$3,000 for a two story commercial building in Korea? Here's how two investors pulled it off...

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On Saturday, Aug 1, a group of Seoul Real Estate Investing Members took an investing field trip to Sokcho, located about 2.5 hours outside of Seoul, to check out real estate investments. Sokcho is a year-round tourist destination because of its pristine beaches and proximity to Saraksan (Mt Sarak - largest mountain range in Korea). It also boasts some of the best schools in the Gangwon-do Province and a ferry that goes to Russia.

Two of the Seoul Real Estate Investing Meetup members have over 10 properties in Sokcho. During the field trip, they showed us their propertiesexplained the process of finding and buying deals, introduced us to their agents, and best of all, went through the detailed numbers of each purchase.

We covered A LOT of information in one day. Rather than write it all up in one post, over the next few weeks, I will be writing a series of posts detailing all that we learned.

Our day started bright and early at 5:30 am. Despite a little drizzle and a 6 HOUR drive to Sockho (note: the drive usually doesn't take this long - but we were leaving on a Saturday during the peak vacation season in Korea. The bus lists 2 hours and 20 minutes for the drive), we were all excited to learn. Later, we would return that night in the rain, giving us a total of 9 HOURS of driving in a single day. If that sounds crazy, then you haven't experienced the commitment to succeed of some of our members!

Leaving Saturday morning during peak season? Expect to see this!

After arriving and a quick lunch at an awesome 6,500 KRW buffet (with fresh vegetables growing outside the restaurant), we were off to see the first property. (Note: To convert Korean Won (KRW) to U.S. Dollars, you can simply remove the last 3 zeros. 6,500 KRW = about $6.)

6,500 KRW? Totally worth it!

Property #1 was located in the heart of Sokcho's retail district on Rodeo Drive (same name as the one in Los Angeles). Rodeo Drive features retails shops from many major brands including Adidas, Puma, and of course...

The street seems to be undergoing a transition - with older looking shops mixed in with some very nice, modern, newly redesigned looking storefronts - a little like Itaewon, a popular foreign district in Seoul. The sidewalks are broad, paved and pedestrian-friendly. According to one investor - Sokcho's Rodeo Drive is home to many big brands as the brands know the tourist traffic from across Korea is a great way to raise awareness of their products. Instead, of opening stores across Korea, open a store in a place that everyone visits.

Rodeo Drive is also home to one of Sokcho's biggest attractions - the Sokcho Fish Market.

As the busiest retail district in Sokcho, Rodeo Drive has a lot of desirable characteristics -consistent foot traffic, an always busy Starbucks, and a fish market that draws large crowds throughout the day and especially at night.

Additionally, a CGV movie theater is being build right behind the main street:

Buying a commercial building (a whole building) in this district might seem like a daunting task. But our investors were able to do it with the help of their real estate agent who held this property as a "pocket listing" - a property that hasn't been officially listed yet. Their real estate agents called them first, as the investors have a reputation for being able to close on a property.

The building they bought is a two story property zoned for both residential & retail.It's located at the beginning of Rodeo Drive. It has a rooftop with a view of the ocean.

It's a connected to the main Rodeo Drive through a walkway that leads to the main building - however, with the space zoned for both residential / commercial, there are lots of possibilities about how to maximize return on investment. Currently, it's being used as a residential space, but the consensus seems to be that renovating it into a commercial space would bring a much higher ROI (Return on Investment).

Blink and you'll miss it!

But this property's desirability lies in its location - right in the heart of Rodeo Drive.

Ocean view. Rooftop BBQ anyone?

So how much did our investors pay for this building? Here's where things get interesting.. and creative.

The initial price was listed at 35,000,000 KRW (remember: subtract 3 zeros for approximate dollar conversion) - it was a 'quick sale', meaning the owner wanted to find a buyer fast. After some negotiations, our investors got the price dropped to 33,000,000 KRW. (about $33,000 USD)

Given the location of this property, the price seemed to be a a steal. But the deal got even better. Our investors were able to market the building for a new tenant BEFORE THE SALE and found a key money tenant willing to put down 30,000,000 KRW to live in the space for two years. This money was given over to the seller.. and our investors only had to pay the remaining 3,000,000 KRW (about $3,000 USD) to take control of this property.

