Success in Small Building Investment Depends on Thorough Verification

The market for 'small buildings' under 10 billion KRW continues to attract intense interest in Korea. As the saying 'building owners rank above the Creator' symbolizes, the public's aspiration for small buildings remains strong. Classified as small-to-medium assets, these buildings have established themselves as alternative investments offering stable cash flows, and the trend of investing surplus funds in real estate continues steadily.

However, contrary to the market's enthusiasm, many investors still rush into transactions without sufficient preparation, which is concerning. In particular, cases where building due diligence procedures are skipped or overlooked are frequent, leading to unexpected risks.

Due diligence refers to the process of thoroughly investigating and verifying all aspects of a target asset before making an investment decision. It is an essential procedure that comprehensively analyzes everything from the building's physical condition to legal issues, financial profitability, and market environment to identify investment risks in advance. Just because a building is small does not mean the investment risk is small.

One common failure case encountered in the field is when investors hastily sign contracts based solely on the expected yield presented by brokers, only to realize problems later. Without reviewing equipment conditions, lease agreement stability, surrounding market rates, and vacancy rates through due diligence before signing, it is impossible to identify weaknesses in the revenue structure.

For example, a building in northern Seoul was listed with an annual yield of 5%. However, the investor who purchased it without due diligence immediately faced multiple problems. Major HVAC equipment was outdated and inoperable, roof waterproofing failures caused leaks requiring tens of millions of won in repairs. Moreover, most tenants were nearing lease expiration, and the prospects for renewal at above-market rents were uncertain. Ultimately, the yield fell to less than half of the initially expected level.

The essence of income-producing real estate is not the 'building' itself but the 'cash flow' it generates. We are not buying buildings; we are purchasing future cash flows. Therefore, due diligence that meticulously analyzes not only the 'quantity' of income but also the 'quality'—tenant stability and contract structure—is no longer optional but essential.

Former US President Ronald Reagan's frequently cited principle 'Trust, but verify' applies directly to building investment. Rather than blindly trusting a broker's words or yield proposals, verification through due diligence is the best way to minimize risk.

Small buildings are by no means a light investment. As a single small mistake can lead to significant losses, it is time to renew our awareness of due diligence. Investment that begins with thorough due diligence ultimately creates investment that does not fail.

<Korea Economic The Moneyist> Kim Yongnam, CEO and President of GlobalPMC Co., Ltd.