Property investing: Co-investing with distressed property owners

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 21, 2017 - August 27, 2017.

Pheh: The due diligence includes looking at affordable housing where the demand is strong. We also make sure the property owners have the title or strata title.

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The property market has had a challenging time in the past three years due to a combination of factors, including a higher bank loan rejection rate. Due to the market conditions, there are more high-end properties being put up for auction.

“There are many distressed homeowners in the market and they are finding it difficult to sell their properties because of the higher loan rejection rate, which has resulted in fewer homebuyers today,” says Danic Pheh.

“The distress level is rising. This is partly reflected by the higher value of properties being put up for auction. This is especially true in the case of homeowners who overinvested in the market during the property boom.”

Pheh, who is founder and CEO of Proponomics Sdn Bhd, says these property owners typically have three options when they urgently need cash. The first is to approach real estate agents and have them sell the properties at fire-sale prices. The second is to let the bank auction them off for at least 40% below market price. And the third is to borrow from loan sharks.

“In all these scenarios, homeowners have been taken advantage of and there is nothing good in it for them,” says Pheh.

It is challenging for these property owners to find good deals because most of them have nine-to-five jobs and lack the resources to reach out to good buyers, he says. “Meanwhile, the demand remains strong in certain property sub-segments, such as the affordable housing segment. That is why the recent launches of good affordable housing by Aset Kayamas Sdn Bhd and SkyWorld Development Sdn Bhd received very good response. People queued up for two to three days to buy the properties.” 

Regardless of market conditions, homeowners will be able to reap a return if they have enough holding power, says Pheh. “Historical data shows that the property market is very resilient. Provided that you have done your due diligence and bought a good property, the price will eventually go up. We had a recession during the 1997/98 Asian financial crisis, but property prices shot up shortly after that.”

Pheh set up Proponomics with the aim of providing its preferred shareholders with a unique opportunity, especially in the current property market downturn. The company works with its shareholders to co-invest with distressed homeowners so that they can hold on to their properties until the market recovers. 

When it does, the company will help the homeowners market their properties so that they can sell them at a higher price than they otherwise would have got via a fire sale. If necessary, the company will even refurbish some of the properties to fetch a higher price.

After the homeowners sell the properties with the help of Proponomics, they will return the money that was provided by the company. Then, any profit from the sale will be shared by both parties. 

“For instance, if an owner of a property worth RM500,000 in today’s market is offered RM400,000 for the property due to a fire sale, that is a whopping loss of RM100,000 in value if he accepts the offer,” says Pheh.

“What we will do in this scenario is invest a small sum, say RM50,000, so that the homeowner can service his loan payments and hold on to the property for another two to four years [as stated in the contract]. Then, we will leverage our marketing resources to help them sell the property at a better price, say RM460,000, which otherwise would have been made by those who bought the property at auction or a fire sale. With the additional value we create for the homeowner, he will return the RM50,000 and share with us the remaining profit, if any.”

He adds that the company’s shareholders will also get returns in the form of dividends. So, via Proponomics, they can invest in the distressed property market and have a diversified portfolio for a relatively low investment amount. “Our investors chip in RM50,000 on average to be preferred shareholders,” says Pheh.

Under existing central bank regulations, Malaysians can take out a home loan with 90% financing for their first and second residential properties. For the third, they can only get a loan with 70% financing. 

Pheh says this has restricted property investors’ ability to diversify their portfolio. “But by joining our company as shareholders, they are able to diversify their property portfolio by co-investing with distressed homeowners. Thus, our shareholders do not need to get a loan to invest in properties because they are leveraging the homeowner’s existing loan.” 

The company’s shareholders also have peace of mind as they need not worry about managing the properties they invest in, which is taken care of by the homeowners. “Other procedures, including the consistent sourcing of great property deals, credit loan applications to finance the property investment and turning the asset into hard cash, are all taken care of by the company,” says Pheh, adding that Proponomics also sources potential properties and homeowners on online platform

Generating healthy returns

He says the company is looking at generating an annualised return of at least a 15% for investors and things have been looking good so far. As at end-July, the company had already co-invested in seven properties in the Klang Valley. 

