Real estate: Articles

This section of the site deals with investing in international real estate as an asset class, rather than as somewhere to live, or a holiday home to enjoy (for the latter, see our Lifestyle section).

Most property investment of this kind is directed towards commercial property, as this generates more income than the residential variant. Real estate has always been a favoured asset class with portfolio managers, as it allows them to diversify away from equity, bond, and currency markets, to a market which follows different dynamics (non-correlated). Property offers the private investor global diversification, long-term asset growth, and stability. Its concrete nature, the fact that the investment is being made into tangible bricks and mortar, is another attraction. It is also a useful means of preserving capital, especially during periods when securities markets are particularly volatile, and it can be a means of protecting against inflation.

Fintactica writes about key commercial real estate opportunities and market trends around the world, both those that can be acquired directly, and those which are accessible indirectly, via a real estate fund or investment trust.

Getting exposure to commercial real estate

You don't need to be a multi-millionaire to get access to the global property market. The easiest way to do so if via an exchange-traded fund (ETF). These are covered in more detail in our Structured Products section. ETFs are listed on stock-exchanges like normal shares, and can be bought and sold as easily as equities can. Property-based ETFs are now coming on the market in Europe and the US. They will seek to track a recognised commercial property index by investing in the shares of property companies, and are the cheapest and easiest way to gain commercial real estate exposure.

More conventional property funds, structured like mutual funds, also with an underlying portfolio composed of the shares of real estate companies, are another avenue into this market. In reality you are buying the shares of companies that hold commercial property so, as with ETFs, this cannot be considered a direct investment into this asset class. But in terms of the relative risk versus returns, and correlation against other equities, these funds do represent a cheaper alternative if you cannot afford to go out and buy your own office building. In addition, you benefit from diversification across the massive international real estate portfolio controlled by the companies the fund invests in. Just make sure you buy a fund that is outperforming its benchmark index consistently. Most funds will state which benchmark they are using, although there is nothing to stop you measuring performance against some other real estate benchmark which you think reflects the market more accurately.

Real estate investment trusts (REITs) are a third popular avenue into commercial property. Many of these will not be taxed on gains and income that stays inside the fund. You will still need to consider your personal tax situation with respect to any income that is paid out to you or entities under your control.

REITs also enjoy good cashflow, are very transparent (it is easy to see where they are investing), and can pay out a relatively high level of income. They tend to trade at net asset value (NAV), which gives them an advantage against conventional property funds, which frequently trade at a discount.

Investing directly

Some investors will already be familiar with real estate investment, and some cultures are more comfortable with large real estate portfolios than others. Investing directly should be carried out with a high degree of caution, particularly if you are not experienced in buying commercial real estate. It can be as easy to lose your investment in this market as in the stock-market. Try to focus on the highest quality real estate, but see below for more on the opportunities to be had in the distressed market.

For example, when investing in the US or UK markets, the best opportunities will be on freehold land, fully-leased, with agreements that contain tenant covenants of a high standard. These should produce secure long-term rental cash flows, and competitive investment returns.

Commercial property can generally be divided into three categories: office buildings, retail units or shopping centres, and industrial warehouses. Multi-tenant properties can be more prudent investments if they use the right lease structures.

Direct investment into commercial real estate can take a variety of different paths, depending on how active you are as an investor. It is easy to follow a 'passive' investment strategy, acquiring existing income-producing, institutional-grade investment property within a set of very conservative investment parameters. Alternatively, if you are wealthy enough, you can provide a forward funding facility to a property development company in return for the right to purchase a pre-let development on completion. This can give you a higher initial yield and generally a longer-term lease structure.

For the more adventurous investor, it may be possible acquire existing properties where the present owner is in a near-bankrupt position, or under pressure to sell, and has not realised a number of features of 'hidden value' inherent in the property. Investments of this kind would require you to lay your hands on at least US$5 million, although a typical transaction would require US$10 million to US$12 million. Working alongside an established blue-chip property developer that can function as your strategic partner is a bonus in this kind of scenario, but do make sure they have excellent credentials.

