The following guest post on buying a property overseas is by Rick Todd of Expat Investing [1]. 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 [2] 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 [1] where he writes on such topics as to whether retiring abroad is right for you [3].