Do your homework before investing overseas

 November 12, 2010 

Overseas properties may offer good returns but risks abound

Signs of a slowdown in Singapore home sales showed in both the number of primary and secondary transactions following the Government’s announcement of property market cooling measures on Aug 30.

The number of developers’ sales, subsales and resales fell by about 28 per cent, 52 per cent and 42 per cent, respectively, in September from the previous month.

While there has been a decrease in property transactions within Singapore, there has been a pickup in marketing efforts for overseas properties from as near as Malaysia to as far as the United Kingdom. There has been an increase in the number of advertisements in recent weeks inviting Singapore investors to exhibitions and road shows for overseas properties.

Investors here are increasingly attracted by potential opportunities overseas as the local market takes a breather. With the current low savings rates, they are looking for better yielding assets to park their money. Potential price appreciation, income guarantees, low mortgage rates and favourable exchange rates are some of the main factors attracting investors to foreign markets.

Based on recent Knight Frank research, Singapore investors formed the third-largest group of buyers from Asia, after those from China and Hong Kong, of prime London properties from July last year to June this year.

Before jumping on the bandwagon, potential buyers should not assume that the same institutional and legal framework that is applicable in Singapore will apply in other countries.

What should buyers look out for when investing in overseas properties? What are the risks and who should they consult?

Many often buy properties in countries that they are familiar with. Some might have studied in a particular country and have developed a fondness for it. Others feel safer if their investment is closer to home and, therefore, prefer to buy a property in neighbouring countries.

From experience, up to 20 per cent of buyers who purchased foreign properties during exhibitions had not visited the city and up to 70 per cent of buyers had not inspected the project site. As environments change and cities evolve, it is prudent to re-visit the site and not to rely solely on memories or gut feel.

For completed overseas properties, it is also advisable to seek an independent professional valuation. One may want to reconsider the purchase if there is a big difference between the asking price and the valuation. In any case, if bank financing is required, a valuation will be carried out by the bank. It may also be worthwhile to get a structural survey done, too. If significant problems are highlighted, one can either forgo the purchase or negotiate a lower price to account for the rectification cost.

Some projects offer purchasers rental guarantees, some as high as 8 per cent. A rental guarantee is a contract between the granter, usually the developer or the vendor and the buyer, where the latter is paid a fixed income based on a guaranteed rate on the purchase price.

For example, a guaranteed rental of 6 per cent on an apartment bought for £250,000 ($519,000) in London amounts to £15,000 per year.

Most rental guarantees are on a gross basis where the buyer is still required to pay all outgoings, such as maintenance costs and property taxes. Because of this, the net return will be lower.

Properties with rental guarantees often also come at a higher price to compensate the granter for bearing the risk of not earning an income when tenants cannot be secured in time or higher vacancies during off-peak holiday periods. Buyers should note that the rent collected may drop significantly after the guarantee period.

It is important to engage reliable managing agents to look for tenants, to collect rent and to look after general repairs. Usually they charge a fee of 5 to 10 per cent of the monthly rent. An agent’s commission for securing a tenant is usually the equivalent of one month’s rent for a two-year lease, similar to the practice in Singapore. Total outgoings average between about 10 to 20 per cent of gross rental income per year.

There are other miscellaneous costs such as legal fees, stamp duties, valuation fees and bank processing fees. The amounts vary across countries and the prospective buyer should seek professional advice.

Potential buyers should also be aware of tax regulations, especially for mature markets such as the United States and Australia. In many instances, rental income is taxed at the progressive personal income tax scale in the country where the income is sourced. While capital gains tax does not apply in Singapore, it may be applicable in other countries. Buyers should consult tax advisers to ensure they understand all tax issues.

To guard against poor workmanship, the sale and purchase agreement should provide for a two- to six-month liability period for the developer to rectify the faults. In instances where there are delays in the completion, purchasers should be compensated or can opt to rescind the purchase with the money refunded.

The types of legal recourse available are subject to the terms and conditions in the sale and purchase agreement. Buyers are advised to read the document carefully before signing and paying the initial reservation fee, which is often non-refundable. They can engage lawyers to advise them on their rights if things go awry.

If a developer goes bankrupt during the construction stage, any monies paid directly to the developer rather than to a trust fund are usually not recoverable. Hence when buying properties off-the-plan or under construction, one should look at the developer’s reputation, track record and financial standing to reduce the risk of potential losses.

There are also other legal considerations to note. Some countries have laws that restrict resale property ownership. For example, in Australia, residential properties can be resold only to Australian citizens, permanent residents and foreign students or foreign companies that have obtained the Foreign Investment Review Board’s approval to buy for owner occupation.

In Malaysia, the government’s consent is required for the sale of freehold landed properties to non-citizens. In some instances, the property can only be sold to the bumiputera.

In a nutshell, while there are many success stories, buying that overseas property is not as simple as some may think. One needs to look beyond the glossy brochures and the glitzy displays. Engaging competent and experienced advisers will help the process but at the end of the day, it is still caveat emptor (buyer beware).

By Png Poh Soon, Senior Manager, Consultancy and Research, at Knight Frank.