Consider these things before you invest in foreign real estate
Real estate is the largest component of most people’s net worth. A person’s primary residence tends to be the largest asset they own, and the ability of a country to provide borrowing towards the purchase of a home is one of the determinants of the wealth of a country. Access to debt is fundamental to the long-term growth of a country.
Real estate is also one of the most common ways to invest in a foreign country, be it the purchase of a vacation/retirement home or the investment in real estate to generate income. There are, however, several factors to consider before investing in foreign real estate. We have invested in foreign real estate and have learned many lessons in the process, our effort here is for you to fully consider whether it makes sense for you.
One of the first things to consider is what impact will a foreign investment have on your local taxes in your country of domicile. Will it be taxed differently than if it was held domestically? Does it risk your residency status locally? Is there a specific structure that would help shield you from taxes?
It is important to have a discussion with a tax accountant who specializes in income derived from foreign sources to determine if there are certain approaches that would maximize tax avoidance.
Whichever country you invest in the local tax regime and how they treat foreigners will be critical in your investment decision. Too often, investors ignore taxes until after they have made an investment decision to their own detriment. Taxes must be integral to the investment decision and any relevant structures that could save tax should be considered alongside the investment itself.
Consider all taxes including certain kinds that you may be unfamiliar with in your own country. Property taxes, foreign buyer taxes, or vacancy taxes that may impact your investment returns. There may also be ‘off-the-record’ taxes where you must pay a local businessperson to ensure that others will respect your rights to the property. A good example of the dangers of ignoring this are in this story. A Canadian’s hotel was seized in Mexico after years of him refusing to pay a local businessperson.
Certain jurisdictions will consider you to be a resident of that country solely due to your investment. This could create some unwanted issues such as potentially taxing your international income. Always check with tax counsel or educate yourself on tax treaties and treatment of taxes between your country of domicile and the country you intend to invest in.
This list isn’t extensive but it is a good place to start, ‘International Man’ provides a list of jurisdictions where you can invest in properties without paying an annual property tax here. PwC provides tax summaries for almost all countries in the world here. This is a great starting point for information, before you approach or seek out a local tax expert.
Management and maintenance
A key success factor in any real estate investment is ensuring that you have good on-site management and maintenance. When investing in equities or other security-linked instruments, the level of diligence and car is meaningfully less than it is for real estate; the main thing you need from an equity brokerage is reliable execution and providing balance information, that is it. In real estate, depending on the type of real estate you need a partner that will be able to manage tenants, negotiate leases, and maintain the property to an acceptable standard. There is remains significant potential for this partner to overcharge you and provide limited visibility on the quality of their respective execution.
It is highly advisable to seek out references for a property manager and ensure that you feel comfortable with their standard of communication. If there are any doubts, you should seek another partner. We believe that a mediocre investment with a good partner is much better than a great investment with a poor partner. Having suffered through poor partners, we cannot overstate the importance of this factor.
Understanding how day-to-day management will take place is important, including your ability to setup a bank account and other necessary items to manage day-to-day operations. If the property management is going to take care of this, then you need to ensure that you have some oversight and reporting built-in that can give you confidence that things are being managed appropriately.
However, from the perspective of appropriate risk assessment it is also important to acknowledge that whatever partner you find will be far from ideal and is likely to overcharge you when repairs are addressed or new tenants need to be found. This overcharging should be built into your assessment of the attractiveness of an investment opportunity.
Another important consideration is currency. The value of the currency that your investment is denominated in may impact the relative attractiveness of the opportunity. GBP continues to test lows and this changes the attractiveness of investment opportunities for Britons looking to invest abroad and others looking to invest in the United Kingdom.
The challenge with currency for illiquid investments such as real estate with unclear time horizons is hedging tends to be difficult and expensive if it is even possible; in most cases in Frontier Markets, it is not even possible. The currency’s value relative its PPP-adjusted value and its volatility should go into your decision-making. A Canadian who invested in US real estate when the currencies were at par has done very well as CAD has moved back to its PPP-adjusted fair value.
Time horizon is a critical investment factor, both for how long you expect to hold it and for how time is specified within the contract of a real estate purchase. Certain countries do not allow foreigners to own real estate so instead provide a 99-year lease on the property. Other investments may be restricted in how soon you may sell. This is particularly true for any real estate investment programs that provide citizenship in exchange for an investment in the country. This is not an exhaustive list, but it provides an overview for many countries with respect to property restrictions, and is also a good starting point for you to assess the attractiveness of a foreign property purchase.
Time can also determine the value of setting up entities to invest and then depreciating start-up costs over time, versus short-term investments where a significant setup cost may make the investment unattractive.
Along with time, liquidity may also affect decision-making for an investment opportunity. Investments that don’t offer liquidity due to some government restriction or that have other provision (such as age restriction or ability to sell is limited to other foreigners) could impact the time it takes to receive your investment back. This can make it riskier to invest in a country and may impair the attractiveness of the investment, especially if you are unable to sell in time of heightened volatility.
Understanding your status as a real estate owner in a jurisdiction is an important consideration prior to purchasing real estate. Would you be able to protect your property rights? How powerful are tenants in this market? Is corruption common? What types of legal issues could I encounter?
Ensuring that there are no major legal issues or that legal issues are known and can be managed is critical to success in investing in real estate. Wise counsel with expertise in your investment is a key factor in getting strong returns from your investments.
Keeping track of pending legislation and regime changes is an important way to ensure that you are not caught off-guard by investing in a regime that is to change imminently. Oftentimes when a country suffers an economic downturn, foreigners are blamed and this may result in punitive actions towards foreign investors.
Understand the legal system or ensure that you are well-represented. Markets where foreigners have not behaved well or taken advantage of rules are geographies to be wary of, as the country may decide to crackdown on certain factors that made investments attractive.
Other things to think about
- Is the investment providing you diversification from your current portfolio?
- Do I depend on these funds, or can I withstand a meaningful loss?
- Is there a corporate structure that would make this more appealing?
- Does this investment inhibit my own travel in some way?
- What alternatives are available to me domestically, how do these foreign opportunities compare?
- Are there any pending political changes that could impact your ability or desire to invest in the country you are considering?
- Why are you investing? Do you need income, capital appreciation or is this an insurance option for you?
- Do you understand the investment or are you caught up in a hysteria for a specific area or region?