Note: Often in Korea, instead of paying monthly rent, a tenant will pay a large "key money" deposit. The key money deposit must be returned to the tenant when the contract ends. However, while the owner holds the key money, the owner is free to invest that to make a return. With interest rates low, many owners do not want key money deposits as they don't have a safe investment to put that the money into (remember - it has to be returned!) Instead, the owners prefer monthly rent. But many tenants prefer paying key money deposits as Koreans often pool money together to make these deposits (from family members) or the key money is paid by parents for their kids, usually after they get married and move out - Koreans are good savers. Korean tenants prefer a key money deposit instead of monthly rent since that lowers monthly disposable income.

In some areas, tenant demand for key money is so high and the supply is low. As such, tenants are willing to pay higher and higher deposits. If you find the right area to invest in, you might be able to find a tenant willing to pay 85%-95% of the PURCHASE PRICE in key money. This deposit can then be applied to the purchase price of the property - in a sense, you get a 0% interest loan from your tenant.

That means, our investors were able to take control of this 2-story commercial building in Sokcho for less than $3,000.

The easiest way to picture what has happened - imagine that the tenants gave them an interest free 'loan' to purchase the building. The investors, of course, are still responsible to repay that money to the tenants when they move out.

I know you have questions - How will the they pay the tenants back? What happens if the market turns? Why did the seller sell at such a cheap price? How did the negotiations work? - and I'll start to answer those questions as best as I can in future posts.

But what I wanted to show you with this deal is that the key to succeeding in real estate rests not with having tons of money but with KNOWLEDGE and NETWORKS. Without having knowledge of this type of investing, knowledge of the neighborhoods in Sokcho to recognize great deals, and without having strong networks such as real estate agents that are willing to send them deals first, this purchase could have never happened.

Now as for clues regarding potential exit strategies for the investors - the property value, according to their agents, has already risen over the original purchase price. Which means, should they choose, they could sell the building or ask for a higher key money deposit from their next tenants. (However, converting it to a commercial space might be the most profitable option of all.) Think about this: if they sold for a mere 40,000,000 KRW (and all signs indicate that the price would be higher than that).. and they paid back the key money to the tenants (30,000,000 KRW), paid themselves back for the original 3,000,000 KRW they spent - that would leave them with a 7,000,000 KRW profit after two years. That's more than 2x's their original investment in TWO YEARS.

Alright, I look forward to hearing feedback, comments, and questions from people. I plan to write about 10 posts about our trip, so there will be more deals to analyze and discuss.

What do you think? Do you think the investors got a good deal? What would you do with that space? Let me know!

The Sokcho Real Estate Investing series is not intended to encourage people to invest in Sokcho. Nor do I have any products for sale or investments opportunities to offer. I simply want to educate others about potential Korea Real Estate investing strategies through the experiences of some of our Meetup members.

If they paid back the tenant that seems to diffuse the whole point for the tenant - is there a law about this where they can do so? does the new owner have to agree to the same rental amount?

tia

klh

@Kara Haney

Great Questions! Let me see if I can clarify:

* Key Money is not rent. It's a large deposit that the tenant pays upfront (before move-in).

* If the Key Money is large enough, the tenant doesn't have to pay any monthly rent.

So in this scenario:

  • Owner of the Building ("Seller") no longer wants to own property. There might be a variety of reasons - Maybe Seller wants to move or maybe Seller wants to use proceeds from sale to buy something else.
  • Investor ("Buyer") recognizes great deal but doesn't have the cash to pay the Seller's price. Buyer gets the building under contract by putting down a small deposit (maybe 3,000,000 KRW) and the Buyer and Seller agree to a closing date. Buyer usually wants to set a closing date as far out into the future as possible because this will give Buyer a chance to find a tenant.
  • Buyer looks for a tenant through Buyer's real estate agent, ads, etc. Buyer finds a tenant who agrees to pay Key Money (preferred by most tenants) instead of monthly rent.
  • Buyer / Seller / Tenant all have the same closing date. On that date, Tenant gives Buyer Key Money deposit. Buyer gives the Key Money to Seller. Seller is now paid off for the purchase price. And Buyer now owes Tenant the Key Money that Tenant gave to the Buyer.
  • The Tenant, in a sense, loaned the Buyer the money to buy the building.
  • This is not a 'cash-flow' real estate strategy - this is about appreciation and building networth.

