In Macau, where I currently live, ‘property millionaires’ are not very difficult to find.
Values have skyrocketed over the last couple of decades, making it very common for a standard 3-bedroom apartment to be worth over $1 million USD.
Any person who holds such an apartment free-and-clear can technically call themselves a ‘property millionaire’ from an equity standpoint. Many of these investors achieved this by entering the market when values were 1/10th of what they are now, and simply holding on to their assets to date.
This style of long-term buy-and-hold investing can be very effective, and has probably produced more everyday millionaires than any other investment vehicle.
However, buy-and-hold has it’s limitations — this is the realm of millionaires. At least in a single lifetime, this style of investing will never produce a property billionaire (unless you start off with a massive capital base, but we are speaking more generally)
To enter the realm of billionaires, we need to dig a bit deeper and explore something I call ‘equity stacking’.
Levels of Equity
No amount of accumulated cash flow will produce a billion dollars of net worth. Instead, billionaires play the game of equity on 3 different ‘levels’, stacking them on top of each other over time to create their fortunes.
Let’s take a look at the 3 levels of equity, with an example at the end to tie them together.
The Equity Stack
Level I: Captured Equity
This is equity that you ‘capture’ when you acquire the asset by purchasing it below the value accepted by the broader market place. You can call this a ‘true discount’, or the ‘margin of safety’.
This is achieved through two primary ways.
The first way is by finding an extremely motivated seller who will sell the asset at a discount in exchange for speed of transaction.
The second way is if you discover unique value in the asset that the seller, and perhaps even the entire market has missed. A hidden diamond in the walls.
Level II: Created Equity
This is equity that you create by altering the asset in some way to make it more valuable to the marketplace. You might change the usage of the real estate, add more space or reconfigure it. Sometimes just making it appear cleaner and more presentable is enough.
Level III: Cultivated Equity
This is the equity that is grown over time through the right market conditions. It’s the level which many property investors limit themselves to, despite it being the level over which the investor has the least control.
Here is an example of equity stacking, combining the 3 levels:
Imagine an investor who buys an old hotel for pennies (Level I) in the middle of town from a man who wants nothing to do with the business anymore. It used to service travellers coming through the town to get to the capital, but since the railway was built nearby hardly anyone comes to stay. But in recent years, the town has grown in population and needs new homes. You turn the hotel into a block of apartments, creating a massive amount of equity (Level II). If you sold it, you could make 10X the amount you originally paid for it. But you decide to hold on to it and rent it out. Over the next 10 years, the town continues to prosper and the property further triples in value (Level III).
If you continue to stack equity like this at increasing scales and across multiple simultaneous assets, you have entered the realm of billionaires. If the tide is in your favour, it becomes possible for you to be a property billionaire in a single generation, as evidenced through the ‘new money’ billionaire tycoons of Hong Kong and China.
It should be noted however that the path to a billion dollars in net equity is a perilous one even with equity stacking. Like I said, you have to do increasingly bigger projects often with enormous leverage, which means that any one project failure could completely wipe you out along the way. The road to billions is paved with broken dreams of those unfavored by the goddess of fortune.
For those who are slightly less ambitious, a more moderate but sustainable style of equity stacking could be enough to generate a net worth of over USD 10 million over time.
After all, “a million dollars just ain’t what it used to be”.
Sam Lee