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Star Mica Pre-owned Condominium Division

2011 11th Porter Prize Winner Real estate
Created a market for pre-owned, family-type apartment units

Industry Background

There are four strategic groups in the real estate investment industry for used apartments. One group focuses on vacant family-size units (typically larger than 50 square meters), which it renovates and sells. Since this does not require a large capital investment, small and medium-sized providers of remodeling services are the main players. To minimize the risk of a decline in prices, they aim to sell as quickly as possible, and hold onto a unit for three months on average. The second group focuses on apartment buildings and office buildings. They purchase a building, improve rental fees and occupancy rates, and then sell that building to an investment fund. As participation in this segment requires large amounts of capital, large real estate investors such as Real Estate Investment Trusts (REITs) are here. Players can make huge profits in just a single deal, but when real estate prices are declining it is not easy to make a profit. The third group focuses on one-room apartments (units typically smaller than 30 square meters). They buy apartment units under lease and sell. Most of the sellers and buyers are investors. They hold onto a unit for three months on average. The fourth group is a new category created by Star Mica.

Executive Summary

Star Mica focuses on family-size apartments (rather than apartment buildings) under lease contract, specifically units which are in the middle price range (between 20 million yen and 30 million yen) and at least 10 years old. Star Mica buys an apartment unit, and holds that unit until the tenant moves out. It then renovates the apartment and sells it to customers who will live there, rather than to individuals seeking an apartment merely for investment purposes. This is a new type of strategic positioning that did not exist prior to Star Mica's entry into the market.

Behind this strategy is the low level of liquidity for apartment units under lease contract. As a result, there is a thirty percent price gap between vacant apartment units and those under lease. Japanese law protects tenants, and the landlord cannot force tenants to move out. Although it may sound easy to imitate this strategy once this price gap is noticed, it is not. There have been many attempts to imitate Star Mica, be nobody has ever succeeded.

Two factors contribute to this inimitability. First, there is a trade-off between Star Mica's strategic positioning and that of incumbents. Star Mica does not rely on upward price trends in the real estate market. Neither does it go after big deals (ones on a scale of hundreds of millions of yen per deal). On the contrary, the scale of investment per deal for Star Mica is much smaller, and it can profit in the case of both upward and downward trends in prices. Also, its approach to market risk is different from the approaches used by others in the industry. Incumbents aim to shorten the holding period, while Star Mica aims to hold onto a large number of apartment units with relatively stable prices.

Second, Star Mica's strategic positioning requires a unique set of activities. In order to implement Star Mica's strategic positioning, the following capabilities are necessary: a pricing model and a database which enables reliable pricing, extensive experience in finance (this approach requires a financing scheme that is different from the simple financing of operating capital or equipment--it requires financing for a portfolio of assets), and a large enough scale of operations (the number of apartment units has to be large enough to form a diversified portfolio to reduce the risk of price fluctuations and it should also be big enough to cover the overhead costs incurred in the execution of various operations for real estate transactions and property management).

Unique Value Proposition

Star Mica's investments are focused on family-type apartments under lease contract. Also, it focuses on apartments that are in the middle price range (between 20 million yen to 30 million yen) and more than 10 years old. This is because the decline in price bottoms out after 10 years. By carrying a large enough inventory (more than 1,000 units), Star Mica diversifies the risk of price fluctuations for a single unit. As of November 2010, Star Mica had 1,000 units, which were worth 21 billion yen and were located in the greater metropolitan Tokyo area. These units, on average, were 17 years old and measured 69.9 square meters. Star Mica was offering owners a buying price of 21 million yen per unit on average.

Star Mica's target customers are the owners of family-size apartments who are interested in selling.

The value Star Mica provides for the target customer is: 1) liquidity for the real estate asset under lease contract. Before Star Mica entered the market, many owners just had to give up the idea of selling, or else had to wait as long as it took to find a buyer. 2) Pricing based on greater market efficiency. Sellers could sell at a higher price, and buyers could buy at a lower price compared with the prices in effect before Star Mica entered the market. As a matter of fact, the price gap for apartments under lease has narrowed.

Unique Value Chain

Procurement
Star Mica collects selling information from real estate agents. Informed by the owners of their intent to sell their property, agents make inquiries to Star Mica, the biggest buyer who can quickly offer a buying price. This way, Star Mica can buy apartment units with a minimum number of staff. In return, it pays 3% of the purchase price as a commission to real estate agents. Star Mica has developed its own system for assessing apartments so that it can offer a buying price within two hours after an inquiry has been made. The market price, the specifics regarding the apartment, fees, and expenses for renovation are used to make this calculation. Star Mica applies its own original pricing model, instead of relying on the experience or the hunches of seasoned real estate agents.

