Buying domains/websites = buying cheap land/real estate?

By: ispeculatornew
Date posted: 06.24.2010 (4:05 am) | Write a Comment  (7 Comments)

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New investing landscape

If you have paid attention to business news in the past few months, you will notice that many big players are investing into internet properties. Sometimes it’s about a name, other times it’s about traffic, revenues and sometimes even profits. Big names like Yahoo (YHOO), AOL (AOL) and IAC Interactive (IACI) have been loading up putting huge amounts of cash into this new virtual world. Many investors and even the population in general have trouble understanding why so many of these transactions are taking place. Why would a major company put so much money into something that is 100% virtual? I decided to do a comparison to start off the discussion!

Traditional business/land

Think of a traditional land owner or rental property owner or even those business men that own multiple small businesses. These have been around for hundreds of years and they are a lot more easy to understand.

Buying land or a residential/commercial property: In this case, an investor is putting up a decent amount of money in order to get future cash flows. In both cases, he will be lending the land/building to someone in exchange for payments, that will usually be made on a monthly basis. Here is how the valuation of the building would be made:

Revenues (monthly rent) – Expenses (Capital+Interest+Taxes+Fees+Wages for concierge, etc+other expenses)

You will then get a monthly profit amount which after all expenses, tends to be very low. Let’s say 800$ per month. To determine how much the building will be sold for, you put up a multiple to the annual profits. In this example, the estimated profits are 9600$ per year. If you set the multiple to 20, you would be getting a value of 192,000$. Expensive but over 20 years you would expect to make back that cost but also profit from any gains in the value of the property right?

It is a simplified example but I’m sure you get the picture. 192,000$ of investment yielding you 9600$ per year in estimated profits. Interested in the deal? Just wait a minute….

Internet valuations

In the virtual world of the Internet, properties that yield a profit would sell for much much less. In fact, you would probably expect to pay about 20,000$ for a property that makes 8-10K per year. Of course, that can vary quite a bit depending on the exact property but the multiple of 20-25 years for an offline business becomes a multiple between 1 and 3 to 4 in most cases for internet properties.

Sounds extreme doesn’t it? I mean how could two investments that yield a similar return in terms of cash flow trade at such different prices? There are a lot of reasons but I would still say that investing in the “virtual world” looks like a mighty good proposition. Unless there is something more to know?

Risks/Rewards Involved

Of course, there are different factors to be aware of when buying a website, a domain or a blog.

Different set of skills/knowledge required: When buying real estate, you need knowledge of price trends, of taxes information, all of the legal requirements and consequences, getting a mortgage, etc, etc. When buying an online property, the range of knowledge required is smaller but I would say that knowing the market is as important or perhaps even more so. There is less transparency around internet properties which means you can get good bargins but also bad apples. It is important to look into what makes the website successful, where does the traffic come from, revenues, etc. Is the business model sustainable? What could change the future perspectives?

Leverage: When buying a house or traditional type of real estate investment, banks will generally be more than happy to help you out buy it. Provided you can make a decent down payment, the bank will generally lend you the rest of the money. That is great because it expands the possibilities in terms of your buying power. But of course, you do end up paying interest on that loan so it’s not all free. Because internet or virtual purchases are considered intangible assets, banks will hesitate greatly before making you a loan guaranteed by such a property. Cash is king when you want to buy such properties.

Risk involved: This is probably the most important factor. When buying a house, you can expect little changes that will impact your investment. Sure, there might be a fire, a natural disaster, a tax increase, etc. But generally, you know what to expect. An internet business can change quickly. You can have a huge competitor jump into your space from one day to another that would impact your investment greatly. So yes, there is more risk. No doubt about it. However, I personally think the rewards are much greater too

Growth: While valuations of a traditional business can rise, a 2-3% rise per year is already considered very important. On the internet, you could expect such a rise every month or so in early ventures, and could easily hope for 20-30% even in a well developed website.

Future valuations?

Because of the fact that few investors know about these virtual investments, they are very cheap right now when compared to more traditional investments. I would expect those multiples to increase in the next few years as the knowledge about these investments becomes more mainstream.

M35 inc

Wondering if I am doing this myself? Yes of course. IntelligentSpeculator is owned by M35 inc. which owns a few personal finance blogs (the more known one is TheFinancialBlogger.com), as well as non-finance related websites. It’s a young business but growing quickly and we hope to accomplish a lot more in the coming years…!

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7 Comments

  1. Comment by The Financial Blogger — June 24, 2010 @ 12:36 pm

    I don’t get how come most people don’t invest in websites yet since the difference in valuation and profit expectation are ridiculously high compared to investing in a rental property.

    On the other side, it’s a good news for us 😀

  2. Comment by Matthew — June 24, 2010 @ 1:00 pm

    IS, where do you find your websites?

    Do you simply send emails to bloggers?

  3. Comment by IS — June 24, 2010 @ 3:40 pm

    @TFB – Hmmm I read today an interesting article about ETF’s and why many investors still invest in more expensive mutual funds and pay tons more money in fees over the years. But they are usually not given the option by their broker/advisor.

    @Matthew – Hmm there are many different places. Contacting bloggers directly is a good way, there are also auctions, etc. I would suggest checking TheFinancialBlogger as more info will be released about this in the coming weeks/months.

  4. Comment by Mark Daoust — June 28, 2010 @ 9:13 am

    @Matthew – there are a lot of places to find good web businesses for sale. Obviously I would recommend a broker like Quiet Light Brokerage (but I am a bit biased).

    Cold calling on websites can be effective, but you need to make a lot of contacts before finding the right site for sale.

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