial investment.
While that's not a 'good thing', investing is all about limiting the downside risk vs. the upside potential.
However, here's where Factor #3 comes into play - buying at a discount.
Since you bought at a discount, in the event of a downturn (or simply if you wanted to cash out right away), you can turn around and sell it for a profit.
If you sell it for $120,000 (and assuming that $150,000 was the 'market price), this will still be a great deal for someone else.
You pay off the $95,000 to your tenant, and you can pocket $25,000 (essentially turning your $5,000 into $25,000).
Is this like a flip then? (or wholetaling as it's called, when you don't actually improve the property and just turn around and sell at a discount)
In a sense, yes.
But the way it differs in these ways:
1. Your getting the money to buy these houses at a 0% loan from your tenant.
2. You can hold onto the property, and every two years when the key money rises, you'll continue to get back some cashflow. (It's like a dividend that pays annually, not monthly).
It still sounds risky
You definitely need to choose your market wisely and buy the right property at the right price. Or else, you can certainly lose money. And you need to limit how much you pay out of pocket.
Why would the owner sell at a discount? Why would people use key money instead of just buying a property if the price is so close together?
Owners: They might be selling for a variety of reasons. Maybe they don't want the hassle of managing this type of strategy because they're not professional real estate investors. Or maybe they just want the cash and not want to worry about having tenants. And also, keep in mind, this:
Let's say the original owner paid $90,000 cash for this property. He can now get $95,000 in key money. That's only $5,000 annually he's receiving for his investment. So his ROI is much lower than yours based on how much he paid out of his pocket. This might not make sense for him, but might be great for you!
Tenants: They might only be looking to live in the area temporarily - maybe their company moved them there. Or maybe they're worried about a downturn in the market and don't know prices well enough to feel comfortable buying. The bottom line: Not all tenants are professional investors, and therefore you, as a market expert, have an advantage.
Conclusion: So while you need to wait a while to realize your returns, over the long haul, your compounded rate of return vs the amount you invested can be very high - we calculated one of the investor's compounded rate of return to be 81%! Imagine that - getting 81% annual returns on an investment. Even Buffett would smile at that - and Charlie too.
Of course, it's only a project (81%). So we'll see if it's realized over time ^^
However, the investors learned the strategy from another investor who has purchased 100s of properties this way. So there's proof that others are making it work.
If you have other questions, feel free to comment. See you on Friday at the Happy Hour!
(oh .. I wrote a few more articles about these strategies on this blog / discussion board, so you can check those out as well)
http://www.biggerpockets.com/blogs/6526/blog_posts...
and
http://www.meetup.com/Seoul-REI-Meetup/messages/bo...
Daniel Ryu, about 9 years ago
Hey Jessica...Great question! I had the same questions when I first learned about this.
The strategy is not a rental income cashflow strategy. In fact, we ran the numbers (IRR) for both rental income vs the key money strategy and found that the key money strategy returns far exceed rental income.
I'll go into more details but in a nutshell, this is a networth building strategy (or you can think of it as an appreciation play). If you're looking to get passive income through rental income, then this strategy may not apply, unless you have many, many properties, which I'll explain.
First off, before trying this strategy, an investor must find these things:
1. A steady market - Seoul, with its big swings up and down, is too volatile (or adds more risk).
2. A market where the Key Money is 85% or higher, relative to the purchase price. This reduces the amount of cash needed to make the purchase.
3. A discount at the purchase. As with all investments, you want to make sure you made money at the purchase.
So how does this work?
So let's say you're able to find a discounted property in a steady market (we'll use Sokcho for this example, but other markets exist).
The owner wants $150,000 for the purchase. You know tenants are willing to put around $95,000 in Key Money to live in the area, rent free. You're able to negotiate down to $100,000.
Once you have an agreement, you put down earnest money of $5,000. You market the property for a tenant and find someone to agree to the $95,000 Key money. You schedule a "double closing." Tenant will move in the same day you take possession. $95,000 goes to the owner + the $5,000 you put down for your deposit. Tenant gets a place to live. You now own the unit.
You have, in essence, received a 0% interest loan from your tenant.
