The Real Estate Investment Lessons I Learned The Hard Way

The city of Fortaleza, State of Ceara, Brazil.

How To Avoid Losing Money When Buying Real Estate Overseas

From vacation rentals to productive land, we talk a lot here about ways to make money in overseas property.

But it’s equally important to understand how things can go wrong out there on the battlefield… so you can defend yourself.

Today, OPA Senior Editor Lief Simon is going to walk you through some of the top ways to prevent yourself from losing money on a foreign property…

Lynn Mulvihill
Editor, Overseas Property Alert

How To Avoid Losing Money When Buying Real Estate Overseas
By Lief Simon

Senior Editor of Overseas Property Alert, Editor of Global Property Advisor

One big loss can wipe out a lot of gains. After more than two-and-a-half decades of property investing experience across 24 countries, I’ve learned that the hard way no less than six times over. I share some of my cautionary tales below, so you can learn these lessons before putting any of your own money at risk.

1. Don’t Be Tempted To Take A Second Bite

Just like every other investor at the time, I got caught up in the exuberance of global markets in the years leading up to the 2008 global real estate crisis…

A colleague had a brother. His brother had a friend who was working with a developer in Northern England. The project fit all the parameters of a great deal. It was preconstruction, so the pricing was below market. The rental-income projections were conservative based on current rents and would slightly better than cover the mortgage and other operating expenses. On paper, the deal was golden. I reserved one of the condos.

A few months after I’d made the purchase, my colleague sent an email saying that 10 units had come back onto the market—at the original price. I broke out my calculator and spreadsheet to remind myself of the numbers and decided to take a second bite at the profits I’d projected. Buying a second apartment in the same building violated my personal diversification rules, but the numbers were that good.

The building was delivered on time, but the timing was colossally bad. It was 2007. Newcastle, England, where the project was located, like many markets at the time, was overbuilt. This global oversupply had a lot to do with the historic bust of property markets worldwide a year later.

I’d never been to Newcastle. When the units were completed, Kathleen and I decided to make the trip to see the apartments firsthand and to work with the management company to furnish and list them for rental. We’d been told that the building’s location was prime, and the building style and amenities were intended to target the local hip and upwardly mobile crowd. Those things could have been true, but we realized they weren’t the point within three minutes of getting out of our rental car and walking down the high street. Newcastle was grey and depressed, shabby and rundown. We saw no reason to stick around and no reason to return.

The rental management agent wasn’t optimistic about getting the rents that had been projected two years earlier. He cautioned us that we might struggle to find renters at all in the current climate. Several other buildings nearby and in other locations around the city had recently been completed. It was not a landlord’s market.

One tenant moved out at the end of the first year, and I wasn’t able to replace him. The other renter stayed on, but the market forced me to lower the rents for both apartments. Not significantly but enough to turn my cash flow negative. I was paying out of pocket to cover expenses. At the end of the second year, the rental manager told me I needed to reduce the rents further. Rental rates continued down as more inventory continued coming onto the market.

Not only had rents fallen due to oversupply over the two years since I’d taken possession of my apartments, but so, too, had property values. Local agents counseled me that the best sales prices I could hope for were about 75% of what I’d paid for each unit. Backing out real estate commissions and other costs, I wouldn’t be left with enough to cover the amounts owed on the mortgages.

In the end, I turned both properties back to the bank.

This was my first lesson in the dangers of leverage. Previous experiences in Chicago and Spain and many leveraged investments since have been casebook successes. It was this one, where I doubled down, that blew up.

However, the biggest lesson I learned from this Newcastle debacle was never to invest in a market you do not know and have not scouted personally. Had I made the quick trip from Waterford, Ireland, where my family was living at the time, to Northern England, to spend a day in Newcastle, I would never have made this investment. Cash-flow math is key to making good cash-flow investment decisions, but so too is your personal understanding of market dynamics.

Lesson Learned:

Don’t buy in a market you don’t know personally without getting on a plane to see it for yourself first.

2. Be Sure Of Your Exit Market

When investing in a residential rental property in the United States, you have a good idea who your future buyer will be. You’ll sell, when the time comes, to someone looking to live in that neighborhood or to another investor shopping for a rental property in that area. Either way, the buyer likely will be someone living within a couple dozen miles.

