Today I’d like to talk about the crossroads of two of my passions: the internet and real estate. I’m not referring to real estate websites, like Zillow or Redfin, I literally mean internet real estate, also known as digital real estate.
Digital real estate is an online asset that has the financial characteristics of real property. It’s a website, app, software, or social account that generates monthly cash flow and (hopefully) appreciates in value over time. However, unlike the piece of land under your feet, digital real estate exists completely online. As the saying goes, “in bits, not atoms” (or in this case, keyboards, not shovels).
Internet property is remarkably similar to real property: both generate monthly rents, have the potential for longer-term appreciation, and share similar market risks factors (valuation multiples change, consumer habits and trends change, etc). Let’s use two fun sites to demonstrate my point: https://catmania.net and https://ourfamilyplace.com.
At first glance, this site seems super goofy: the site title is By Cat Parents For Cat Parents, and the website layout looks like it is from 2012. So what’s so special about this site? For starters, it’s worth about $50,000+. I’m not kidding. To understand why, keep reading to learn how we value digital real estate.
Originally registered and built in 1998 for homeowners, ourfamilyplace is now a website for Millennial homebuyers. Most of its readers are interested in mortgages & financing, or home buying & selling. Traffic is low but slowly growing. What do you think this site is worth? Some would say $0, while others say much more. Why? Keep reading.
How to value a digital asset
An online asset that is generating consistent, monthly returns can be bought, grown, and sold just like physical real estate. Whether it’s a website, mobile app, or even social media account, so long as it’s making money, we can back into a valuation for it.
Here’s the math: if a website is making $100 a month, and hosting costs are $5, then the site owner can anticipate $95 net profit each month. If the owner/investor puts the time and effort toward growing the traffic and sales, their monthly profit should also increase. Once the owner is ready to sell their website, the market will value their asset as a multiple of its monthly net profit (called the valuation multiple).
This valuation multiple is used to calculate how much a website investor can sell their asset for. In real estate, there is a similar concept, called Cap Rate. The cap rate helps an investor determine how many years it will take them to get their money back; it compares a property’s rental income potential against its overall value. Said another way, it’s the annual return as a percentage of the total investment. There are lots of details and fancy math involved but in its simplest form, the calculation is the net operating income divided by property asset value. For example, if I pay $1 million for a duplex that pays me $50,000 annually (after subtracting for operating expenses), then my cap rate is five percent (50,000 / 1,000,000 = 0.05, or 5%).
- Average cap rate for multi-family investment property: 3 to 5
- Average valuation multiple for a content website: 2.5 to 3.5
Value-add property vs. development deal
One last abstraction before we wrap up: In real estate, there are two common types of properties investors look for: value add deals or development deals.
A value-add deal is one in which investors buy a property that they believe could be worth more after some love and care (called CAPEX, or capital expenditure). They see an opportunity to fix it up and eventually sell it. Maybe they’ll add an additional bedroom to a home or upgrade all the units in an apartment building. This allows for increased rents and hopefully increased valuation at the time of sale.
The other type, a development deal, is one in which the investor starts from scratch, from the bottom up. It’s much riskier but the payouts can be greater. Many times these investors start with a fresh piece of land and build from there. Once completed, the property can be sold and the investors cash out. Huge profits, but huge risks too (i.e., development costs get out of hand, delays, no buyers, etc).
Now, back to our first website above. Even though catmania.net looks like something from the early 2000s, it’s worth $45,000 because it’s producing enough revenue to justify this price tag. An investor would see this site and think, “I can fix it up, increase the revenue, then flip it!” Here is a breakdown of its monthly revenue and profit:
The website is netting about $1,500 a month. If we annualize that ($18,000) and multiply it by the valuation multiple (2.5 to 3.5), we get $45,000 to $63,000. As an investor, you will want to check other metrics, like website traffic:
And we would check the traffic channels and countries too:
What this data shows is that traffic is mostly Google Organic from the United States. That’s a good thing for the seller because that traffic is valuable. But traffic is down over the past couple of months, which be a negotiation point for the buyer. On the other hand, traffic does seem to have picked up last month and it also doesn’t appear to be too strongly correlated with revenue. The buyer and seller will go back and forth on these points, and many others, until a fair price is reached.
In sum, if I were a cat lover and had $50k to play with, I could see myself buying this site, upgrading the layout, adding new pages, then flipping it in 12 to 18 months.
Whereas our previous site was a value-add property with a record of online traffic, ourfamilyplace.com is more like a development deal. This site did not have much traffic and it looked childish when it was acquired. It had to be rebuilt from the ground up. Here it is in 2006:
And again in 2019:
The homepage isn’t even about real estate anymore! So now you must be asking yourself, who in the world would buy this silly site? Answer: me!
Why would I purchase such an asset? Scroll up and re-read the first line of this post: “Today I’d like to talk about the crossroads of two of my passions: the internet and real estate.” Specifically, I liked the following characteristics of this site:
- It was first registered and built in 1998, and has been about real estate for over 20 years. Google has indexed it and categorized it as a residential real estate site, which preps it for excellent long-term traffic growth.
- The subject matter, real estate, is something that fascinates me and easy to monetize.
- I like the risk profile of development deals. One day I’ll eventually transition to a less risky lifestyle but for now, I’m young so YOLO.
In an upcoming post, I hope to share with you the metrics and my growth roadmap for OurFamilyPlace but in the meantime, here are a few recent pieces of content I wrote that are starting to rank at the top of Google:
- Best Day Of The Week To Lock-In A Mortgage Rate
- When Is My First Mortgage Payment Due After Closing?
- Is It Better To Pay My Property Taxes Directly Or Include Them In My Mortgage Payments?
As you can see from these titles, I’m publishing home financing content. My thesis when I first purchased the site was that if I can get the needle moving on website traffic for a highly valuable audience (homeowners), then I’ll be in a good position later to monetize it.
If you take anything away from this, it is that digital assets can be valued in almost the same way as real estate. Both provide monthly rents, have a spectrum of risk profiles, and hopefully are blessed with some asset appreciation.
If you’ve made it this far, leave a comment below — I’d love to hear from you!