IL Postcard

Diversify Your Way to Wealth

Date: 06/27/2008 Author: Lief Simon

Saturday, June 27, 2008

Get more tips on investing in foreign real estate in International Living Postcards —Saturday Edition

I met an investor recently who had created a big, profitable portfolio of rental houses in the Boston area. He was highly leveraged, but he had positive cash flow. Mortgage payments were made. Repairs were covered. And there was a nice bit left over at the end of each month. Life was good...until the local economy skidded. In a matter of a few months, as jobs were lost and people moved out of the area, this guy found himself with negative cash flow. Long story short, he eventually lost most of his houses to the bank.

Many real estate investors never get beyond their backyards. They add to their investment portfolios over time, yes…but by buying more of what they are familiar with. This approach can seem prudent, but it carries a big risk. If the market that you know…that you’ve made money with in the past…that you’re comfortable with, turns…well, you’ll wish, maybe too late, that you’d diversified at some point along the way.

The leverage was a critical factor in this situation, of course, but the fundamental problem was that this investor had all his eggs in one basket. He wasn’t able to ride out the downturn in the Boston rentals market because every one of his investments was in that market. Had he owned even a few rentals somewhere else, maybe he could have juggled cash flows and held on to his assets.

Another investor I met during the pre-construction boom in the U.S. bragged that he controlled more than $10 million worth of apartments under construction. He controlled them with small deposits...mostly 5% down...and planned to flip them before they were completed, as most pre-construction investors do. He hadn’t been at this long, and he didn’t understand the risks. The key risk with pre-construction, is not being able to sell on your contract before the balance of the purchase price is due for closing.

Again, the local market turned, and this guy was blindsided. Unable to close on the majority of the contracts comprising his $10 million portfolio, he lost most of his deposits.

Again, had he diversified into other types of real estate assets and other markets, maybe the story would have had a different ending.

Diversification in terms of both type of property and location is the key to long-term success in the world of real estate investing.

Here are some tips on how to successfully diversify your portfolio:

Don’t move all your investments overseas: Some investors make the mistake of moving all of their real estate capital from their home country to another country. They seem to overlook the fact that the result is the same. They’re still undiversified…only in a new country.

Think locally: Even as many countries have entered new, downward cycles, certain localized regions can still make sense for investment. Particular regions…and particular kinds of buys. It is not enough to say you should or you shouldn’t buy in Panama, for example. You’ve got to look more closely to understand the local opportunities.

Choose different types of properties: Your portfolio should include rental properties, short-term and/or long-term, pre-construction, raw land, and lots in developments.

Rentals: The income from rentals gives you cash flow...to cover mortgages if you’re leveraged and to offset the holding costs of your other properties. Keep your expectations in line, though. Don’t count on more than 5% to 8% net a year. That’s the range worldwide. If a market promises some return outside this range, you have to ask why. A lower yield may indicate the property is overpriced. A higher yield may indicate it’s under-priced…because it’s in an undesirable location, for example…meaning it could be hard to find a next buyer.

Pre-construction: A pre-construction investment can turn into a rental if you can’t flip the unit before it’s completed. And that can be ok. The most important thing to remember with pre-construction is not to buy if you don’t have the means to close...either with cash on hand or an available local mortgage. The upside of pre-construction is free leverage during the construction period. Potential profits can run into the triple digits, but with high returns come greater risks.

Raw land: Raw land in the path of progress is a low-maintenance investment with big potential upside. Buying right is the key to any real estate investment, including raw land. However, here the other important thing is to make sure you buy at the local price. Pay the gringo price, and you’ll have to wait longer to see your return…and maybe it won’t ever come at the level you’re expecting.

Building lots: Building lots in residential developments are typically low maintenance as well, but can offer better liquidity. The downside is higher carrying costs—taxes and community fees, for example. Buy early in a development, when the developer is trying to get the project off the ground, though, and you can see excellent appreciation over the mid-term (three to five years).

You aren’t going to build a portfolio containing all these kinds of investments in multiple markets overnight. But real estate investing is a long-term game. Set a goal from the outset. Give yourself six to eight years, say, to diversify effectively in terms of both asset types and markets.

Lief Simon
For International Living

Editor’s note: Most new global real estate investors learn from their mistakes as they go. Some can be minor hiccups, but others may cost you dearly. Learn how to avoid the pitfalls and become a successful real estate investor in this report from Lief Simon.

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