Bear in mind also that acquisition costs and leasing practices will vary widely from country to country. Apart from local taxes like VAT and transfer duties, agency fees will vary, as will restrictions on foreign ownership. For example, despite vast interest in the commercial property sector in the Czech Republic, especially Prague, foreign legal entities were barred from this market until the end of 2001. Since then the local government has allowed foreign players into the market, so long as they maintain a registered office in the country. Forestry and agricultural land remains off-limits, however.

Similarly, there will be broad variations in the ease of obtaining planning permission. Even in the US, which alone represents nearly half the global commercial real estate market, planning regulations will be different from city to city, and state to state.
The average lease will tend to fluctuate as well: in Central Europe alone it can range from three years (Hungary) to up to 15 (Austria). The frequency of rent reviews and the statutory right to renew leases will also vary.

Strategy

Real estate has no place in a short-term investment strategy. It represents a long-term investment characterised not by spectacular short-term gains but by regular returns. Investors buying real estate in safe havens have always had their patience rewarded by seeing the value of the property appreciate and their assets accumulate.
Remember that a real estate portfolio, unlike liquid securities, entails not only regular income, but also expenditure in the form of financing costs (mortgage interest) as well as operating and maintenance costs. For newer property, these can amount to around 20% of the return.

Because real estate is such a long-term investment play, you will need to consider all the features of the property concerned, and draw up a list of objective and subjective criteria. There will inevitably be an element of uncertainty: it is hard to predict socio-economic developments that might take place during the life of the investment. Looking to past trends can help in this respect. Think hard about factors like political stability and security, the state of the economy, and prevailing rates of unemployment. Population structure and demographic trends are also worth considering.

In real estate investment, the golden rule is quality before quantity. Analysis of the relative benefits of the site's location is essential. For example, with offices, make sure they are easily accessible by public and private transport, that there are suitable parking facilities, that companies are moving into the area, not moving out, and that there is synergy with other users of the local area. Do not take the assurances of those seeking to sell the real estate that things are improving locally: carry out independent research, or pay someone to do it for you.

Be prepared to accept a low rate of return, however, if the risks associated with the location are also relatively low.

The success of an investment is also determined by the property's own inherent features, such as its architecture and the quality of construction. To avoid a possible drop in the rate of return, it is essential to draw up a long-term renovation and maintenance plan at the outset, with a projected investment schedule, and profit and loss account. This is the only way to ensure that in the long run the property remains attractive, keeping its value in terms of price and rate of return. To run a property competently requires considerable expertise. The complexity of tenancy laws, among other things, makes property management a daunting task for the layman. Fintactica can provide some pointers as to how to provide yourself with some level of commercial real estate exposure, but it is also important for private investors to seek professional advice in this respect.

Tax planning

An active investor in international real estate needs to pay attention to his tax planning strategy. It is essential that you consult a good accountant with cross-border expertise who can advise on the various tax liabilities involved. This will vary according to where you live, and where your investments are held.

It is of the utmost importance to ensure that a tax deduction is available for the costs of financing the investment, and, at the same time, to minimise the tax costs of the lender through withholding taxes. Interest paid on any loans taken out for real estate acquisition could well be tax deductible, along with non-interest expenses incurred in managing the property (e.g. cost of repairs).

It is also worth finding out if any double taxation treaties exist between your country of residence (or the jurisdiction in which the investing entity is domiciled) and the jurisdiction in which the real estate is sited. This can affect how much withholding tax you pay. Value-added tax is likely to substantially affect the economic analysis of any investment: although land and buildings are generally exempt, some governments retain an option to levy VAT. If VAT is charged on rent, it may reduce the range of possible tenants or else require rent to be offered at a discount.

Many experienced real estate investors will create a company to purchase and manage their portfolio. This will either be in their country of residence, or in a third jurisdiction. A real benefit of holding an investment via a company is the ability to choose between selling the property itself - therefore realising any capital gains or losses in the company - and disposing of the shares in the company, and crystallising the gain at shareholder level.

Be aware that property investors are treated differently for tax purposes according to how long you hold the investment, and how active you are in its day-to-day management. Depending on the country you are investing in, this can have an impact on how it is taxed locally. Find out about the treatment of death duties as well, as this could affect which structure you choose (a limited liability company or other distinct entity may be needed), especially if you are planning to pass on your wealth to your descendants.