Q.
A friend asked me what are the differences between appraisal used in business venture, stock market and property investment. How are they different from each other? Can you use the same measurement to evaluate investment in property?
A.
On the first look, everything is possible. You can even compare a man to a woman, correct? Although they are largely different in physical and mental attributes.
First of all, comparing biz venture, share performance and property is like comparing apples, oranges and grapes. They are all different things.
Although you could ask how sweet is an apple, an orange or a grape when compared, the outcome of the comparison may not be meaningful. This is because grapes are meant to be sweet although it is still a citrus, oranges are acidic in nature.
Similarly, a bungalow house is not a condo or double storey terrace. Although the measurement of size may be a key comparison, it is not the most important comparison. The point is people who stays in condo probably does not mind the reduced size; for they see space as burden to their living.
In the context of comparing fruits above, some people prefer oranges more, not because of anything about taste but because they like yellow?
This characteristic of different variables, is compounded with even more complicated bases of comparisons like the tangible and intangible values of the property, as compared to business and financial instruments.
To simplify the matter, I would give some examples to distinguish property from stock and business venture.
1. Property is both tangible and intangible.
Property in the eye of investors can be briefly broken into two parts. First is the physical size and build, etc (capacity and utility) and second is the location, and the space it occupies, which is irreplaceable.
The tangible portion - the size and usability of the the space. The intangible portion - its mere location and strategic look. You cannot have a business or stock which has this type of combinations. So, how then can you compare them?
2. Property investment is both active and passive.
Property as in land, is almost idle. However, if you have a commercial building, it is usually actively tenanted, or partly utilized. A stock or a business, if is viable as an investment, inevitably has to be actively traded. A viable business would require continuity as a going concern in generation of return. Or else, it is a liability.
3. There is residual value in property. It is used as a leverage. Further reading here.
Property has an indefeasible title, be it land, bungalow, strata unit or even a parking bay. This has a value, even when the property is damaged or destroyed. Worst case scenario - when it is under Land Acquisition Act, 1960 it is still compensated with a 'market value'. Stock or business venture do not necessarily have this kind of advantage.
With the above characteristics of property, you can see that property is beyond that of the stock and business venture. That is why business and stock could build on property as asset. But property would not likely be a prerequisite to own stock or business. What this means is you do not own a property to get the right to own a stock. You try to buy a share in a company which owns a whole lot of property (REIT). It would be unfair to use the yardstick of financial appraisal to evaluate property.
In general business appraisal, you would take the return on investment (ROI) to determine if this is a good business venture. So, for a business that employ workers and pays salaries, the return would mean to deduct the expenses of the workers to arrive at an operating income. This can be a comparison between businesses. If say a fast moving consumable market, manufacturing cost (labour) can be a big portion of the cost. So, taking it at 50% of the total expenditure, you can quite accurately say the business is making a profit after deducting cost of labour.
For Stock, ROE is usually the yardstick - return on equity. The stock borrowed money from investors. The return - in dividend declared, usually is a measurement of the return on equity, where the stock gives back to the investor. So, a big expenditure of the stock - likely again - labour cost, would be taken out from the total income generated in that company to arrive at profit. This profit then pays dividend to the stock investors.
In the case of property, labour cost is never a big expenditure. The running cost of the house tenanted is probably less than 10% of the income on rental. This consists of mainly maintenance fee, sinking fund, annual rates paid to local councils and insurance cost. So, the investment outcome rely very much on the intangible factors - like location and accessibility of the property. Such portion consists of namely:
1. Ease of access - like LRT, Road.
2. Entertainment outlets nearby.
3. Security, theft and sense of peace.
4. Lifestyle, e.g. condo and apartments - community living.
5. Type of title - as category 'building' is of higher value than 'agriculture'.
*Title is probably the single most interesting part of 'value' to property that other investment types cannot offer. There is no similar distinct characteristic to a property like that of 'title' to land. Preference share, for example would defer from ordinary share so to illustrate this significance. However, such distinction cannot be translated to the magnitude of the difference in land title.
Preference share for the example above, would have its limitation from sharing the profit of the company. On the other hand, title is able to open up entirely the potential of the land.
Therefore, the driving factors to an investment outcome of a property is very much NOT in the control of costs or efficiency of the operation. It is more on the intangible factors. These factors contribute probably more than 80% of the reasons that property could do well, rather than the reduction of cost or efficiency of running the business.
Take for example, a commercial property tenanted as a food court. The rental of the property would not double unless there is a high traffic flow of people coming to patronize this food court. There is some elements of comfort in eating there - for example air-conditioning. However, there is no direct effect of more people commuting to this food court just because of air-conditioning. Hence, increasing workers and putting air-conditioning might have no major impact in increasing rental of the food court.
For the business of the food court, it is definitely so. Because when a food court is well managed, there is an increase of volume of food sold, hence increase in return on investment (due to more worker and air-conditioning).
The investment on the property - commercial food court, would only be making more return when there is higher rental. That higher rental can only be realized when there are favourable elements like:
1. More parking bays, or a shopping mall next door.
2. More accessibility - by public transport.
3. Better security - may be interpreted as patrons feel save when eating there.
4. Food court be turned into Restaurant, being a different class of lifestyle.
And, yet the determining factor of the investment in this commercial property would very much be its location (accessibility) which cannot be replaced by another critical substitute.
You cannot substitute a space with another space. It is irreplaceable.
You can substitute a business by another business, for example a business of selling washing machine to households to selling washing machine to laundrette operator. Or, selling handphone online from giving to supermarket display.
You can substitute a stock by another stock. You can buy one blue chip, and later sell it to buy another blue chip. You can even sell all your blue chips and put all your monies into emerging stocks, and make the same money (or more) provided that you are clever for such trade.
BUT, you cannot substitute a space with another space. It is that characteristic of property that more than 80% of its value is intrinsic of its own. Its return on investment cannot be compared with stock market or business venture on the same yardstick. It is not comparing the like to like.
I rest my case.
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