How to Invest Successfully in Emerging Market Real Estate

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Reporting from Laguna Beach, California…

Since today’s edition of The Daily Reckoning is a little longer than usual, your California editor will keep his remarks a little shorter than usual.

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Therefore, to summarize yesterday’s trading action, stocks in Europe rallied because the European Central Bank (ECB) has fixed the Portugal problem and stocks in the US rallied because Ben Bernanke has fixed the slow-economy problem. The prices of corn, wheat and soybeans soared because the ECB and Ben Bernanke have not yet fixed the weather problem.

Portugal’s pitiful finances are capturing headlines at the moment, but soaring grain prices are a much bigger – and more important – story. For one thing, the rocketing price of key foodstuffs is an early sign that America’s “non-existent” inflation is starting to exist. For another thing, in most parts of the world, food price inflation is more than a mere data point that affects the Consumer Price Index (CPI); food price inflation is a data point that affects life and death.

Food riots are on the way.

But your editor does not wish to be a “buzz kill” today. Instead, he wishes to invite our dear readers to dream a little…to imagine living in a foreign land…or at least to imagine buying property in a foreign land.

In yesterday’s edition of The Daily Reckoning, our colleagues at International Living, Ronan McMahon and Margaret Summerfield, highlighted real estate opportunities in Brazil. This duo returns today with some how-to guidance on buying properties overseas.

After considering their expert observations, it will be your turn to contribute your insights…to the latest Daily Reckoning Group Research Project.

Specifically, we invite all readers to submit their selections for:

“Best Under-$300,000 Condominium Anywhere in the World.”

Please send descriptions, photos or whatever else you wish to this address: joel@dailyreckoning.com. If you happen to be the seller of the “Best Condo,” please disclose that fact. Being the seller would not disqualify your submission; we’d just like to know that detail.

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The Daily Reckoning Presents

How to Invest Successfully in Emerging Market Real Estate

Ronan Mcmahon
Ronan Mcmahon

Today, I’m revisiting my “Five Golden Rules for Buying Pre- construction.” I find this a useful process whenever a pre-construction project I have invested in or recommended is delivered.

To remind you, buying pre-construction is where you buy into a development before it has been constructed. You are relying on a set of architectural plans. Frequently, developers will offer substantial discounts to buy off-plan. Often the best units go to “insiders.”

Developers do this because they need investor funds to finance the project. That’s a strong incentive to create simple and profitable investor terms. Moreover, bank finance for construction costs will typically be dependent on a certain level of pre-sales. The developer will want to hit that number as soon as possible. The developer will also want to share some of the risk by selling pre-construction. He knows he is giving a good deal based on today’s prices – but who knows what the market will be like when the units are delivered in two years time?

Buying pre-construction makes more sense for the investor than for someone buying for personal use. For the investor, the unit doesn’t have to meet your own taste, and you probably don’t mind that it will take a few years before you take possession of your unit, as long as the market is seeing appreciation.

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When you buy a unit pre-construction, however, it should be a property that a large portion of the general public wouldn’t mind owning or renting. You are buying the unit to eventually sell or rent to an end user, and you want to make sure the property will be attractive to as many end users as possible.

The end user may be a long-term renter, a first-time homebuyer, a short-term vacationer, or even another investor. That will depend on where and what you are buying. Analyze who the end user will be before you put your money down, as you will want to make sure there will be a big enough market to sell or rent your property to. Plus, pay attention to how much similar supply is in the pipeline in the area.

You get a discounted price to compensate you for taking on some of the early development risk, but the real incentive to buy pre-construction comes from leverage. While the terms of the payments vary from project to project, no matter what the terms are, you are leveraging your returns to some degree. A typical deal will start with a small down payment…say, 5%…and work through various stage (progress) payments during the construction period, until you have paid anywhere between 5% and 80% of the purchase price. The balance is due when the keys are turned over.

Let’s walk through a sample deal to show how leverage works when buying pre-construction. You purchase a $100,000 condo with a 10% down payment. The balance is due on completion in two years. A 20% increase in price during the build period means a 200% return (net of fees) if you were to flip. Of course, leverage, like buying an option, can work in two ways; a 10% fall in price means that you are down your entire investment.