But so what? You're not 'making money' off of rent? So what's the point?
Here's where factor #1 comes into play - a steadily increasing market.
In two years, when the contract is up, if the market has appreciated to say $105,000 for key money deposits, you can either: a) ask for more key money or b) find a new tenant.
Let's say your tenant wants to leave and you find someone else who wants to pay $105,000 in Key money to live there.
You take the $105,000 from the new tenant, give back $95,000 to the old tenant. That person leaves and finds a new place to live.
The new tenant moves into the property.
And you pocket the difference - $10,000 - between what the new tenant gave you and your repayment to the old tenant.
You pay yourself back $5,000. And you have a $5,000 profit.
So in two years, you've managed to double the money you paid to 'purchase' this property.
What if the market doesn't go up?
Of course, people will naturally ask - what if the market doesn't go up? What if there's a downturn?
There's certainly that risk.
That's why Factor 1 is important - steady market. But now Factor 2 also comes into play.
What did you risk to take ownership of this apartment? Your out of pocket payment has to be 'small enough' so that you limit your downside risk.
If, worst case scenario, the market takes a severe downturn and the key money rate drops dramatically. Let's say it drops to $50,000 - highly unlikely, but let's just say.
Now you don't have enough to pay back your tenant. What happens?
The property becomes their property. And you lose your initial investment.
While that's not a 'good thing', investing is all about limiting the downside risk vs. the upside potential.
However, here's where Factor #3 comes into play - buying at a discount.
Since you bought at a discount, in the event of a downturn (or simply if you wanted to cash out right away), you can turn around and sell it for a profit.
If you sell it for $120,000 (and assuming that $150,000 was the 'market price), this will still be a great deal for someone else.
You pay off the $95,000 to your tenant, and you can pocket $25,000 (essentially turning your $5,000 into $25,000).
Is this like a flip then? (or wholetaling as it's called, when you don't actually improve the property and just turn around and sell at a discount)
In a sense, yes.
But the way it differs in these ways:
1. Your getting the money to buy these houses at a 0% loan from your tenant.
2. You can hold onto the property, and every two years when the key money rises, you'll continue to get back some cashflow. (It's like a dividend that pays annually, not monthly).
It still sounds risky
You definitely need to choose your market wisely and buy the right property at the right price. Or else, you can certainly lose money. And you need to limit how much you pay out of pocket.
Why would the owner sell at a discount? Why would people use key money instead of just buying a property if the price is so close together?
Owners: They might be selling for a variety of reasons. Maybe they don't want the hassle of managing this type of strategy because they're not professional real estate investors. Or maybe they just want the cash and not want to worry about having tenants. And also, keep in mind, this:
Let's say the original owner paid $90,000 cash for this property. He can now get $95,000 in key money. That's only $5,000 annually he's receiving for his investment. So his ROI is much lower than yours based on how much he paid out of his pocket. This might not make sense for him, but might be great for you!
Tenants: They might only be looking to live in the area temporarily - maybe their company moved them there. Or maybe they're worried about a downturn in the market and don't know prices well enough to feel comfortable buying. The bottom line: Not all tenants are professional investors, and therefore you, as a market expert, have an advantage.
Conclusion: So while you need to wait a while to realize your returns, over the long haul, your compounded rate of return vs the amount you invested can be very high - we calculated one of the investor's compounded rate of return to be 81%! Imagine that - getting 81% annual returns on an investment. Even Buffett would smile at that - and Charlie too.
Of course, it's only a project (81%). So we'll see if it's realized over time ^^
However, the investors learned the strategy from another investor who has purchased 100s of properties this way. So there's proof that others are making it work.
If you have other questions, feel free to comment. See you on Friday at the Happy Hour!
(oh .. I wrote a few more articles about these strategies on this blog / discussion board, so you can check those out as well)
http://www.biggerpockets.com/blogs/6526/blog_posts...
and
http://www.meetup.com/Seoul-REI-Meetup/messages/bo...
Daniel Ryu, about 9 years ago
What was the purpose of the purchase? Rental income? Because with key money that high, the rental income can’t be enough to make it worth the investment, IMO.
Account Closed, about 9 years ago