When buying for cash flow in another country, especially a short-term rental unit, the location and the type of property play big roles in determining who your potential future buyer will be. Typically, your potential future buyer pool will include other foreign investors. However, the more you can expand that pool, the greater your chances for maximum return.

The Spanish costas are a good example of a market that has relied on foreign buyers and investors entirely. In 2008, when real estate markets across the globe collapsed, those along Spain’s Mediterranean coast fell faster and harder than any others. There were three reasons for this—the amount of leverage in play, overbuilding, and the fact that the majority of buyers on this coast were foreign.

Prices fell, too, at the time, in Barcelona, but not nearly as far nor for as long as they did along the costas. The three factors that spelled disaster on the coast helped to insulate values in Barcelona. The percentage of leveraged investment properties was lower, the volume of overconstruction was less, and the market didn’t rely on foreign money.

Even along the costas, owners of well-positioned properties of interest saw their values recover quicker than owners of cookie-cutter units in the massive oceanside complexes where dozens and hundreds of identical properties came onto the market from distressed sellers overnight.

In some markets, you’ll have no choice but to resell to a foreigner. Ambergris Caye, Belize, is a good example. Most of the construction on this island is geared toward the tourist and expat retiree markets. Beachfront condos aren’t in the budget for a typical Belizean local. The economies you need to pay attention to if you invest in a cash flow property on Ambergris are in North America.

When the United States falls into recession, fewer properties are sold on Ambergris Caye. When U.S. markets are booming, more real estate is sold on this little Isla Bonita. The local Belize economy is irrelevant. Same goes for rental returns. Most rentals are to North Americans and some European tourists.

Buy right in a market like Ambergris, and you can see good rental yields until the economy slows in the countries your tourist renters hail from. And, when your occupancy stats fall, so will your ability to sell the asset quickly or at a decent price.

Lesson Learned:

Think through the future potential buyer pool when making any cash-flow investment and choose properties that expand that pool as much as possible.

3. Manage Your Rental Manager

I’ve owned rental properties in eight countries. The property is important. You need to buy right—right location, right size, right number of bedrooms and bathrooms, right furnishings, and so forth. However, at least as important as the rental you purchase is the person you hire to manage it.

A good rental manager can squeeze a good or great return from a so-so property, but, if your manager is no good, you will not make money, no matter how ideal your property. Finding a good rental manager isn’t easy. In some markets, it’s not possible. If the rental market is thin, no serious management industry develops. Whoever you find, even if they are experienced and professional, you’ll need to invest time launching them and then you’ll need to pay attention over time. Leave a rental manager on their own without checking in with them regularly (I recommend at least once a month) can lead to depressed returns.

My first experiences engaging a rental manager were in Paris. Kathleen and I invested in an apartment with friends and were responsible for getting it rented. The agent who’d sold us the apartment told us she knew the best rental manager in the city. We didn’t know any rental managers in this city, so we went with the agent’s recommendation. We furnished the place, decorated according to the advice of the manager woman, and then turned the apartment over to her.

A month later, I noticed an unexpected transfer into our bank account. The money had come from the rental manager in Paris. It was the net from our first month’s income. Exciting surprise to have money show up out of the blue like that, but what did the amount represent? I contacted the manager woman and asked for a report. I explained that we wanted to see rental dates, gross amounts paid, and expenses deducted. The typical data points any rental property owner should want to review and that you need to calculate occupancy rates, to track your yield, and to control your expenses.

We didn’t receive a report, but more money appeared in our account about four weeks later.

This continued for months. Finally, we reached out to the agent who’d sold us the apartment. She was a friend of the manager woman. Would she, we asked, please request a report for us. She did, but what we received wasn’t much better than no information at all. Meanwhile money continued posting to our account monthly.

After 12 months, we totaled our annual net income and calculated the annual net yield for the property. It was 5.3%, which is good for Paris. Still, we had no idea about the occupancy rate, what the manager woman was charging on a nightly basis, or what costs were being backed out. Was the agent reporting all the income? Was she charging market rates? Was she padding expenses?

