Buying Real Estate Overseas For Cash Flow (And A Better Life). Kathleen Peddicord
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was going to increase. She didn't bother to ask about the potential for rental yield or try to project the cash flow she could expect.
She (we assume and would have loved to have had a way to confirm), along with multitudes of other global property investors, learned the hard way and only four years later that, when investing in real estate, rising prices are not guaranteed. The 2008 crash wiped out values worldwide and, with them, investors who hadn't run the numbers but had bought for appreciation rather than yield.
Property values move up and down and matter only if you're selling the property. Cash flow can be reliable and is always bankable. Buying for appreciation is chasing paper profits. Buying for cash flow is putting money in your pocket.
What Frank Lloyd Wright Taught Us About Other People's Money
Lief's first real estate purchase was in Chicago. He was renting in a three-flat when the owner sent a notice to all the tenants informing them he was listing the property for sale. It was a Frank Lloyd Wright building. Lief's apartment was big, the layout comfortable. He didn't want to give it up, so, rather than considering where he might move, Lief began figuring out a way to buy the building where he was living. Unfortunately, the people living on the top floor had the same idea and approached the owner with a plan to convert the building into condos so they could buy their apartment. That inflated the price in the seller's mind.
Undaunted, Lief put together a spreadsheet to see if he could make the numbers work for an outright purchase. He'd continue living in his apartment, paying himself rent, and rent out the other two. He calculated that he could charge more for those other units, as the current rents were below market.
Banks were offering special programs for first-time buyers. Lief knew he could get a loan. The question was whether the cash-flow math worked. Would the three apartments generate enough income to support the mortgage?
Using leverage to buy a rental property is a common strategy in the United States. The theory is that the rent pays back the bank, month by month, and covers your other expenses, hopefully with some cash flow left over. Meanwhile, equity builds up as the mortgage gets paid down … while, in theory, the property's value appreciates. How to buy with other people's money (OPM) is the first strategy you learn at any real estate investment seminar.
Lief obtained a mortgage with a loan-to-value ratio (LTV) of 98%. However, it wasn't for the building where he was living. His neighbor's condo plan botched that deal. But the seed had been planted and the spreadsheet created. Lief's math showed him what to do next.
He found a real estate agent and explained his parameters. Today we make buy decisions based on projected rental yields, gross and net. For this first purchase Lief didn't think beyond paying the mortgage.
He spent four months considering dozens of properties and entering the details for each into his spreadsheet. Two-flat buildings never came close to break-even cash flow, though Lief figures he probably could have made the math work for many of the buildings he looked at by increasing his own rent, but he didn't want to do that. Again, his stubbornness paid off (as he likes to point out for Kathleen's benefit). Lief kept active in the market, looking daily at new listings, until he found a property that fit his requirements. It was a building that had come back onto the market after the woman who had signed a purchase contract for it failed to qualify for financing. She was a hairdresser (but not Irish).
The price was good. The location was within the zone Lief had targeted. Most important, the numbers worked. Lief could keep paying himself the same rent and would be able to cover the mortgage even without increasing the rent for the other two apartments.
We met two-and-a-half years later, when, coincidentally, we both were making plans to move to Ireland. We were engaged two-and-a-half months after we met and married two months after that. Then we moved together—Lief from Chicago, Kathleen from Baltimore—to Waterford. The timing was ideal for selling Lief's three-flat. The Chicago market was frothy. He set the price above the going market rate, and the building still sold quickly. He walked away with 80% more than he'd paid less than three years earlier. The leveraged return on Lief's 2% down payment was 3,000%. He had turned $5,000 into $150,000 after closing costs and commissions. And he'd had positive cash flow from rental income every month he had owned the building.
It was an as-good-as-it-gets property investment experience, first because Lief made the buy decision based on cash flow math and second because he was able to leverage the purchase.
Buying with OPM can—as any property investor will tell you—mean an upside, but it comes with risk. It doesn't matter what your property is worth if the cash flow it generates doesn't cover the mortgage. We've known too many U.S. real estate investors who have lost too many properties when market changes collapsed their highly leveraged portfolios.
Even though we've benefited from it, we don't preach the OPM mantra. Twenty-five years of experience across 24 markets worldwide, including the United States, have taught us to respect the fundamentals. We don't buy unless the projected net rental yields translate into cash flow enough to support the investment.
Never Invest for 2% Thinking Appreciation Will Make Up the Difference
After Lief sold that three-flat in Chicago and we made our move to Ireland, we began analyzing Irish real estate markets looking for investment opportunities. At the time (1999), most rental properties in this country were generating net yields of 2% or less. Dismal. But the Irish didn't care. Property values across the country had been appreciating 10% a year or more for years, and the Irish expected that to continue indefinitely.
They were investing and reinvesting using OPM. Banks were lending easily (though not yet at 2005 levels, when 110% LTV mortgages—the extra 10% to cover the “stamp duty” required at closing—were being handed out like chocolate buttons to tykes at Christmas). Investors were subsidizing mortgage payments out of pocket because rents weren't doing the job. They saw it as a sensible ongoing investment in the windfall appreciation they were certain would come.
In 2008, Irish property values fell 50% and more, depending on the region of the country, almost overnight. Most of those 110% LTV-financed properties were returned to the bank. Didn't seem so clever any longer to top-up mortgage payments out of pocket.
Leverage isn't always a good idea and, when investing overseas, it isn't always—or at least not always easily—available. In Part II, we'll detail your realistic financing options, but you should understand as you set out to start and then grow your global cash flow portfolio that OPM isn't always an option. Sometimes that's for the best.
Ignore Gross Returns Because It's Only the Net That Matters
The math is the same whether you're calculating the rental yield for a property in Arizona or Argentina. The expenses, though, can be different, and this is the second critical factor to take into account when projecting cash flow from a property investment overseas. Calculate what your return will be gross and then ignore that figure. Only the net matters.
In Ecuador, for example, the tenant pays the homeowner's association (HOA) fee on top of the rent. Some countries impose a withholding tax on gross rental income when it's paid; you recover any overpayment by filing an annual tax return. And management fees for short-term rentals can range from 15% to 35% and more, depending on the market.
A gross rental yield of 25% sounds great until you calculate the expenses and find that it nets to 3% after backing out management splits, building fees, and other higher-than-typical expenses for that particular property. Looking only at the top-line return, you could dismiss a gross rental yield of 12% that nets to 6% in the same market.
Nondollar Cash Flow Can Fund Local Adventures
The third difference between buying real estate for cash flow in the United States and buying real estate for cash flow overseas is that often the