The prospect of buying a second home in an idyllic tropical setting or dynamic, exciting international metropolis is definitely appealing. With dreams of easy, passive rental income, sun-drenched end-of-career vacations, and big capital gains fueling us, we charge ahead. Yet, the truth about investing in emerging market real estate can be incredibly nuanced relative to those aspirational fantasies. It’s an enormous risk to take on, to be sure. As dangerous as this journey is, I think it’s a journey well worth taking – if you go in with the right mindset and do your homework.
I’ve spent most of my professional life studying international markets for my website OverTraders.com. I’ve seen the promise of tremendous returns—but even more clearly, the peril that awaits those who venture outside the safe boundaries of developed commercial markets. The trick, I think, is to understand the complex dynamics at work and take steps to avoid the dangers.
Particuraly today, one of the most convincing arguments for investing in emerging market real estate is diversification. It’s time for investors to spend less time fixated on developing domestic markets. Yet this narrow approach risks leaving them exposed during economic downturns or market fluctuations back home. Developing markets present an opportunity to offset your risk, investing in economies with a wholly separate set of internal growth factors and cycles.
The prospect of capital appreciation is perhaps the second biggest lure. In much of the rest of the developing world, rapid urbanization coupled with a rising middle class is driving up property values to new heights. Housing and commercial demand is following suit, with growth outpacing even that of much more established markets. Not to imply that prices only ever increase, but the opportunity for serious long-term appreciation is most definitely alive.
Emerging markets traditionally offer the chance to purchase real estate at prices far below what you might experience in more mature markets. This affordability consideration makes this factor particularly appealing for investors with smaller amounts of capital who are looking to get the most bang for their buck. Higher rental yields are facilitated by a lower upfront cost of entry. This is an issue because rental rates rarely drop at the same rate that home values drop.
Personally, I’ve witnessed first-hand the incredible potential for high yielding rental income in developing markets. For instance, a few years ago, I looked at where we should invest in Southeast Asia. I learned about the incredible rental yields that markets such as Bangkok and Ho Chi Minh City provided. This remarkable trend was fueled by affordable property prices and a steady demand for properties coming from both locals and expatriates. This is why it’s so important to explore your local rental market. Be sure to take into account the maintenance of vacancy rates and property management as well!
You can’t pretend the inherent risks don’t exist. Political instability is one of the key risks that affects a number of emerging markets. Across the board, government changes, civil unrest, and policy shifts have had immediate and lasting impact on property values. They have a huge impact on rental income. It will be important to read the tea leaves for the political environment and consider the risks involved before making a big investment.
Economic volatility is third consideration. This is partly because emerging economies are often more vulnerable to economic shocks and currency fluctuation than developed markets. To that end, a sudden local currency devaluation can massively eat into or completely erase your returns. This is true even if the underlying property value in local currency remains flat.
Beyond double-spending, liquidity can be just as big an issue. Ironically, selling your property in an emerging market can be more difficult than selling in a more liquid market. Locating a willing buyer might take longer than anticipated. You may even need to get accustomed to a lower sale price than you expected to achieve.
I still remember one conversation with a very prominent real estate friend who had made a great deal of money in development in Mexico. The project took longer than expected due to unexpected circumstances, and he was left in a tremendous financial hole that made recovery of his investment nearly impossible. This experience cemented in me the need to vet developers very well as well as iron out what it means to buy off-plan, the risks involved etc.
Equally, if not more, important is understanding the legal and regulatory landscape. Intellectual property laws and regulations vary widely from country to country. Connect to the legal landscape. Beyond tax law, consider all other applicable legal requirements to steer clear of litigation. This means appreciating limits on foreign ownership, protections of property rights, and tax consequences.
Understanding these complexities takes diligent research and, when possible, should be done with the support of local professionals. Locate and hire a local market-savvy attorney, realtor, and tax adviser. They will assist you in assessing the site, understanding the local market, navigating the legal and regulatory waters, and avoiding expensive missteps.
Before you dive in, there is some due diligence that should be done. This involves carrying out a title search to verify that the property does not have debts, legal claims, or disputes. It means evaluating the walkability, safety, and overall desirability of the immediate surrounding infrastructure, local amenities, and proximity to future development.
Another tip I give investors is to make sure you visit the actual property, and the area around it before you ever purchase anything. You’ll feel the energy of the neighborhood as you walk through and get a taste of it. Get a hands-on assessment of the construction quality and identify areas of concern. It gives us a chance to meet with local stakeholders and hear directly from local residents about what they see in the market.
A third, but no less important, issue to understand is FIRPTA— the Foreign Investment in Real Property Tax Act. This American law requires foreign sellers to pay a withholding tax on the sale of US real estate. This state of affairs impacts all foreign sellers of US real estate. It drives home why it’s so important to know and plan for the tax ramifications of owning foreign property.
To sum up, putting your money into emerging market real estate is definitely a risky bet. There are major risks and dangers here, and that’s why it’s important to enter into this space with full recognition and understanding of the risks and potential pitfalls. The rewards, however, are great. With potential for diversification, capital appreciation and higher rental yields, it can be a profitable undertaking for those who are prepared to put in the research and understand how to mitigate the risks involved. The bottom line is to be educated, to plan ahead and to be patient. The right approach can reveal the promise of developing and transitional economies to pioneer inclusive, resilient, clean growth. Develop a global real estate portfolio that’s meant to flourish!