Of the seven properties, two are being prepared to be sold. “One of the properties is a semi-detached house in Bandar Seri Putra in Bangi while the other is a condominium in Taman Desa, off Old Klang Road,” says Pheh. 

Proponomics, which was incorporated in June, had RM700,000 in capital at the end of last month. Pheh says he aims to increase it to RM1.5 million by the end of this year, which will allow the company to comfortably co-invest in 14 properties.

Capital preservation is a key goal of the company, he says. That is why it conducts due diligence before co-investing in a property.

“The due diligence includes looking at affordable housing where the demand is strong. We also make sure the property owners have the title or strata title to make sure they are the actual owners,” says Pheh. The company defines affordable housing as properties that are valued at less than RM1 million.

“On top of that, we only invest in properties in mature neighbourhoods with an occupancy rate of more than 70%. This ensures that we invest in the right up-and-coming areas.”

He is particularly careful about choosing the locations of the properties due to the lessons he has learnt from his experience before he started Proponomics. “That was in 2012 during the property boom, when everybody made money except me,” he jokes. 

In 2010, Pheh co-founded an outdoor advertising company and sales grew very fast over the next two years. By helping his clients put up advertisements on billboards across the country, with the best location and price possible, the company’s revenue tripled and the team expanded.

He and his partners decided to buy their own office space at The Tube in Dataran Prima, Kelana Jaya. They initially bought an 800 sq ft duplex. But as the company grew, they bought another 2,500 sq ft. 

“Then, we tried to rent out some of the space, but we couldn’t. The demand was quite bad at the time. After a while, we decided to cut out losses and incur a small loss on our investment, instead of holding on to the property and paying more instalments. It turned out to be the right decision. Until today, the retail shops in the area are still empty,” says Pheh.

“After that, I attended a lot of seminars and read many books to find out what I did wrong. That is how I came to understand the importance of location. I continued to acquire more knowledge and apply it after getting burnt.” 

But it was also this experience that got him into property investment. In 2014, he managed to buy a property at Desa Impiana in Puchong for RM345,000. Then he sold it for RM400,000 a few months later. He made a total of RM22,000 from investing RM50,000 that year. 

“This showed me the potential of the property market,” says Pheh, adding that he then decided to sell his outdoor advertising firm and focus on property investment instead. He has since invested about RM10 million in 14 properties over the past two years. 

Mitigating risks 

Pheh says there are two key risks in the company’s investment strategy. To protect shareholders’ money, he has implemented various measures. 

The first risk is that the properties are unable to be sold within two to four years of the homeowners receiving the money from Proponomics. Under such circumstances, the company will take charge of the property and sell it for the highest price possible. After disposing of the property, it will get back its capital while the rest will go to the homeowner. 

The company has appointed a law firm to ensure that it receives its capital and profit (if any) after the property is sold. “The money from the sale of the property will be received by the law firm we have appointed, as stated in the agreement. It does not go to the homeowner. We then collect the money from the law firm,” says Pheh, adding that the same process is used in the case of profit sharing. 

The other key risk is if the homeowner passes away before the property is sold. Pheh says the contract with the homeowner stipulates that the company has the right to receive its capital even after the property has been inherited by his next of kin.

“We had an unfortunate case like this, where the homeowner we co-invested with passed away. However, we were able to recover our money after three months,” he says.

“It is our contract that allows us to do so. Typically, the homeowner’s family understands the situation and will pay us our portion.”

Pheh is launching this model at a time when there are concerns about property investment schemes. The Singapore police are investigating a property company in Australia over a suspected Ponzi scheme that collapsed last year. The scheme allegedly misappropriated about RM373 million from 1,783 investors around the world, including 651 Malaysians. The incident has raised public concern about the various property investment schemes being introduced in the market.

In the light of this, Pheh emphasises that Proponomics is involved in genuine investments. “It is a valid concern. However, the Australian case is a Ponzi scheme with no real estate involved, whereas our shareholders own a portion of the properties we invest in,” he says.