The following guest post on buying a property overseas is by Rick Todd of Expat Investing. These are Rick’s views, not necessarily mine — so let us know what you think in the comments below.
Most people who are in a position to buy a property overseas are buying for their retirement or because they live abroad.
Only the wealthiest investors can afford to buy a property overseas and then hire someone to manage that property while they live elsewhere. For the rest of us, the option to buy a property abroad is intimately tied to our work and our time after work.
The traditional view of property
Until recently, the purchase of property was seen as a reliable investment that was sure to go up over time and to make its owner a decent profit upon its sale.
Yes, there were those unlucky few who bought home next to a uranium mine or a new expressway and saw it depreciate in value, but for most investing in property was a great way to get rich.
And then came the crash.
Many markets worldwide saw property plummet as in many cases property prices were closely correlated with most other asset classes in the global market crash. In many countries, particularly in such places as the United States, Spain, and places over-reliant on property sales like Dubai, the property market will not recover for years if not decades.
Property is no longer seen by everyone as an investment, and to many now it is probably not viewed as a necessity to purchase. In many parts of the world, most people rent property throughout their lives and suffer no consequences at all.
In my opinion the crash has taught us a valuable lesson: speculating that a property will appreciate in value is very risky.
It is not a given that it will appreciate enough to be worth selling, either now, or far into the future. However, I believe the purchase of a property, regardless of the location, does serve a purpose: it can act as a hedge against inflation.
Property as an inflation hedge
Most property is purchased in the form of a personal residence and most personal residences are purchased with bank loans that fix a monthly payment for a considerable period of time, say 15-30 years. [In the UK shorter fixes or variable rates are still more popular, but they shouldn’t be! – Ed].
During the life of the mortgage the payments stay the same but inflation begins to act. While the initial payments on a home loan will probably be more than the monthly rent on a comparable place, as the years pass and inflation affects the local currency more and more, the fixed monthly payment made on the home loan stays the same. Someone renting property over the same period sees their rent increasing year after year.
The result is that over time, a home owner saves a tremendous amount of money. By the time the loan is paid off, the home expenses are related only to maintenance and taxes. When a person with a paid off property reaches retirement, the home is not a burden on the person’s retirement savings, and their house or apartment can continue to be lived in or sold to further fund a retirement.
Of course, this only works if property is purchased with a long term fixed rate loan, and the person who buys it intends on keeping it for a long period of time. Someone who moves frequently will find it difficult to accomplish.
A worked example
In the past 100 years, the UK has experienced about four per cent inflation annually on average. The US has experienced a little over three per cent. So I’m going to assume that a stable developed economy experiences about three to four per cent per year.
So let’s say Person A buys a property for the long run, and Person B decides renting is the way to go for the long run. Both Person A and Person B are going to live in identical properties.
- Person A pays £1,000 a month in rent.
- Person B agrees to a loan (with 20 per cent down payment) with a monthly payment of £1,500.
The premium Person B pays per month is a reflection of buying into a healthy market, when most properties are purchased.
If we assume that a landlord is going to raise your rent annually to at least match inflation, we can expect a four per cent rise in rent per year which would directly affect Person A. Person B has locked in his monthly payment with a long term fixed rate loan.
So Person A pays £1,040 per month in year two, Person B continues to pay £1,500 per month. In year three Person A pays £1,081.60 per month, while Person B continues to pay £1,500 per month. This continues with Person A’s rent compounding upwards by four per cent per anum
In year 12, Person A begins to pay more than Person B, when Person A’s monthly rent hits £1,539 per month, and Person B’s rent is at the same £1,500 per month.
By the end of the twenty year period where Person B has finally paid off his loan and is paying nothing monthly, Person A can expect to be paying at least £2,106.80 per month in rent.
I have only adjusted the rent for inflation and I have not added any arbitrary raises in rent a landlord might ask for over and above inflation.
As you can see, the savings are considerable for a person who is willing to commit to ownership for the long run. But anything less than a decade or so of ownership isn’t worth it. In short, if you are investing in a home, you are asking yourself to predict that you will have a stable income over the next decade and a half in order to see yourself to a profitable result.
These rules also apply to someone who wishes to move overseas for their job. An expat who intends to stay for years in their new country is better able to buy a property than an expat who is going to move from country to country.