This strategy works because of the following reasons:

  • Owner is selling at a discount
  • The market rate for the Key Money Deposit and Purchase price are similar - usually Key Money is within 85-90% of the purchase price.
  • The Buyer knows, going in, that he/she has already made money.

Let me update a few numbers (I was off on a few things but I re-checked with the investor):

  • Original Seller's price: 45,000,000 KRW
  • Agreed upon price: 37,000,000 KRW
  • Tenant Key Money Deposit: 34,000,000 KRW
  • Buyer's estimated value of the building at time of purchase: 50,000,000 KRW +
  • Amount the Buyer paid out of pocket for this building: 3,000,000 KRW

Assuming the Buyer's estimate is of true value of building is right:

Equity at time of purchase: (conservatively) 50,000,000 KRW (true value of property) - 37,000,000 KRW (price paid) = 13,000,000 KRW

If you paid 37,000,000 KRW to earn 13,000,000 KRW of equity, that would be a great deal! But the beauty part is this - the Buyer only paid 3,000,000 KRW for that equity.. The Tenant in a sense, loaned the Buyer the rest of the money at 0% interest through the Tenant's Key Money Deposit. 

Assuming the Buyer sells the property for 50,000,000 KRW, this will be his return on investment (not taking into account Time / Value of money for simplicity's sake):

If purchased 'normal way' using one's own cash:

13,000,000 KRW / 37,000,000 KRW = 35% Return on Investment - that's great ^^

When purchased using Tenant's Key Money:

13,000,000 KRW / 3,000,000 KRW = 433% Return on Investment - that is truly phenomenal..

So.. as you can see, it's quite a return on investment.

Let me know if that helps clarify things ^^

the numbers are great no doubt - I was just wondering about the legal status of the key money and what that entitled the "renter" to get - if it isnt rented to him on the terms he paid the key money to it seems he would be entitled to get it all back. perhaps I misunderstood but the first description sounded like the key money was applied to the rent.

thanks for the feedback!

@Kara Haney

Great questions.. let me give a few more details and see if that helps clear things up:

The key money is a deposit. When a tenant moves into an apartment, the tenant enters into a contract with the building owner & gives the building owner the key money. The contract usually states that the tenant can live in the property for 2 years, and at the end of the 2 year period, the owner must return the key money deposit in full to the tenant. During that time, the tenant pays no rent. When the contract is up, the owner must return the full amount of the original key money deposit.

The key money is collateralized against the property. So if the owner didn't return the key money in two years, it's my understanding that the tenant would be entitled to take 'ownership' of the building.

Are there 'regulations' regarding what the owner can and cannot do with the key money?

This is a good question.. I don't know offhand. But I do know that using a key money deposit from a tenant to help an owner purchase a building is not an unusual strategy. 

The idea behind key money is this:

1. Koreans often live together as a family unit before the kids get married. During that time, everyone is contributing to household income and lots of money is saved up.

2. In general, Koreans are good savers.

3. Koreans don't want to pay rent because it's a big monthly expense.

4. Instead Korean tenants prefer to put down large key money deposits that must be returned to the them at the end of the contract.

5. The owner of the property accepts key money because he/she will invest that money for a return. The return the owner gets from investing the key money equals the 'cashflow' for the owner.

6. When interest rates are high, the owner might be able to deposit the key money into a bank CD for two years and get a nice 5% return and be satisified with that.

7. However, when interest rates are low, the owner must find an alternative, safe investment that will return enough to make it worthwhile to the owner WHILE being safe enough that they can return the key money to the tenant at the end of the contract.