After about a year-and-a-half of this uncomfortably murky situation, we were introduced to another rental manager in Paris who was looking to add to his rental portfolio. We interviewed him and explained our concerns about our current manager. He assured us that he’d send monthly reports showing all the details we were looking for, so we switched to the new guy.

He sent reports as promised, in the format we’d requested, but our cash flow plunged. Occupancy rates were easy to calculate some months because they were zero. This new manager was much more organized than the old one had been. He just couldn’t rent the apartment.

If you have to choose, which would you rather have? Reliable reporting or cash in the bank? You hope you never have to ask yourself that question. We learned from this early experience that, if a rental manager is producing healthy cash flow, think long and hard before making any changes. If the situation isn’t broken in the one way that really matters (the amounts of net cash flow being earned), don’t try to fix it.

We ask for (insist on) reports from every rental manager we work with, and you should, too, but, if the agent is keeping the place rented, we’re willing to work with them to improve their administrative skills.

Lesson Learned:

Choosing a rental manager is as important as choosing the rental property.

4. Remember The Fundamentals

When we arrived in Ireland in 1998, the standard net return from a rental property was 2% or less. The country was a decade into its Celtic Tiger economic boom, which had been fueled by two things. The first was American businesses setting up shop in Ireland to take advantage of low corporate tax rates and hiring incentives being offered by the government. The second was real estate.

In fact, we were in Ireland for the first reason. We’d made the move to open an office for a U.S. publishing company wanting in on the Irish Investment and Development Agency’s 10% tax.

All the foreign business activity created an employment boom. For the first time in the country’s history, young Irish people were able to leave their parents’ houses before they got married. They could afford to live on their own or with roommates. This phenomenon created an unprecedented housing demand. Developers bought land from farmers to build housing estates, and the farmers gave some of those windfall land profits to their kids so they could buy houses. A lending industry emerged. Mortgage broker offices popped up on the street corners of every town and village across the country.

All of Ireland were buying and selling property either for their own uses or, eventually, as investments. The whole of the country watched prices rise dramatically year after year after year and felt compelled to get in on the game. No one imagined an end to the cycle.

It was a house of cards that eventually collapsed completely. One Irish friend who jumped in at the late stages of the boom and bought a house in 2006 to live in with his family has been upside down in the mortgage for that house for more than a decade. At least he’s been able to keep up with the mortgage payments. Many pre-2008 Irish buyers have not been so fortunate.

Hardest hit were those who’d bought for investment. So many of these properties were taken back by banks, which had lent as much as 110% of the purchase price, the extra 10% to cover closing costs.

Every Irish investor at the time bought with the expectation that they’d make their return from appreciation. They ignored the fundamentals of property investing and abandoned common sense, buying into the going belief that property prices would continue up indefinitely.

It wasn’t only the Irish infected by this disease pre-2008. I met an American property investor back then who bragged to me that he controlled US$2 million worth of property. He had made initial payments of US$5,000 on eight US$250,000 condos. His plan was to resell one or two condos at a time to come up with the next payment due on the rest. He’d created a leveraged ladder that he believed would turn his US$40,000 into a small fortune.

Then came the crash of 2008. The guy couldn’t sell his condos for a reasonable price or at all. He lost all eight properties, along with his US$40,000. Like all those Irish investors, he’d counted on perpetually appreciating market values. That’s La La Land.

The key fundamental that too many property investors ignore or maybe aren’t aware of, both pre-2008 and, alas, today, is that a rental property should generate enough rental income to give you positive cash flow and a decent net yield. Those are the two critical requirements for any successful rental investment. Do not buy a rental property for any reason other than because you are confident both of those things are going to play out.

I look for a net yield from a rental investment of 5% to 8%. I do not make a purchase unless I believe, based on reliable market data, that I can realistically expect a net return of at least 5%.

If you’re earning net cash flow of 5% to 8% a year from a rental, that investment is solid. Maybe you’re realizing capital appreciation, as well, but trying to predict value growth is speculation. Buying for positive cash flow is building wealth.

Lesson Learned:

The projected net return from cash flow should be the primary determining factor when making any property investment overseas.