Also, someone who is older and closer to retirement may not want the burden of a home loan when they retire with a shorter time horizon than someone in the beginning or middle of his career. The purchase of a home is probably more realistic for someone younger.
Currency risk
Of course, the purchase of property overseas makes you an unintentional player in the currency market.
If you purchase in a developed country, I would argue that your risk of currency depreciation for your property is low. Is it likely that a developed country will revalue their currency in order to pay off external debt? No.
Historically, the countries most likely to default have been developing economies. The world’s largest developed economies have not really defaulted since the Second World War, and the low interest rates on their bonds reflect the market’s confidence in their credit worthiness. Even if they were to default, the IMF and other countries would quite likely bail them out, as we have seen in Greece.
In developing economies, it’s a completely different matter. Buying a overseas in a developing economy is where you take on the most currency risk.
If you buy a home in a developing economy that devalues its currency, the first group that is going to be scared away from purchasing your property is going to be foreign investors. You may list your property in your home country’s currency because that’s all you’ll accept, but unless the property has a lot going for it, many potential buyers may be scared off if there’s been a recent devaluation in your property’s country.
Buying property for retirement
What about buying a property overseas for retirement? I think it’s extremely risky and not a good idea.
- When you retire, you retire on a lower income that is often reliant on investments. These may no longer grow substantially as you are not increasing them through a salary.
- People in retirement are generally in worse health than those who are working and younger, and the burden of a new property can take its toll.
- Ownership can act as an anchor if you wish to move back home for any reason.
In short, my advice to people who are thinking of moving overseas is to put themselves in the uncomfortable position of predicting what they will be doing for their next few decades. Are they planning on staying in the same place?
If yes, then buying a property is a good idea. If no, forget it. And if you are retiring and moving abroad, rent a place instead
Rick Todd posts at Expat Investing where he writes on such topics as to whether retiring abroad is right for you.
Comments on this entry are closed.
What about a new boiler or a new roof? That’s going to cost the home buyer much more in 2020 with inflation, not to mention 2030.
You need to bring wear and tear into your sums Rick.
Sali (a homeowner anyway!)
Exactly – if you rent the landlord is responsible for repairs and (at least in Sweden) for replacing white goods (dishwasher, washing machine) at reasonable intervals. And surely a fixed rate mortgage takes expected inflation over the period into account in the interest rate?
What I would like to see is a move away from mortgages to buying a home piecemeal. This would be something like a housing co-operative where your flat or house is worth a certain number of “shares” which you can either rent or buy. The only mortgage will be a corporate mortgage taken out by the co-operative to buy or build the buildings, and everyone who buys a share helps to pay off some of the mortgage. Then even if the housing markets fall only the co-op, not its members, will risk negative equity and people could still sell their shares to move (though at a loss).
Swedish housing co-operatives (bostadsrätter) are something like this, except that you have to choose between buying the whole flat at once or renting, with no middle stage.
Sali,
Wear and tear is certainly an issue, but it’s really difficult to assess what the costs are to the average homeowner in that area. In my experience a roof tends to last about 15-20 years, and that’s probably the largest expense a homeowner will pay over the course of ownership. Many jurisdictions require an inspection to be performed before a house is purchased, and these inspections can make or break a sale by revealing an excessively damaged property, preventing a buyer from being stuck with a property that requires a great deal of maintenance and repairs. If you buy property for the long term, you will probably only need to repair your roof twice, and I am skeptical that those two repairs will be enough to make buying a house unaffordable versus renting long term.
.-= Rick on: The Financial Guide to Retiring Abroad is now on Amazon =-.
> Is it likely that a developed country will revalue their currency in order to pay off external debt? No.
What? Is this not exactly what the US and to a lesser extent the UK are doing right now with Quantitative Easing?
> Person B has finally paid off his loan and is paying nothing monthly
I have paid off my house, and while my house outgoings have dropped and are below typical rents of £600 in this area, I can assure you that the cost of owning a house outright are not zero. Bits fall off a house in time – I had to replace my garage roof, I expect to have to replace a flat roof in the next 5 years and have savings in place towards that, my boiler is over 20 years old and will need changing at some point, I had to replace the windows two years ago, I really ought to get the exterior painted or do it myself, I got someone to do the gutters and soffits a few years ago…
I agree with some of your points, such as needign to stay in a house for ten years at least – shame the average dwell time in the UK is seven years but those were times of escalating house prices so people got away with it.
