Finding the right city to invest in is the key. Do not restrict yourself to the area in which you live in.
International property investments are being considered as an additional investment product for many investors around the world.
With the intention of earning a return on the deployed capital, investments earn revenues either through rental income, the future resale of the property or both in overseas markets just like they do in a domestic market. We have seen the advent of overseas property investments during the early 1990’s with epicenters of activity concentrated in a few international city centers including Hong Kong, Singapore and London.
These three cities have seemingly acted as the vanguard for overseas property investment albeit at different times and very different locations. Hong Kong became one of the primary investors into property markets of Beijing, Shanghai and Guangdong province all throughout the 1990’s whilst Singapore, a bit later in the 90’s started investing into the surrounding countries of Malaysia, Thailand and Indonesia.
Investors in the UK have for many decades been keen for European properties primarily located in the South of Europe but it wasn’t until the early 2000’s that the overseas property industry in the UK took off with a blast, witnessing thousands of families and individuals buying “fun in the sun” vacation homes in Spain and Italy. With many fortunes made and lost there are some very important lessons to be learned from this property investment history.
There are many beneficial returns from investing in real estate overseas. The opportunity to immerse yourself in a foreign culture, diversify your investment portfolio, and perhaps see substantial returns over time, to name a few.
People’s reasons for overseas investments vary wildly but vacation homes, immigration opportunities or just straight forward investment returns are some of the most compelling reasons we have found that have enticed investors into the international property marketplace. However, it is important to study up a bit about risks you might face in a foreign real estate investment before jumping in and keeping in mind the mistakes of the past can help us to avoid these mistakes in the future.
Understanding the RISKS
First, let’s talk about the key risks associated with the overseas property investments. It’s wise to understand the potential risks you might face in the country or market you are choosing to invest in. Doing research in a particular investment location where you intend to invest in is the essential stage of your strategy for dealing with risks specific to your business, because risks vary with a market”s size and location. But here we brought you the most cited and common risks you need to consider when investing your funds to any foreign market. In every case, advanced planning and preparation can reduce the likelihood of accidents and misplaced investments.
- Currency exchange rate risk
The exchange rate between currencies fluctuates over time. It can bring unexpected gains or losses in the total return of the investment. However, if you are planning to be a long-term investor, the impact of currency risk should not be a deterrent to your decision to purchase real estate in most countries, especially in more developed markets. In this case, one should always consider the possibility of hedging risks as well by purchasing foreign exchange contracts to lock in a certain exchange rate. Unfortunately hedging mechanisms are not always available especially in frontier and emerging markets.
Unfortunately in the past we have seen investors make excellent returns from rental yield as well as capital appreciation in the local currency only to see their gains wiped out by a currency that has depreciated equal or more to their gains in the country. Therefore investing into a country that requires investment in a local currency and doesn’t have any foreign exchange mechanism for hedging needs to be considered carefully.
Unfortunately in the past we have seen investors make excellent returns from rental yield as well as capital appreciation in the local currency only to see their gains wiped out by a currency that has depreciated equal or more to their gains in the country. Therefore investing into a country that requires investment in a local currency and doesn’t have any foreign exchange mechanism for hedging needs to be considered carefully. Adding to this we can observe that most emerging and frontier market currencies have depreciated over the last twenty years. It is in these emerging and frontier markets where we find many properties that are at a depressed or suppressed value offering interesting and potentially lucrative property investments but there are also higher risks associated with these countries one of which is the currency depreciation aspect. This cost benefit analysis is quite important to consider in these cases.
- Political risk
It refers to uncertainty of government actions and decisions and understanding the general risks associated with any political landscape. Does the country have strong and stable government or is it prone to corruption and weak governance? The answer to this question highlights an integrated or a separated process incorporating potential worst case scenarios.
Because a greater political instability is likely to lead to higher fluctuations in exchange rates and can possibly lead to economic slowdown resulting in poor real estate price performance. The paradox here is that it is in these riskier emerging economies that we can find faster growth which is essential for a robust property market. Regardless, there is no substitute for doing one's own research and seeking out capable advisors whether investing into developed markets or the fast growing emerging markets. Whether a country’s political system is free market, socialist, totalitarian or any myriad of combinations of the above, there is always a way for politicians and leaders to make decisions that adversely affect property market returns. Keeping abreast of legislative changes in the past and expected ones in the future will help you determine the suitability of any given market and also help define the timeline for investment and divestment of a property venture.
