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Investment Property Guide

Article written by Diarmaid Condon in 2008

You could be forgiven for thinking that the Irish overseas property market had suddenly disappeared down a black hole. The good news is that it hasn’t – but those who would have been investing in overseas property have become far more circumspect about their options and are a lot harder to separate from their cash than was previously the case. This in itself probably isn’t any harm, as we are unlikely to see a lot of the poor decisions made during the boom times. It is, however, causing a lot of pain for agents and developers. Those in the true ‘investment’ side of the industry have noticed a significant slowdown, and claim that they have to explain their products in far more detail to prospective clients, but they are still doing business.  Those who can’t make an investment case for their products are really struggling. 

Investment and property - the two words are almost constantly inter-twined, but one would really have to question should they be as synonymous as they are often made out to be? In short – not always. This seems like a strange statement from someone in the industry, but there is a good reason for it. In my experience, there are at least as many people who have made disastrous ‘investments’ in the overseas property arena, as there are those who have successfully invested abroad.

It is easy to lay the blame for such investments at the feet of unscrupulous agents, hungry for commission, and pushing product with limited or no investment upside. The truth is, though, that unless there is a very willing and gullible audience that refuses to do in depth research of its own before investing in such products, they can’t be sold. Therefore the culpability cannot always be laid exclusively at the feet of salespeople.

There is no doubt that investment potential of resort property has been oversold on the Irish market for years simply because it has been recognised that the vast bulk of the Irish buying public is looking to justify its purchases by finding an ‘investment angle’.

In this piece we will seek to differentiate between some of the different types of overseas property, or means of investing in property, presented to the Irish market and seek, to some degree, to investigate their investment potential.

Flipping

This is the most contentious means of investing in property so we’ll deal with it first. Flipping is, essentially, the process of putting a down-payment on a property off-plan and then selling it before taking ownership. It is often also used to refer to selling a property on shortly after taking possession but, in this case, the investor gets caught for full capital gains tax which a proper ‘property flipper’ would seek to avoid. Avoiding the capital gains tax is, incidentally, illegal in most countries, Ireland included, but it was still a very common form of investment until the beginning of the current economic crisis.  

Flipping is the single most dangerous means of investing in property. Firstly you are working on the presumption that the value of the property will go up, rather than down, from the time you purchase it until you sell it. As we can see in today’s market, this isn’t a given. Even in a strong market with good capital growth the actual ability to ‘flip’ a property is strongly suspect. How do you make a profit when you are competing against all the new off-plan property currently on the market?

In reality, flipping is not property investment, it is gambling. It may well suit those who are into high risk investments, but even at that you’ll often do far better taking your chances at an online casino. 

Investing for Capital Gain

Investing for capital gain has become a popular euphemism in the overseas property industry since property prices started going berserk. It really means ‘property prices are so high you won’t be able to pay your loans with rental so you’ll have to depend on capital growth instead’. Basically, it’s not a very sound investment mantra. If a property investment won’t pay down its loans over a period of time, having allowed for expenses and taxes, then either the property is too expensive or the rent is too low to justify it as an investment prospect. It’s a pretty simple calculation. If you can’t get the property cheaper or there is no scope to raise the rent then it is not a very good investment.

We should remember that rental income can be accurately calculated, presuming the property is rentable, and there is demand in the area. It can generally be relied upon within reason, apart from voids. Capital gain, as recent events have underlined, is not a given. It can vary wildly depending on what market conditions are currently in train and is almost impossible to predict. Relying on it is a very dangerous investment principle unless you’re prepared to remain in the investment for a long time.