Buying pre-construction is a strategy that will maximize the retail investor’s ROI in the early to mid-stages of a market appreciation cycle. Buy pre-construction at the top of the market and you risk losing your entire investment…and maybe even more than you have invested, if you are contractually bound to complete and that clause is enforceable. All the benefits of buying pre-construction are tied to a rising and active market. Without a rising and liquid market, pre- construction almost never makes sense.

If there isn’t activity in the market, you run the risk that the project you buy into won’t be completed. Or if it does get completed, half the building will be empty. This can be a big problem when it comes to maintaining communal areas or amenities and security.

White-hot pre-construction markets can frequently overheat. Too much supply becomes a problem. Prices rise too fast. If prices rise to the point where there is no expectation of future price increases, the market will stall. Five years ago, Panama was one of the hottest pre- construction markets I have seen. Today, as you know, it’s a different story.

As I said…you want to play the pre-construction market in the early to mid-growth stages of the market. The market punishes late arrivals who think prices will continue to rise as they have been rising all along.

The “right deal” should always follow all five golden rules, below. To illustrate the essentials of investment in pre-construction projects, let’s look at the Sian Ka’an project near Tulum on the southern edge of Mexico’s Riviera Maya.

1. An appreciating market in the early to mid-stages of growth. Sian Ka’an is set in the Riviera Maya, home to Mexico’s best beaches. It’s close to the site for a new international airport, and is positioned directly in the path of progress.

2. A developer with a strong track record who is financially stable. Sian Ka’an’s developer, Benjamin Beja, has built and/or sold 1500 homes across Mexico, mostly to the North American market.

3. Supply constraints – a lack of developable land, for example. Sian Ka’an is in a location with a lack of developable land. The Sian Ka’an biosphere and other preserved land close by on this section of coast cover 1.5 million acres, and can never be developed.

4. A market with an abundant supply of end users. Benjamin conceived Sian Ka’an in response to a supply shortage of hotel rooms. Sian Ka’an is in the Gran Bahia Principe resort, which has 2,700 hotel rooms…but it needs 3,000. So Benjamin built Sian Ka’an, with 300 condos.

5. A liquid market with a large volume of transactions. More than 400 sales in less than two years at Sian Ka’an alone, tells us that this is a liquid market.

Pre-construction success isn’t a fluke. Good fortune is always welcome but the key to pre-construction is following these five golden rules. They are simple, easy to follow…and should stand you in good stead.

Regards,

Ronan McMahon
for The Daily Reckoning

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In Real Estate, Size Matters

Guest Editor
Margaret Summerfield

A 1,000 square-foot condo covers 1,000 square feet, right? Doesn’t matter if you’re buying in Paris, Buenos Aires, Miami, or Montevideo…when you pay for 1,000 square feet, isn’t that what you get? Surprisingly, the answer is: not always.

Most of us use an area’s average price per square foot or per square meter as a gauge to know how much of a good deal we’re getting when we buy. For that reason, you need to know that you’re getting what’s been advertised.

Let’s take condos. Not all 1,000 square feet condos are equal (most Latin countries use square meters; for a quick conversion, multiply square meters by 10 to get square feet). Some 1,000 square foot condos can feel spacious, while others feel cramped. A lot depends on the internal layout, and how many rooms the architect has squeezed in. But sometimes it’s more than just the layout. Sometimes it’s the fact that one 1,000 square foot condo is just plain bigger than the other.

It all depends on how that 1,000 square feet is calculated. Is it only interior living space, or does it include balconies, terraces, storage areas, and outside patio space? In some places, that outside space counts towards the size of your unit.

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Some markets count outside areas, but at a different value; maybe half the average price per foot. It costs significantly less to construct a patio or balcony than a bathroom or kitchen, after all.

Similarly, ask if the 1,000 square feet includes common areas (halls, stairways, or entryways). Is the measurement from the outside or inside walls? Yes, that sounds crazy; who can live in wallspace? But that’s how it’s sometimes calculated.