- Regulatory risk
Sitting alongside political risk these days one must consider regulatory risks as well. The fast changing regulatory environment in places like Europe can make finding profitable high returning investments quite difficult. The world’s most prolific regulations factory, otherwise known as the European Union can create a more complex investment environment whilst simultaneously reducing potential profit by increased transaction costs and higher taxes. Finding countries with a stable regulatory regime that favors foreign investment is the key to narrowing down a country and city search for property investment. Countries that might make the top of that list change from time to time so research is very important and staying in tune with local property markets. Issues such as tax changes, transaction fees and required documentation are some of the key items to keep an eye on.
- Institutional risk (Property law)
Depending on what country you are investing in, property laws in some countries can be restrictive or non-flexible for foreign investors. Regulations for foreign investors may limit or may not affect the actions of the particular foreigner investing in real estate. So, make sure to be educate yourself well enough with the local property law of the country where you are interested in investing. Understanding the history of foreign investment in a country is quite important to understanding why the laws for foreign investors were created and if there may be changes afoot in the future. Many countries such as Thailand require properties to be held in a locals name, creating the risk of theft or misappropriation of one’s property. Other countries may have a regulation that limits foreign buyers to only 30 or 40% of the buildings ownership and some countries require a building to be designated specifically for foreign investment before accepting foreign buyers. One should also consider where the property market cycle currently is as some very popular investment destinations can become overheated prompting new government regulations to curb foreign investment. We have seen this happen in Spain after a flood of investment from overseas countries. There are also foreign investment surcharges in places such as the UK and Hong Kong either by directly taxing foreigners or putting a tax on the more expensive properties which inadvertently captures many foreign investors. These surcharges can generally be used by governments to cool down hot property markets and also to attempt to collect more taxes from foreign investors. In many cases this simply causes foreign investors to look elsewhere for the returns.
- Portfolio risk (Volatility of returns)
Portfolio risk or investment risk is normally associated with stability of country’s economy vis a vis other countries. It acknowledges the fact that you are not always going to be correct with your decisions and diversification can greatly reduce potential losses. Diversifying your portfolio can offer an increase in expected returns and a reduction in portfolio risk. Many people comment that stock markets are very thinly traded and selling shares are difficult especially in emerging markets while selling real estate isn’t much different than selling stock in developed countries. The liquidity of the property markets differ greatly from country to country and even within countries the liquidity ebbs and flows depending on the strength of the economy and the liquidity within the market. We must keep in mind that the economic fortunes rise and fall over time and our investments will not be correctly placed 100% of the time. With that in mind it is worth considering spreading out one’s investment portfolio over a few geographic areas keeping in mind the fast growth will always support a healthy property market. Risk reduction is one of the benefits of diversification but it also will require monitoring of more than one property market which can increase costs when considering property management.
Although investing in overseas property is a complex and sometimes difficult exercise, the efforts that you put into can lead to large financial gains from rental income as well as the prospect of capital appreciation in the long run.
We tried to cover the most popular risks that might happen in your overseas investment. But if you want to be successful in this kind of business, you can’t let these risks hold you back.
MORE RISKS, MORE REWARDS!
Key Takeaway CONSIDERATIONS
Keep in mind the main risks and challenges mentioned above. Now, let’s delve into some considerations before making the decision to move into the international real estate pool.
- Market selection
The first thing you need consider is choosing the right destinations where you would like to focus your capital. There are many countries which are ripe for property investment. Conduct the research into the locations where you are interested in and do your research thoroughly. Procuring the right property investment advisor is key and don’t shy away from getting various opinions and suggestions from advisors. Local specialists who have been active in the relevant market for long periods of time can be invaluable sources of information at the very least to learn the historical aspects of the market including anecdotes of successes and failures, changing regulatory environments and the developers who have been consistently successful and those who have not.
Property rights are the most important factor for market selection. Other institutional and market maturity factors, such as the availability of professional services in a real estate area, taxation as well as market liquidity and size are also important in the market selection process.
When looking at various markets it is often useful to create a matrix to help keep your analysis organized and make sure you are comparing apples to apples. Ranking countries in terms of taxes, regulation, growth and investor friendliness can help bring clarity to a complex decision process. One must also gain an understanding of the current state of the property market and where it has come from. If the market is just starting to grow and appreciate then you might conclude that the property market cycle is just beginning however, there are any instances where a market has been appreciating for some time and concluding where the market cycle is will inform your decision about whether to buy or to hold off on your investment.
Property growth is highly correlated to economic growth but one also needs to consider the liquidity in the marketplace. In the early 2000’s the property market in Almaty Kazakhstan received an enormous boost from the introduction of housing mortgages. It turns out the Kazakh banks were able to raise large sums of money from issuing eurobonds which were in turn fed into the property market by way of mortgages. This caused the luxury property market to climb from about USD3,000 per square meter to as high as USD10,000 per square meter in a short period of time. Therefore understanding mortgage availability in a market should be a key consideration.
