Last Updated on 10, December 2016
An article from Straits Times said that the Council for Estate Agencies (CEA) issued an advisory note warning about real estate agents involvement in selling potentially dodgy foreign property investment schemes here. Some real estate salespersons have already been fired, said the report.
For the past year, I’ve increasingly seeing very strange property investments in my new clients’ balance sheets. For existing clients, I’ll tell them to stay away from these strange investments. Due to the runaway property prices in Singapore, many property buyers turn to cheaper but controversial alternatives. The following are some examples of controversial real estate investments:
- Purchasing an overseas property which prohibit foreigners from owning more than x% when the buyer’s share already exceed x%. This is breaking the local laws already. Definitely the investments will end up in tears.
- Purchasing an overseas property through a proxy (e.g. wife, friend) in order to circumvent foreign ownership rules. A very common one I seen is that the purchaser and the proxy signs an agreement stating that the proxy is merely a trustee. The ‘agreement’ is actually a trust deed. Guess who drafts these trust deeds? Lawyers! And these lawyers do it knowingly it is against the law. This is another example of an investment that will end up in tears.
- Landbanking is another controversial real estate investment. This is not a new form of investments. Raw lands are split into smaller plots and sold to investors. It is hoped that eventually the raw lands will appreciate in value in the future. What is controversial in such a method is that the tiny plot owned by an investor is too small to be sold on its own. Thus, in order to liquidate, it may be necessary to sell the entire plot - this means all other owners must consent to sell. As a result, the land banking marketing company ends up becoming the sole market maker. This is different from traditional real estate investments in which an owner can simply engage any registered real estate salespersons to find another buyer. In United Kingdom, land banking has been declared as a collective investment schemes (CIS). Once an investment is declared as a CIS, these landbanking products must be regulated in accordance to the relevant law. As a result, many land banking companies in UK ceased operation (guess where they go to market their products?). The UK regulator uses the following to determine whether a land banking product is a CIS or otherwise (source: HERE):
- Investors do not have day-to-day control over managing their plot;
- The scheme involves pooling investor funds; and
- The operator is responsible for managing the scheme as a whole.
In my personal opinion, the land banking products sold in Singapore appear to meet all three tests. Unfortunately, MAS refused to regulate it despite it has qualities of a CIS.
- As land banking represents the highest risk in the real estate investments regime, some investors prefer a lower risk by investing in land that is about to start development. The scheme typically goes like this: the marketing agent would setup a BVI company (or any tax efficient country) and solicit investments from individuals. Individuals become the shareholders of the company. The BVI company in turn invests in land which is to be developed into a commercial building or residential buildings. To increase the potential returns, the investment is leveraged. This is important because the cost of the project is very high and not to forget the necessity to pay capital gain tax. If all things go well, the BVI company exits from the investments just prior to the completion of the development. Prior to 2008, this kind of investments were quite popular but the party ended during the 2008 crisis when credit dried up. I have clients who lost money in such investments (but not sold by me. Lucky!). Previously, such investments were only sold to high networth individuals although I did come across retail investors buying .
The usage of using a company appears to be quite common these days. In the financial world, we labeled such company as Special Purpose Vehicle Entity (or SPV for short). Typically the marketing agent setups a company and solicit investments from individuals. These individuals usually do not know each other. The company is a vehicle to pool the individuals’ monies. The company may leverage. In turn the company invests in properties. The investors of such company may benefit in one of more of the following manner:
- As shareholders, get dividends based on the pro-rated share of the net rental income generated by the underlying properties.
- As shareholders, get capital distributions based on a pro-rated share of the capital gains if the underlying properties are sold.
- As preference shareholders, get a regular dividend of X% but this income is not guaranteed. But if there is a payout, the income is fixed.
- The investor and company signs an agreement in which the company make some promises such as guaranteed Y% returns or make payout based on rental of a particular hotel room. Such promises are economically equivalent to liabilities to the company.
- A unit trust is setup in a tax haven buys preference shares from the direct owner of commercial properties. The unit trust is marketed to high networth individuals in Singapore. As long as the underlying preference shares continue to give up dividends, the unit trusts continue to grow in value. Note that the entire unit trust only buys preference shares from one owner. So there is completely no diversification.
I have spoken to some clients and it seems many people do not realised that investing through an unlisted company and having a direct stake in the property is not the same thing. They had thought it is identical. This is due to the very poor financial literacy in Singapore. The difference between direct stake and through a company is as follows:
| Investing property through an unlisted company | Investing directly in a property |
|---|---|
| There may be different share classes issued by the company resulting in some shareholders being ‘more equal’ than others. For example, some shareholders have voting rights while others do not. | Tenancy in common or joint-tenant. No differing ‘share classes’ confusion. |
| No direct control on the day-to-day running of the underlying properties. Cannot sack the management unless you have voting rights and your share is majority stake. | Direct control. If outsource, can always fire and hire managing agents. |
| You do not know who are the other shareholders – whether are they laundering money. You could end up being associated with money launders. (If the company is setup by a group of friends you know, that risk is lowered significantly.) It is virtually impossible to determine the identities of other shareholders for companies setup in certain jurisdiction because of extreme secrecy. | You know who are the other owners because all owners’ names are printed on the title deed. |
| You can never be sure whether the company actually buys the properties. You have to rely on auditors. In certain jurisdictions, the company’s financials do not require any audit. | The title deed is the proof of ownership. |
| Similarly, you cannot be sure whether the company’s cash is withdrawn by the Directors for their own use or otherwise. The Board of Directors are appointed by the shareholders who have voting rights. | As you have to be in charge of the day to day running, you know exactly how much you are spending and how much rent you are collecting. |
| Shares of such companies are not liquid. You have to rely on the marketing agent to sell your shares away. | You can approach the traditional property agents to help market and sell the properties. |
| If you are investing based on an agreement with the company, the agreement is subject to default risk. The default risk depends on the credit worthiness of the company which is impossible to ascertain because very often the company do not require any audit (due to the company located in the jurisdiction that do not require audited statements) | No default risk because you are not relying on anyone’s promise. |
From my knowledge, real estate salespersons can only market real assets. But if the assets are encapsulated and securitized as company shares, they should not sell them. In fact, I advocate that such company shares be regulated as ‘securities’ under the MAS. There are situation which such securities should not be regulated. For example, if a group of friends decide to combine their resources to setup a company and buy properties, what they do should not be regulated. To determine whether such securities be regulated, I suggest 4 simple tests:
- Do investors have day-to-day control over managing these properties?
- Is there any pooling of investors’ funds?
- Is the operator responsible for managing the scheme as a whole?
- Is the scheme marketed openly?
Take for example, if anyone starts to market an investment and hold marketing seminars, the investment must be regulated by the government. So it does not matter whether the underlying investment is gold trading, wine investment, art or properties (real or unreal). In this fashion, even forex trading courses must be regulated because it is openly marketed.
In another example, say an investment is marketed through word of mouth to many individuals. However, the investors do not have any day-to-day control over the underlying properties. This means that scheme should be regulated.
Unfortunately it appears no government authority in Singapore is willing to regulate if the underlying investments are properties.
Update 22 July 2014
Perhaps MAS read this article and they have decided to regulate land banking. See Land banking in Singapore will go out of business
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