8. Nowadays, the owners are having a hard time finding investments that fit that criteria so they'd rather get 'monthly rent' instead. However, as mentioned, most Korean tenants prefer making a key money deposit.

There are of course stories where the owner DOES NOT return the key money at the end of the TWO YEAR contract. And tenants either try to foreclose and take ownership of the property or sue the owner. This is a risk involved with using Key Money deposits. 

When entering into a key money contract, a tenant usually does two things:

1) Looks at the property's 'records' to ensure there are not other liens or mortgages against the property.

2) Registers with a local housing office to ensure that the amount of the key money is on record and should something go wrong, the tenant would maintain a claim against the property for the amount he/she is owed. (like getting first position on a lien)

Alright.. ask any other questions you might have! I'm sure your questions will also aid in other people's understanding.

Thanks, I am more clear on the recourse and there idea of some legal protection for the tenant - that is good - as long as the tenant actually is paying the rent every month!

Low interest rates have been the scourge for savers all over the globe, for some years, They have been a boon for borrowers - as long as borrowers dont get over extened...they have ruined a lot of pension plans who used to invest in AAA as well. "The stretch for yield!"

@Kara Haney

Yeah.. definitely need to watch how much debt you add on. 

With the strategy above, tenants usually aren't paying rent. Just putting down the key money deposit.

Glad I was able to help clarify things ^^

All of this makes perfect sense the way you explained it and the the way you added additional details; however, there is still one major thing being left out...

In this real-world example, the owner spent the key money deposit on the actual purchase of the building; therefore, I'm left wondering how exactly will he be able to return the key money deposit at the end of the two year contract? Does he plan on selling the building at market value (50,000,000 KRW) at the end of the contract to return the tenants key money and make the 13mill KRW profit?

Or is he going to do something different to 1. repay the tenant the key money and 2. keep ownership of the property

Originally posted by @Dominic Jones :

All of this makes perfect sense the way you explained it and the the way you added additional details; however, there is still one major thing being left out...

In this real-world example, the owner spent the key money deposit on the actual purchase of the building; therefore, I'm left wondering how exactly will he be able to return the key money deposit at the end of the two year contract? Does he plan on selling the building at market value (50,000,000 KRW) at the end of the contract to return the tenants key money and make the 13mill KRW profit?

Or is he going to do something different to 1. repay the tenant the key money and 2. keep ownership of the property

Great Question! ...and therein lies the rub!

This strategy is definitely speculative but it works because of the low money out of pocket to gain control of a property, the discount you buy at, and the 0% interest on the money you are in essence "borrowing." 

The investors are looking for the following conditions:

1. A steadily appreciating neighborhood not prone to wild swings in both directions (ie. Seoul would not be ideal for this).

2. A sharply discounted deal (need to negotiate this which is definitely a skill in itself and something I'll post about later).

3. A Key Money to Purchase Price that's close enough to make the 'risk' worth it. For example, there was another excellent property we saw being sold at a sharp discount. However, the existing key money contract meant that the buyer would have to put about $150,000 of their own money. In that case, you're taking on a lot more risk, and you'd be much more exposed if a downturn occurred.

4. Inherent desirability of the property (touched on this in the follow up post: Korea, Sokcho Investing

5. As far as my understanding of risk, if the market were to take a sharp downturn and you weren't able to return the key money to the tenant, then the tenant could take control of the building. While this might not be ideal for the tenant (or maybe they'd really like it), often times, a property buyer would take out a loan to purchase the property IN ADDITION to using the tenant's key money. In this situation, the tenant is in a much worse position as the bank would likely have first position in the case of a foreclosure. So a tenant might actually prefer this type of protection - being the only lien holder.

And for you, in this situation, as far as I've been told, you'd only be out the money you originally invested.

I posted about the second property we visited in Sokcho and touched more on the risk / reward value proposition here:

Korea, Sokcho Investing

This deal was an absolute home run!  It almost makes me want to jump into the Korean real estate market.  Kudos to the happy buyers for being able to pull this off. 

@Daniel Ryu

Thanks for the interesting post!

