A while back, I was invited by a mutual contact to attend an event about a new property investment model. Though I had my doubts, I decided to be open minded and went along.
The presenter was enthusiastic about his new model and said he had spent five years developing it. He had also spent a lot of time and energy battling the Financial Markets Authority (FMA) to get it approved in New Zealand so that it could be offered to ‘mum and dad’ investors (essentially those without much knowledge on property investment and how it all works and hence the most vulnerable).
I had to bite my tongue throughout the presentation as the model wasn’t anything new. In fact, a company in Auckland had been running a similar model for years.
The new model the presenter was referring to was equity crowdfunding for property investment. His company allows potential investors to invest as little as $100 to gain shares in a property. Investors are also required to pay a 4% application fee on top of their investment. Shares in a property are allocated based on the amount invested.
The company purchased its first property early this year for $1.2M and has been trying to get investors on board ever since then.
The company also promotes home ownership; however, home ownership is not about having a piece of paper that shows you have a 1% share in a property. It’s about people actually owning the house and living there. What the company is doing is not going to solve home ownership issues.
I’d also like to address the return on investment with this company’s model. The current project is forecasted at 4.6% gross; however, once you take off land rate, insurance and general maintenance (which is approx 0.6% in this case) you are left with 4%. Additionally, you also have to subtract the company fee of 4%. So do investors receive a 0% return?
The other part of this model that I’d like to discuss is liquidity. When it comes to liquidity, real property investors do not sell property to liquidate. They top up their mortgage from their lender to withdraw their initial investment (it usually takes one to two weeks). Investors are accumulators not traders. With this equity crowdfunding model, the investor has to sell their shares in order to liquidate which means they have to find another investor who is willing to purchase their shares.
Therefore, I don’t see the new model as property investment, where you use other people’s money (mortgage) to invest, and to recycle the deposit for the next purchase.
The company also says they are planning to spend $150,000 to renovate the property they have bought and are going to increase the current value of $1.2M (purchase price) to $1.4M. This is someone who knows nothing about property investment. For every dollar you invest in renovation, you should expect four dollars back. For our renovation team, it would cost $50,000 at most for a floor area of 230 square metres.
The comparison they use is the cash deposit rate. They may have a market edge compared to savers, but there is of course one question that seems unanswered: if people can receive a 3% return from their deposit and have liquidity from their bank, why would they invest in this model?
There are also property shares that investors can invest in with dividends and capital growth via companies like Kiwi Property. Companies like Kiwi Property have been around for a long period of time and offer shares in diverse sectors including commercial property.
Commercial syndicates work well because the returns are usually running at double digits. Bank funding is harder with commercial properties compared to residential, which is relatively easy.
The issues with this company’s model are:
- For their business to be sustainable, they would need to continue their fee, not just have a one off 4% fee at the beginning. However, in doing so, it will be a struggle to get people to invest.
- The company will be dealing with retail investors, which will take a lot of time and energy compared to commercial syndicates where you are dealing with wholesale investors that are more sophisticated.
In saying all that, this model could work well in countries with negative interest rates.
In regards to home ownership, New Zealanders simply don’t realise their financial potential. Home ownership is not that hard, people just need more education around how to get into it. I am currently working on something to make this happen.
Although I was impressed with the founder’s passion, I don’t believe the model will work well. It’s sad to see people spend all their time and energy on something they believe in but does not necessarily get them where they want to be. If he came to me five years ago, I would have outlined the issues with the model and perhaps he would have done something differently.
I actually believe if they can’t find investors and end up keeping the property for themselves, that would be the best outcome.