Property Development in Mongolia
Supply and demand mismatches can also be found in a number of markets and a good example is Stockholm Sweden. When governments are reluctant to give development rights due to a negative outlook on property development at a time when there is high demand it can cause a demand led squeeze on property prices. In the case of Stockholm a technology boom caused a large demand for office space as well as housing but the approval process for new developments was difficult and often unsuccessful causing a strong increase in real estate prices throughout the city. Keeping your ears and eyes open for these types of situations can be very beneficial to the astute investor.
Supply and demand mismatches can also be found in a number of markets and a good example is Stockholm, Sweden. When governments are reluctant to give development rights due to a negative outlook on property development at a time when there is high demand it can cause a demand led squeeze on property prices. In the case of Stockholm a technology boom caused a large demand for office space as well as housing but the approval process for new developments was difficult and often unsuccessful causing a strong increase in real estate prices throughout the city. Keeping your ears and eyes open for these types of situations can be very beneficial to the astute investor.
There is a lot of room for growth in emerging markets!
Expected economic growth in emerging markets is highly correlated to a good return on the property investment so try to target countries that have just recently started growing rapidly. Usually strong economic growth is followed by property price increases as peoples increasing disposable income facilitates the volume of property purchases in a country. Recently, emerging markets in the Asia Pacific region have been hot spots for many international real estate investors. Basically, because of the region’s strong economic performance and huge growth potential in the future these markets have experienced across the board appreciation over the last decade. Investors continue to expressing their investment interests in Asian developing markets where competition is thinner and yields are higher.
Execute all financial decisions in line with your estimated return. And secure your finance with the consideration of international laws. The need for funding? If you need to take out a loan, do the search on banks that can offer you a mortgage for overseas properties. Have a knowledge on loan value ratios, interest rates, and repayment periods. The ability to source debt financing at a low rate and invest into a country with high rental yields is key to success. Having high capital appreciation of the asset is always a bonus but finding high rental yields should always be the foundation for your property investment decisions. There are many misconceptions that exist about rental yields. So, make sure you have the right information. And always look for something that is going to generate cash flow, regardless of appreciation.
- Exchange rate
As mentioned earlier in the risk section, exchange rate or currency fluctuations is one of the potential risks you might face, because you are required to convert your domestic currency into the the currency of another country. Making a forecast on future exchange rates with precision is not an easy task, especially when the rates are freely decided by the markets. But at least try to understand the value of local currency and movements in the associated exchange rates. A country with strong export growth and good fiscal balances will generally have either an appreciating currency or one that can withstand depreciation pressure.
Of course being able to invest in an international market with a major currency such as the Euro or the Dollar is one way to avoid the large currency swings often witnessed in the emerging and frontier markets.
- Tax liability & Local laws
Tax liability is a crucial part to consider when you intend to invest your money in overseas properties. Conduct the research on the interaction between the taxation system of your local city and that of the city where you are investing. If you are not able to do the research on your own, finding a good real estate attorney who knows the country’s laws and taxation systems will help you to familiarise with the taxes involved in the properties. Because obtaining reliable information and advice on the taxation implications associated with the overseas investment property from the start will help you to avoid future surprises.
So, do your research and choose your partners wisely!
Remember the most important calculation is your profit after tax and after repatriation. If there are high rental yields and good appreciation but the taxes are high and there are exit taxes for your investments. These need to be taken into consideration before investing. Make sure that local laws can ensure your property remains well-maintained. To do so, keeping up with local policies and regulations for foreign investment into real estate is the first approach.
- Safety first exit strategy
If you intend to develop a global real estate investment portfolio, remember that you might face inconveniences and potential risks causing financial loss. Having an exit strategy is very important and taking money off the table never hurt anyone. It will help minimize damage in an asset at a certain point. Think about what your exit strategy will be if you ever want to get out of your property investment.
Keep your eye on the global real estate market and economic trends. Understanding what’s going on in markets and economies as a whole always keeps you stay abreast about every aspect of your investment. Following the trends in the scope of the market you intend to invest in will help you to make better forecasting which could be used to map your both business and exit strategies.
In sum, finding a fast growing economy with favorable tax laws and low taxation is a key consideration before making any investment. Political stability and pro growth government policies should be highly desired by a property investor. Furthermore a market with a high volume of transactions providing for suitable liquidity on exit is very important and finding countries that have high rental yields is a very good starting point. There are many factors to consider which is why international property investment is not for the faint of heart but there are many successful cases around the world and keeping abreast of the international real estate consultants recommendations regarding markets to watch is a clever way to discover new and exciting markets.
Are you ready for overseas real estate investments?