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Pizza, Prada and foreign makaan - Corporate News - livemint.com
When buying Indian real estate is complicated enough, foreign real estate must seem posi
tively daunting. But is it really?
Investing in foreign real estate is not a fiendishly complicated task. iStockphoto
The ongoing global economic malaise has created an opportunity for Indians to own prime residential real estate. The domestic populations of countries such as the US and UK are still working off the loans they took during the boom. Anaemic domestic demand has led to declining house prices. As the balance of power has shifted towards buyers, foreigners have exploited this opportunity to own residential real estate at fairly reasonable levels. The scope of the opportunity in some markets can be seen in chart 1 (see below). In most countries, the decline in house prices following the global credit crunch has left them at levels where they were five or more years ago. The exceptions being Canada and Australia, which are yet to see any meaningful decline.
Additionally, the strong recovery in foreign equity markets from their lows in March 2009 is yet to be seen in housing markets. Apart from stagnating or falling prices, the number of transactions has also fallen compared with the pre-credit crunch period. A few courageous buyers have stepped into this fearful market following Warren Buffett’s dictum that the time to be greedy is when others are fearful. However, most of the foreign buyers have been the global ultrarich buying multi-million-dollar properties. But this does not mean that one needs to be a Russian oligarch or a Middle Eastern sheikh to buy a house in London, New York or Valencia for that matter. For example, there are decent London properties available under half-a-million dollars.
The question to be answered is whether it makes sense to invest in real estate abroad. Intuitively, total returns (both capital appreciation and rental yield) from real estate in Western countries are expected to be lower than in India. Chasing the highest return in India has merit but is a blinkered view. From a portfolio perspective, foreign real estate has two advantages: first is of diversification and the second is wealth preservation.
A foreign asset denominated in hard currency in a nation with stable rule of law provides protection against unexpected downside. Russian, Middle-Eastern and European investment in the London property market is mainly to benefit from this characteristic.
Where to start
Investing in foreign real estate is not a fiendishly complicated task. The standard metrics of evaluation are applicable but need slight modifications. What needs to be borne in mind is that unlike financial assets, real estate is a domestic asset with risk and return driven by domestic factors. The first step is to gain knowledge of the domestic economy and demographics. This sounds obvious while making real estate investments in one’s own country. Overseas, however, this is a much greater challenge.
Once the fundamental drivers are analysed, the investor needs to evaluate the legal landscape. This would include whether foreigners are allowed to buy domestic housing and the strength of protection afforded to their property rights. It would also include the degree of regulation and transparency in the housing market. A lot of Western nations would satisfy the criteria of being open, transparent and with regulated jurisdictions. However, for Indians, the US and UK are preferred investment destinations. This is because of language and presence of similar commonlaw legal systems.
Other Commonwealth nations such as Canada and Australia would also be in the list were it not for the fact that their housing markets are yet to deflate. Ireland could be a contender were it not for its poor macroeconomic outlook.
Having decided on a country, the next step is to drill down to the city and area level. Economics and demographics are also important to evaluate the attractiveness of cities. For an example, New York with a resilient finance industry is better than Detroit with a declining car-manufacturing industry. Determination of a specific area requires the services of a local expert. It also involves enormous amounts of due diligence. The final step is to analyse investment economics under the familiar heads of transaction costs, tax treatment, mortgage availability, rental yields and running costs.
Graphic by Naveen Kumar Saini/Mint
Local experts such as estate agents and lawyers are necessary to execute the investment decision. While there are specialized real estate agents and legal firms catering to the international buyer, most of them operate in the multi-million-dollar segment (around Rs. 5 crore and above). Investors with smaller pots may be better off just talking to the agents and lawyers that the locals use.
Let’s use the London market as an example.
London is one of the investment options that Indians should consider. The UK economy, bogged down after the credit crisis, is recovering, albeit slower than the US. London is the main contributor to the UK’s gross domestic product and the main destination for immigrants into the UK, around 250,000 of whom arrived between June 2010 and 2011. Immigration combined with limited land availability and restrictive planning laws keeps the demand for housing up. London prime property is also the object of desire for the rich from Russia, the Middle East and Europe. Their purchases in the sought-after postcodes such as South Kensington, Belgravia and Knightsbridge led to a percolation of demand to other areas of London. This is mainly the reason why the London property market has massively outperformed the broader UK market.
Unfortunately, for rupee-denominated investors, the currency’s recent plunge has made London property 13% more expensive compared with last year. However, waiting for the rupee to appreciate or depreciate should not enter the investment decision since, when you think about it, that is a separate foreign-exchange trade in itself.
Having decided upon London, the next question to answer is where and what type of property to buy. Unless one wishes to compete with the global superrich and pay an enormous premium for a postcode brand, the lesser-known residential areas outside of Zone 1—as the heart of Central London is called—are preferable. They offer potential for capital appreciation and are still reasonably priced in comparison as shown in chart 2 (see above). It compares Wandsworth, a popular residential area for young families, and the Royal Borough of Kensington and Chelsea, a magnet for the global super-rich.
The ideal investment property is one which costs less than £1 million. This has two main advantages; the first obvious one is of a lower stamp duty. Properties between £250,000 and £500,000 pay 3%, and those between £500,000 and £1 million pay 4%, compared with 5% for properties above £1 million and 7% for those above £2 million.
This exemplifies the implicit political advantage of not being classified as a ‘‘rich man’s property”. It is very important in today’s economic environment where Western governments are trying to raise tax revenues. The second advantage in choosing such property is dual demand—from people lower down the property ladder looking to upgrade, and from people above looking to downgrade, such as when children move out and the couple wishes to move into a more manageable property.
London is only one of the options from a plethora available to the smart and affluent Indian investor wishing to add foreign real estate to his portfolio. There are hundreds of more options from chalets in Swiss ski resorts to cut-price Spanish seaside villas. However, due diligence of national and local factors are the key. Those who are short on time can still add foreign real estate to their investment portfolios using real estate investment trusts (REITs). But that is a discussion for another day.
Shashank Khare is a London-based investment professional, learning from the capital markets what they didn’t teach him at IIM Ahmedabad.
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Arun Gupta