Investing for Cashflow

Essentially this is what the professionals do. You’ll often see this referred to as ‘investing in cashflow positive product’, particularly in the US which has a whole industry devoted to writing complicated books about this relatively simple concept. The idea is to invest in a property or product that will give enough return to pay down associated borrowings, presuming there are some, and there generally are where true investors are concerned. Ideally the property should also throw off some extra income over and above the mortgage repayments to make the investment worthwhile. It is a very simple premise in theory but can be amazingly elusive in reality, particularly if you don’t know an area and its property very well, which is often the case with overseas investors. There can be a vast difference in the returns available from two very similar properties, in relatively close proximity, due to local factors about which you will often know nothing.

To get a property or portfolio that will pay its way in terms of cashflow involves an awful lot of work on the ground to ensure that you are getting the property at the right price, in an area that is desirable for rental purposes and within an environment that will allow you to hold on to a sufficient amount of your income to make it worth while.

Capital gains in markets worldwide over the last decade have meant that finding good ‘cashflow positive’ property has become more and more difficult. Prices are stabilising but they will have to drop considerably in many countries to make them attractive. Countries currently attracting a lot of attention for this type of product are Germany and Sweden.

Guaranteed return products

Guaranteed return products have got themselves a very bad name over the years. The premise is that the developer will itself, or in alliance with a management company, offer to pay back a certain percentage of the value of the property, usually from 3 to 5%, each year over a certain period. This gives the investor the knowledge that they will have income to cover expenses and loan repayments.

Properly done, guaranteed return property is actually a good idea, even though it will rarely pay down a mortgage unless it is quite a small one, but it has been badly abused over the years. The biggest problem, particularly for product sold with short term guarantees of up to three years, is that the money your receive in your rental guarantee has very often simply been added to the price of the property. It is then given back to you over the period and you pay tax on it. Not the best use of capital you could envisage.

To carry out a good guaranteed return transaction involves a property in a desirable area, a well run management company and a constant supply of high quality tenants. For the purchaser, knowledge of the value of property in the area and the actual achievable rent is essential prior to purchase. You will have to let your property in this market once the guaranteed return period has expired. If there is a limited rental pool and you have simply being receiving your own money as rental, you will have a very poor investment.  

Guaranteed return product is fine if you want your property to provide some income to pay down expenses, it would typically not be considered a true investment product though.

Syndicates

Investing in the commercial sector is an unrealisable aim for most small scale investors. Commercial property is inherently more stable than residential counterpart, but is generally extremely expensive if it is worth buying. Positive factors include the hands off nature of commercial property, longer term contracts and lack of tenant contact.

Of course commercial property isn’t without its downsides. Gearing is normally far lower than for residential, often limited to 60% loan to valuation (LTV), which means having to come up with a lot of money to get off the ground. This very substantial barrier to entry is, understandably enough, what stops most people from entering the commercial arena. Vacancy is also a problem, commercial vacancy is normally far more financially damaging and more difficult to rectify than its residential counterpart. Commercial property is still a very desirable product though.

Enter the Syndicate. In a typical syndicate the investor purchases a share of the property investment and holds it for a specific period of time, normally between 5 and 10 years. It is usual for up to 85% of the value of the property to be financed with what is termed non-recourse debt. This allows the bank security over the property and rents emanating from it but contributors cannot be held liable for more than their investment stake.

By their very nature each individual investment will be relatively unique so it is difficult to be specific about exact returns, appreciation, debt repayment, mortgage arrangement or length of term as these are all project specific. A professionally organised syndicate will release a substantial information memorandum on a particular investment. Most of these vehicles usually work in a projected range of 5 to 10% yield and 7 to 12% annual appreciation.  

The biggest problem for syndicates is lack of regulation. Consequently the products on offer can vary greatly in quality and fees and charges vary wildly. There are further limitations inherent in the product which must be considered. Lack of flexibility and the difficulty of extracting oneself from a syndicate ahead of the final property sale is a major deterrent. A syndicate seldom returns any income during its lifetime, although some do offer a small return, but it is not generally a suitable product for investors needing ongoing income. Returns are used to pay down the usually substantial debt within the syndicate. A good quality syndicate would generally be considered a sound investment option.