The point is, don’t take that 1,000 square feet at face value. Ask how it was calculated, and what it does (and doesn’t) include. Measure the space yourself. That way you’ll know for sure what you’re paying for.

And you do need to know.

Overpay now, and when it comes to rental or resale time, you could face a shock. If the average sale value in your location is $200 a square foot, and you pay $200,000 for your 1,000 square foot condo, you don’t want to find out later that the market’s only giving you credit for 850 feet.

In reality, the most important thing is not what’s counted or not counted in a given market…it’s that you consistently compare the value of one property to the next when deciding what you’re going to pay…and that what you’re paying is consistent with the local market pricing for the living space you’re getting.

The same applies with land parcels. Here, you pay a price per acre or hectare. And again, you need to measure the land yourself. Often, large land parcels stay in the same family for generations. The deed may quote landmarks (the house of a Sr. Gomez, the boundary of another piece of land) that no longer exist. Often the family isn’t sure of the boundaries, or how much land they have.

I’ve seen wide variations in the amount of land in a parcel, from different sources – the seller, the brokers involved, the neighbors. In one case, reality was half the size the muddled owner had told me.

You need an accurate survey to fix the boundaries and determine exactly how much land there is. That way, you pay market value, not an inflated price.

So, ask what you’re paying for. Ask how the measurements were calculated. And then measure it yourself, or have a survey done. Just doing that little extra homework when you’re buying could mean the difference between a healthy profit – or a disappointing loss – later on, when it comes to selling or renting the property.

Regards,

Margaret Summerfield,
for The Daily Reckoning

Joel’s Note: The International Living team has been scouring the globe for decades, hunting down the best real estate deals on the planet. Recently, they launched the Alpha Hunter, an explosive emerging market research service that uncovers opportunities in high growth markets around the world. To learn more about putting your money to work for you in some of the most exciting, fast growing markets going, read on here.

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Bill Bonner

The Growing Fiscal Disparity Between Insiders and Outsiders

Bill Bonner
Bill Bonner

Reckoning from Paris, France…

To the barricades!

Today, we continue to explore our new idea. Alert readers have already figured out that it is not a completely new idea. The ancient Greeks toyed with it too. Really new ideas are extremely rare.

In our modern version, it might be called the General Theory of Decadence…or the Cycles of Growth and Decline, or more playfully, the Unified Zombie Theory.

Life goes on. Material progress accumulates. The story of human life on earth grows longer, and more interesting. We see no end to it. But each component part comes to an end. Each life, each economy, each company, each society and each civilization still shrivels, corrodes, and exterminates itself. The past must become history so that the future may become the present.

It takes many downsides to make upside progress. And then, the progress – if there is any outside of real science and technology – is probably only barely positive…and painfully cyclical. One generation learns. The next forgets.

We’ll come back to this in a second…

First, a look at the news:

Dow up 83 points yesterday. Gold headed towards $1,400. And the Great Correction continues.

As to Europe’s debt problems, the press seems unable to make up its mind.

“Portuguese bond sale boosts confidence,” says The Financial Times.

Oh yeah?

“Portugal fails to quell fears with auction,” counters The Wall Street Journal.

The International Herald Tribune threw its lot with the FT:

“Pessimists kept at bay in Portugal’s bond sale.”

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In short, who knows? Europe has too much debt. Just like America. Sooner or later, some of that debt will be written off. Or worse. Portugal is just like Illinois or California. Only smaller and less important.

Meanwhile, in the US…

“Housing weighs down the recovery,” writes Mort Zuckerman in the FT. There are 5.5 million households with mortgages that are at least 20% higher than their houses’ value, he says. Delinquencies are still rising. The loss so far is greater than in the Great Depression, adds Zillow. And the Case-Shiller numbers show it getting worse.

But let’s turn to murder for a minute…

“Obama says polarized nation needs healing,” says a headline at Yahoo! News.

A guy goes off his head and starts shooting people in Arizona. The whole nation needs “healing,” says the president.

The media is full of argument on the subject. Are Rush Limbaugh and Sarah Palin to blame? Strident political rhetoric? Loose gun laws?