To confirm, the investor looking to developer that small amounts of space between the two existing buildings?

If so, what are the zoning restrictions?

@Daniel Ryu

Assumptions:

Buyers estimate of market value on purchase is accurate.

Market is not currently peaking and buyer will have financial power to hold on to property with zero cash flow until the next peak and property had appreciated.

If both of these are accurate, then he'll likely make money.  If the first is off, he MAY make money.  If BOTH are off he will lose money.

@Jon S.

Hi Jon... Thanks for you joining the conversation.

Zoning

That space is a 2 story and zoned for both commercial and residential. Right now, in terms of what to do with it, the ideas they're thinking about:

* Restaurant

* Craft Beer bar

It's not a huge space so it has to be something "niche." (my opinion ^^)

Assumptions

Your assumptions are correct. I will add that this strategy works because of these two important factors:

1. Buying at a discount to start with (to weather a downturn).

2. Low money out of pocket. (The downside risk is losing the property to the tenant and therefore losing your initial investment).

We ran some IRR numbers based on assumptions of a steady rise in Key money rates. We have a chatroom setup and some of our members were new to IRR. So I put together a sheet, the buyers threw in the numbers, and results were - a 6 year compounded annual return of - 81%. It was a clear winner over renting the property out for cashflow.

This same strategy is used by some heavy hitters in Korea to purchase much larger commercial buildings.

As per your assumptions, the strategy requires a less volatile market - Seoul might not work.

Probably, also - my thinking - I wouldn't want to hold too many properties in this manner for too long, so as not to be too overleveraged.

@Sandra Roddy

Hey! Nice to see you on the post, and our insider's Kakao chatroom ^^

We missed you at the field trip but I'm trying to make up for all those that couldn't come with these posts.

I think the next field trip will be closer to Seoul!

@Daniel Ryu

Greeting.  Field trips are always nice and educational.  After seeing the pictures, and reading the posts w/ comments, I knew I missed out.  Thank you for keeping the rest of the group informed and involved.  BTW, this would be a great tradition to start.  Most of us are busy, yet we are also passionate.  Therefore, we would certainly allocate time to support our hobby ... and dream.  

It amazes me that deals, like this, can be had with the right strategy.  Our Sokcho folks make it look too easy.  Yet, behind every good deal there is a lot that usually goes behind the scenes.  

Real estate is where it is at!  This hobby of mine is getting out of control!  I have caught the real estate bug!  Lol.  BTW, I am now looking at purchasing two more properties -- at auction -- back in Arizona.  If the prices are right, two more properties will be added to my portfolio by the end of the month.  

@Sandra Roddy

A-check-a-day is gonna definitely happen!! Damn.. That's awesome. Your a real inspiration with your focus and action. 

It's definitely a bug for some of us. It's like that SNL Cowbells skit, only instead of cowbells, it's - 'I need more Real Estate!!"

Keep making things happen and look forward to hearing about your latest deals at next week's Happy Hour^^

@Daniel Ryu

Yes, I agree with your remarks.  All good points, particularly the over leverage comment.  It's all about risk management. Watch the downside and upside takes care of itself.

@Jon S.

At $3,000 - $10,000, in my opinion, because of what the relative value of those amounts are, the decision to take the risk is not so difficult considering the upside. 

An interesting question tho - what if I had the opportunity to purchase a $5,000,000 building and what need to only come out of pocket 5-10% of the amount using the same strategy. Only now, it's $250,000 to $500,000 at risk. At that amount, even though it's the same risk equation mathematically, I would probably pass because of what other ways I could invest $250-500K vs a lesser amount like $3,000. 

But I've heard that other Korean investors do exactly that. Maybe if there had just been a severe downturn in the market when I was purchasing (ala 2009) and I had adequate reserves stored away, then maybe. 

At heart I'm a cashflow investor ^^.. at least for now.

Great conversation! 

Here's another post I wrote about a different property of theirs in the same area. Same strategy. 

http://www.biggerpockets.com/forums/76/topics/2185...

Thanks for the contributions. Reach out anytime. ^^

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