Irish syndicates are active across the world but the most popular areas are the US, UK and Germany. You will find higher risk options investing in Eastern Europe and even South-East Asia. Entry levels vary from around €50k upwards.

Property Funds

Property Funds can be found in numerous locations but retail versions are normally found at your local bank or financial institution. Property Funds are pretty self explanatory, amounts of money gathered by an institution to invest in property. They sound remarkably similar to syndicates, and indeed there are a lot of similarities, particularly in the type of product purchased, but there are also some big differences.

Unlike any other investment in property, regulated funds, which are officially titled ‘collective investment schemes’, are regulated by IFSRA (the Irish Financial Services Regulatory Authority), or at least some portion of them will be. The ‘Investment the big attraction of a fund is that someone independent is keeping an eye on how it is being set up.

Funds will also typically ‘trade’ property, i.e. they will buy, sell and manage property within the fund as the fund manager sees fit. Typically a syndicate does not engage in trading to the same extent. Funds tend to be open-ended, i.e. there is no specific end date, whereas a syndicate typically has a date time-frame in which it is wound up and the profits divided between the investors.

You can generally cash out of funds within pre-defined notice periods. With a syndicate, outside of optional trading windows, you have to wait until the property is being divested and the syndicate wound up. Funds typically offer a lot more flexibility.

The big problem most investors find with funds is that they have no control over what is being bought and sold, this is being entrusted to an individual they do not know. This removes completely the adrenaline rush that investors typically get from ‘finding a nugget’. It is consequently often viewed as being as exciting as putting your money under the mattress. A fund is generally a lot safer than investing in property in your own right, but if you want the ‘investment buzz’ it probably won’t be for you.

Some of the criticisms regularly levelled at funds are that fees can be quite high and not very well justified. Encashment penalties are also charged if you wish to exit before your agreed maturity date. Funds are also very often organised by financial institutions which, in the search for increased productivity, tend to promote them with more than a little bias. In general, like syndicates, funds would be regarded a pretty sound investment option.

There is a more in depth discussion of funds of all descriptions at the Irish Funds Industry Association (IFIA) website on www.irishfunds.ie.

Publicly Quoted Property Companies

It can take a considerable amount of money to invest in property. If you don’t have this kind of cash, or simply don’t want to invest so much, then purchasing shares in a publicly quoted property company is an option. You do expose your investment to the vagaries of stock market sentiment, which may have nothing to do with your chosen company or the property industry in general. In some countries, such as the US, investment may also be made via Real Estate Investment Trusts (REITs), entities which own and manage large property portfolios. You’ll find more info on REITs at www.reit.com.

The biggest problem for most property investments is liquidity. Investing in property related shares avoids this problem as you can sell shares in the company whenever you wish. Although you are not guaranteed to make a profit, at least you can recoup some portion of your funds fairly quickly. Selling a property when you need to can often be problematic and, at best, will take a significant period of time. If you need funds urgently this can be a very big problem. Share investment is a cost effective means of investing in property without having to commit huge amounts of funds, but it is not very hands on or transparent, which can put off real property investors.

Buy to Let

For those who wish to go it alone, like to have that deed in their name and be able to claim the spoils of victory for themselves, buy-to-let tends to be the first port of call. Since buy-to-let became a loss making industry in Ireland some years ago, buyers have moved abroad and the Irish are still active in the US and UK in particular, where they are to be found fishing for value. They have, in the recent past, also been active in places such as Spain, France Hungary, Lithuania, Poland and Bulgaria with varying degrees of success.

The principle of buy-to-let is very simple and all in the name – purchasing a property, normally residential, so that you can rent it out – hopefully for a profit. As with guaranteed rental product, a good buy-to-let transaction necessitates a property in a desirable area and a supply of high quality tenants. It will also normally, but not always, involve a good management company as managing property abroad can be incredibly problematic. Again, knowledge of the value of property and the actual achievable rent is essential prior to purchase.