Palin says she is a victim of “blood libel.” The New York Times refers to a “climate of hate.”

Why are people so angry at one another anyway?

Relax… Our theory explains it. When people are creating wealth they have little reason to get mad at one another. Sure, someone takes a shot at a Congressman from time to time, but it tends to be a personal matter. And the politico probably has it coming.

Not so in the degenerate phase. When people try to live at each other’s expense, it naturally gives rise to widespread rivalry and resentment. The poor want food-stamps, welfare and unemployment comp. The rich want tax cuts and government contracts. The feds try to give everything to everybody – especially to their insider friends. Then, they go broke and everyone gets mad.

And more thoughts…

Just take a look at the TSA’s new peek-a-boo screening machines. They probably do no more for the safety of Americans than US troops in Afghanistan. But, like the war, they make some people rich.

Government officials – including many ex-congressmen – pushed hard for the machinery…despite much evidence that it didn’t work…and then went to work for the manufacturer.

This kind of soft corruption is so ubiquitous that the media barely thought it newsworthy. But thanks to TSA, the wars in Iraq and Afghanistan, medicare, shovel-ready stimulus projects and hundreds of other initiatives, a lot of people are a lot richer than they were a few years ago.

Naturally, with so many greasy bones on the ground, no wonder the dogs fight.

And, naturally, the inside dogs are soon the envy of the outsiders. The insiders…smart, well-connected hustlers…are able to move fast and take advantage of the opportunities as they present themselves. The outsiders – the lumpen, the middle and lower classes, the taxpayers, mooches, and patsies – get the scraps…if there are any left.

One phenomenon that has been much discussed is the widening gap between rich and poor. Some economists think the gap itself causes financial crises. Others think it is merely “unfair” and needs to be addressed by government. Often they believe it is a consequence of a lack of intervention on the part of government. The feds shouldn’t have cut taxes on the rich, they say. Or, the feds should have regulated Wall Street more effectively.

Almost no economists have been able to identify the real cause of this wealth disparity. But it is obvious. It is explained by our theory…

As far as we know, this is the first time it has been explained. So pay attention: as a wealth-producing society degenerates into a wealth redistributing society…and then finally, a wealth-destroying society, the difference between insiders and outsiders becomes more pronounced.

A man with the right connections in Washington can get a juicy contract. Soon, he can be sipping coffee in Potomac, along with your editor. He has a huge advantage over the hoi polloi. He can leverage his insider status into million-dollar paydays.

On a larger scale, let’s look at the work of the US Federal Reserve. This insiders’ bank is supposed to be working for the good of all. It didn’t even exist during much of America’s most productive, wealth- producing history. But now it fiddles US money and interest rates. For whose benefit?

Again, it is obvious… It lends to insider banks below the rate of consumer price inflation. It has been doing so off and on for decades, and consistently for nearly the last 10 years. Even with free money coming their way, the bankers still manage to lose money, pay themselves fortunes and occasionally go broke. And then, the Fed steps in to bail them out.

Pretty nice deal, huh?

Less obvious, the Fed’s easy money policies encourage asset price speculation. Today, the Fed gives the bankers money. The bankers put the money to work where they think they can earn fast profits – not in difficult and risky new business ventures, but by betting against the Fed itself. They buy commodities. Emerging markets. And debt too.

This speculation provides no jobs to the working classes. In fact, it hurts them. It raises the cost of food and energy.

“World moves closer to food shock,” says one headline.

“India may ban wheat exports,” says another.

“Grain prices soar as US slashes outlook,” adds The Wall Street Journal.

Corn is at a 30-month high. Brent Crude oil hit $98 yesterday. And the poor working stiff is stuck. His income is falling. His costs are rising.

Meanwhile, the very few, very rich get richer. Their portfolios bulge with financial profits… And their businesses enjoy relatively low labor costs.

This is the kind of situation, left unchecked, that leads to revolution. In Germany, the hyperinflation of the ’20s led to street fighting…and the rise of Adolph Hitler. In France, hunger in the late 18th century led to the guillotine.

More to come…

Regards,

Bill Bonner
for The Daily Reckoning

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