In this second part of the industry series, where I look more closely into the inner workings of each industry, I will be discussing the property industry — specifically on property developers (as there are many different segments for properties, including REITs or real estate investment trusts). You can read about the banking industry in a previous article I wrote.
The Core Business Of Property Developers
As the name would imply, property developers are companies which develop and build physical properties, and this covers a wide range of categories including residential, industrial, commercial, retail and “others” (e.g. healthcare, special facilities).
Developers would start out by bidding for land to replenish their land banks, and once they manage to secure a site, they would then hire a team of architects, contractors and interior designers to construct a building.
In Singapore, all land belongs to the Government and there are different land tenures depending on the “zoning” for each plot of land. Zoning would refer to whether the land is to be used for commercial, residential or industrial use.
Development Versus Investment Properties
Most property developers would have a mix of development and investment property.
Development property refers to property which is constructed and then sold, and the revenue would then be recognised progressively as the units are sold off, but there is no further income to be recognised once the entire development is sold off to the buyer.
Investment property, on the other hand, is a property which is owned by the company and leased out to tenants for recurring rental income. By having a mix of the two types of property, companies ensure that they have a steady “base” of recurring rental income with the development profits as additional “upside”.
There are risks aplenty in the property sector, with the main one being regulatory risks, especially when it comes to residential developments.
The Singapore Government announced in July 2018 that it was raising additional buyers’ stamp duty (ABSD) and tightening loan to value (LTV) ratios on residential property purchases. The aim was to cool the property market before prices rise more than income levels, causing a potential bubble to form. Though there are less regulatory changes concerning other types of property (i.e. industrial, commercial), there is always the risk of a change in regulations as property is a sector which is heavily regulated and controlled by the government.
Companies with a high proportion of development property also experience “lumpy” revenue, profits and cash flows, as the projects would be sold off in phases and therefore, the income stream would not be continuous and predictable. Such contracts usually translate into drastic falls and rises in revenue and profits for the property company, making it a much more volatile business to own than say, a company with purely investment property earning rental income.
Finally, property companies usually have high debt levels as they need huge sums of money to bid for land and to replenish their land banks. Bank loans are taken with the underlying property development as collateral, but when the economy turns south, the high debt levels could cause a property company to go belly up if it does not manage to sell its property units.
How Are Property Developers Valued?
As a general rule of thumb, developers are valued using the “revalued net asset value” (RNAV) methodology. This is because the company’s asset value hinges primarily on the real estate within its portfolio, and independent valuers periodically revalue the portfolio to arrive at the RNAV.
Developers are then said to be trading at a discount or a premium to RNAV if the share price is lower than RNAV and higher than RNAV, respectively. Do note that RNAV is an accounting concept as the company can only realise the true value of its properties if it manages to sell them in the open market at the agreed-upon valuation as determined by the valuer.
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