> The result is that over time, a home owner saves a tremendous amount of money.
Don’t forget that he also pays three times over for it in capital + mortgage interest payments… In a rising market, that’s no big deal, it will probably end up more than making up for that.
Housing is a complex and illiquid investment. Combined with currency risk it becomes even more complex. There’s nothing wrong with complex investments if you have a good reason for it, but I feel the inflation hedge analysis is simplistic if you don’t also account for the potential divergence in economy between your own country and the country hosting your investment.
For all that I agree with your conclusion of buying a property for retirement – ie don’t, but the inflation hedge I think is too one-dimensional.
.-= ermine on: send not to know for whom the bell tolls =-.
I agree with the general comments about wear and tear and maintenance costs, and also feedback I’ve had over email about property taxes being greater for homeowners.
On the other hand one of those comments was from the US, where homeowners receive tax breaks that renters don’t, and Rick hasn’t included that in this article, which is understandable given it’s a general non-country specific case study.
Rick has also not allowed anything for capital appreciation, which in the big developed countries has long easily kept up with inflation, and generally done much better.
I rent yet would prefer to own for that reason (inflation, both of rent that Rick covers, and from an investment perspective in terms of capital values) but London property has seemed too expensive for at least seven years so I’ve kept renting, and suffered according!
Good to see Rick’s piece opening up a debate.
I purposely did not mention capital appreciation because I am assuming that it may not happen. As we have seen in many countries around the world including most prominently the United States, capital appreciation is not guaranteed. It will probably be a couple of decades before home prices are at the level they were pre-crash.
My chief concern in buying property is that property not be seen as an investment but as an inflation hedge. Once you put capital appreciation into the mix, you start on a slippery slope to speculation, borrowing against your property, and even purchasing a property you can’t really afford because you’ll just flip it in the near future when it has appreciated. This latest near global recession has shown that capital appreciation is not really guaranteed, particularly over a short period of time like two decades or less. This site, and myself, are proponents of index funds, which entails a buy and hold mentality. The same mentality must be used in the purchase of a home.
.-= Rick on: The Financial Guide to Retiring Abroad is now on Amazon =-.
> I’ve had over email about property taxes being greater for homeowners.
> On the other hand one of those comments was from the US, where homeowners receive tax breaks that renters don’t,
I believe that these two are both US-specific. I can’t think of any particular way that property taxes in the UK are greater for homeowners than renters. This used to be the case with rates which were levied on a property rather than on the inhabitants as the Council Tax now is, though in practice renters ended up eating the rates as a part of the rent anyway even if the landlord nominally paid the rates.
In the US they seem to have interest tax relief on mortgages, which greatly aids the inflation hedge argument. And they seem to have staggeringly high levels of annual property taxes which vary from State to State, they make our Council tax look cheap.
If what Rick meant by inflation hedge is for someone buying with a large capital lump sum then I follow the inflation hedge angle in terms of preserving that lamp. For ordinary people who generally start their working lives with at best the shirts on their backs and start homeownership using a mortgage, particularly in the UK without tax relief on the interest then I don’t think the inflation hedge angle holds water, since you generally pay more in mortgage interest than the rate of inflation. The only thing that makes having a mortgage work in the UK is the capital appreciation of the house integrated over the duration of the mortgage. A mortgage is basically a highly leveraged investment, except in US states where you have the added advantage of non-recourse mortgages so you can bail if the investment goes pear-shaped, making it a one-way bet if you have the chutzpah.
.-= ermine on: send not to know for whom the bell tolls =-.
The inflation hedge argument refers surely to the ongoing cost of property in the long term. In the example given, over the life of the mortgage, the costs incurred will be approximately the same. The true benefit kicks in when the mortgage is paid off and is not related to any capital gain.
Factoring out (in the UK) council tax and energy costs, the owner’s ongoing charge falls rapidly, with only maintenance being an issue. For the renter, cost continues to rise until death, usually against a background of reduced income. Generally, this is not a good situation to be in. Of course, you may keel over or be forced through ill health into care and lose all your gains, but that is life (or death).
.-= Salis Grano on: The Comprehensive Spending Review =-.