Star Mica keeps enough cash on hand so that it can buy apartments as soon as the terms and conditions have been agreed upon. It has also developed an ICT system to support the execution of complex transactions, as well as associated operations and property management.

Property management
Star Mica outsources property management functions, such as rent collections and insurance payments.

Renovation
It does not customize renovations, nor does it use expensive materials for the purpose of increasing property value. Rather, it standardizes the design to obtain volume discounts on materials and to quickly sell to new owners. Star Mica outsources renovation services.

Marketing & ssales
Star Mica sells through real estate agencies. Star Mica pays 3% of the sales price as commission to the agents, which is the industry standard.

Technology development
Star Mica's R&D activities are focused on two areas: 1) Improving the pricing model, and 2) creating new financing schemes. Finance: Star Mica finances the capital necessary for acquiring apartments from the capital market (it is listed) and by borrowing bank loans with terms of three to five years. This is contrary to the standard practice in the industry. Most resellers of used apartments can get loans for only three to six months.

Firm infrastructure
Star Mica has developed an ICT system to support the execution of complex transactions and related property management operations. Through this system, its employees share information regarding the entire life cycle of a property (i.e. property assessment, purchase negotiations, rent, tenants' schedules for moving out, and sales).

Star Mica can obtain financing, arrange rental contracts, and prepare or dissolve mortgage contracts on apartments with just a limited number of employees. Star Mica had only 65 employees, including executives, as of October 2011.

Star Mica keeps fixed costs (such as its own office rental fees and labor costs) below the profit on rental income in order to ensure a positive cash flow. This policy will limit the speed of growth because Star Mica cannot add people. Still, this policy significantly lowers the risk of bankruptcy.

Fit among Activities

At Star Mica, activities are selected and coordinated around the key strategic choices, namely: 1) a focus on family-type apartment units under lease; 2) concluding transactions on a large number of apartment units and holding those units; 3) the establishment of a solid financial foundation that will support long-term holding periods; 4) low fixed costs; and 5) precise pricing. (Please refer to Star Mica's activity system map, which appears at the end of this report.)

Innovation that Enabled Strategy

  • Created a new strategic positioning, which is called the "Star Mica model" in the industry.
  • Applied an extensive knowledge of finance to the real estate business.
  • Conceptualized its business as a market maker.
  • Star Mica views apartments not as real estate properties but as commodities.
  • Star Mica views inventory as a profit-generating opportunity that creates a positive cash flow. Also, it sees vacancies as a business opportunity, not a risk. This thinking goes against what is considered common sense in the industry.
  • Financing schemes. Created a real estate fund for real estate transactions in order to finance initial investments. Created a non-recourse loan that has a mortgage allowing for the replacement of the real estate property offered as collateral.
  • Developed an assessment system for apartments.
  • Developed an ICT system to support the execution of complex transactions, as well as related property management operations.

Consistency of Strategy Over Time

Star Mica was founded in 2001, and it focuses specifically on investment in family-type apartment units under lease. Although there have been improvements in activities such as financing, its core components of the strategy have remained unchanged.

Trade-offs

  • Does not buy one-room apartments.
  • Does not buy high-end, family-size apartments. The high-end market is smaller, and high-end customers are less likely to accept standardized renovations.
  • Does not conduct activities other than market -making activities in-house. Activities other than market-making activities include property management, renovation, and sales.
  • Does not increase fixed costs beyond the amount of profit received from rental income.
  • Does not pursue aggressive growth.

Profitability

Return on invested capital exceeds the industry average, which indicates that Star Mica efficiently creates value added on invested capital. The difference between the return on sales and the industry average is negative. This reflects Star Mica's unique competitive strategy.

Return on invested capital (ROIC)   (Unit = percentage point)
Difference from industry averag
over 5 year period
Difference from industry average, by year
2006 2007 2008 2009 2010
7.5%P 8.6%P 7.3%P 7.4%P 7.2%P 7.2%P
Inter quartile range (IQR) = 1.0%P
Return on invested capital = Operating income / Average invested capital

Return on sales (ROS)   (Unit = percentage point)
Difference from industry average
over 5 year period
Difference from industry average, by year
2006 2007 2008 2009 2010
-32.1%P -29.7%P -32.5%P -32.9%P -32.8%P -29.8%P
IQR = 16.4%P
Return on sales =Operating income / Net sales

Activity System Map

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