Buy-to-let is suffering somewhat of an identity crisis at the moment as property prices in many countries have meant that the figures don’t add up. The closure of a number of buy-to-let ‘investment clubs’ in the UK has also left the industry there in turmoil. The lesson to be learned from this is that you need to do your own market research. Unless you do the legwork yourself you run a pretty high risk that you’ll be in possession of a non-profitable unit.

Banks have cooled on the whole buy-to-let phenomenon considerably since the credit crisis has hit. They were pushing out 95% BTL loans not that long ago but these same loans are now nigh on impossible to achieve.

If you can get a property at the right price then buy-to-let can work very well. Working from overseas, however, one of the biggest problems is the cost of management which does eat into profits. Unless you have a number of units in close proximity where you can spread the management overhead it can prove a deal breaker.

You can find buy-to-let property from €100k which, if you can get an 80% mortgage, will leave a cash investment of around €20k plus expenses.

Leaseback

Leaseback is the everyday term used to describe the ‘Residence de Tourisme’ scheme in France. This is essentially a scheme to increase the quality and quantity of tourist accommodation available across France. It has been seen to pop up in various guises in other countries such as Spain and Portugal, but it is essentially a French product.

Leaseback is often sold as an investment product, but it’s not really. It is a product that straddles the lifestyle and investment market. It is suitable for those who want to use the property for a period of time in the year but would also like some income to take the sting out of the expenses and debts associated with the property. In general it takes most of the first guaranteed rental period, up to 11.9 years, before the property actually ‘washes its face’ i.e. pays the bills without having to be supplemented from your own funds. The argument normally used is that it should be treated as a ‘pension policy’ where you put in a certain amount every year for a period and then prosper in later years.

Leaseback certainly has a place for some investors, particularly if they are prepared to put a value on their use of the property, although strong returns have become almost impossible to find as the value of French property has soared in recent years. It would certainly not make the kind of returns that a true investor would envisage.

Leasebacks are available from around €150k with loans available up to 95% LTV in some cases.

Apart-Hotels

Apart-hotels, called ‘condo-hotels’ in the US and ‘serviced apartments’ in the UK, have been around since the 1970’s. They are experiencing renewed interest across Europe in the past few years as hotel operators explore new routes to circumvent the capital intensive nature of owning their own property portfolios. Essentially you purchase a room or unit in the hotel which then gives you a cut of the profit made by the hotel.

The units come fully-furnished, are maintained to hotel standards and are managed and marketed on the purchasers’ behalf, making them relatively hassle-free – which appeals to Irish investors – while still being a freehold property. As the units are generally quite small the entry levels can often be quite affordable, from around €75k with borrowing normally available at around 80% LTV. The rental returns can also be attractive, at up to 8% Net, although many deals involve a percentage share of hotel profits, meaning that returns are not guaranteed. Included in the deal can be a level of use at that particular hotel, or in other related hotels worldwide – but with reduced rates of return.

If there were to be a query about such investments it would reside with the residual value of a room/suite in a hotel down the line. It restricts your exit market to investors and capital gain may not be all that it would be with traditional property. Investors are often prepared to accept this on the basis that the cashflow is attractive. The strength of the hotel chain offering the guarantees is an important factor to keep in mind as is the location and desirability of the hotel in question. In general, though, apart-hotels can be a reasonably attractive investment product.

Diarmaid Condon is an independent overseas property consultant with significant agency experience. He can be contacted via his website at www.diarmaidcondon.com.

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Further Information:

Further information on Syndicated Property Purchase.

For a selection of property from around the world click here. 

For a listing of agents selling overseas property click here.

For independent articles on overseas property click here.

For advice on purchasing property overseas click here.

For news on the world of overseas property click here.

For new releases and product updates from agents around the world click here.

For a list of upcoming overseas property exhibitions around the country click here.

You may also enjoy a visit to the OverseasCafe.com's topical blog or my own blog.

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