Investment: Understanding risk

Risk is the chance that events will not turn out as expected. Our approach to risk is determined by many factors, but the main influence is clearly our character, personality or profile. We are all very different and as such will not tolerate risk uniformly. Some people avoid risk while others get a real thrill from it.

What determines your attitude to risk in investment terms?

• Age
• Upbringing
• Family
• Past experiences
• Future expectations
• Goals
• Overall wealth

Risk and reward

It is worth noting that higher risk is associated with potentially higher rewards and lower risk attracts lower rewards. The savvy investor strikes a happy medium and spreads his exposure to risk and reward with a combination of investments. This is known as a portfolio approach, which can be defined as ‘minimising risks while maximising returns through diversification’.

Your approach to risk is personal and is highlighted through investor profiling.

Remember that risk and reward go hand in hand. In fact, replace the word reward with ‘opportunity’ because this reflects more accurately the reality you face.

The reality is that one day soon you will be faced with an opportunity. It may be in the form of land purchase in Mauritius, off-plan in Morocco or in a syndicated joint venture project in Moscow. Whatever it is, you will be faced with an opportunity and opportunities generally carry a risk to your capital. It’s how you deal with opportunities which will determine your success as a jet-to-let investor.

It’s by thorough research, analysis, planning and hedging that you mitigate risk. In life we face risks and learn to deal with them on a daily basis. So why can’t we do that with property investing? Well, we can.

There are a number of potential risks involved with jet-to-let investing which this article terms, ‘total risk’. It includes everything from just being in the property market, to a tenant falling down the stairs and suing you.

Let’s have a look at the risks you must look out for and the questions you must ask yourself when considering jet-to-let or property investment in general.

Risk checklist

• Political risk
• Is the government of the country you are investing in stable or on the brink of a revolution?
• Are there any factors which may contribute to that government becoming unstable?
• If it becomes unstable, what might the implications be for foreign investors?
• Would a future government confiscate land and property or other assets held in the country?

• Opportunity risk
• Are you missing a great financial opportunity by not investing in overseas property?
• Are you investing in the wrong country or property for your strategy?
• Is your equity working as hard as possible for you now that your investment properties have increased in value?

• Market risk
• Will the market crash or stagnate?
• Will other markets crash and have a knock-on effect in your market? In other words, is your market dependent on others, such as Spain and the UK?

• Liquidity risk
• How quickly can you turn your overseas property into ready cash?
• How strong is the resale market?
• Is there likely to be an oversupply of property in your chosen market and region?
• Will demand be sufficient in relation to supply, to maintain or even increase prices?
• Will a buyer purchase this property from you at the price you want?

• Business risk
• Is there a strong rental market for your property? Is it for holiday lets or longer-term tenancies?
• Is the demand from foreigners or locals?
• If foreigner-demand dries up, can the locals afford to rent your property?
• What are the local health and safety and legislative requirements for letting property?
• How easy is it to evict tenants?
• What are the squatting laws in your chosen country?

• Legal risk
• Is your lawyer independent?
• Does your contract favour the developer?
• Is your contract fully assignable?
• What protection do you have as a foreign investor?
• What historically has happened with regard to legislation concerning foreign investors, property rights, title deeds and enforced nationalisation of private property?
• What title guarantees are there?
• How robust is the law relating to property ownership?

• Financial risk
• What if you cannot get a mortgage on completion?
• If you can’t, how much money will you lose? What does the contract commit you to?
• Can you make your monthly payments with ease?
• What about currency risk?
• In what currency should you have your mortgage?
• In what currency should your rental income be advertised?
• Can you cover voids and for how long?
• What if interest rates rise; can you still cover your operating costs?
• What is your break-even point if interest rates rise (i.e. at what rate does your revenue match your costs)?
• What will happen to your income after the rental guarantee expires? Will you get the same net yield renting independently?
• Have you got the best mortgage product available?
• Are there any hidden costs that you have not accounted for?
• What is the tax situation in your chosen jet-to-let country?
• Does it have a double-taxation treaty with the UK or will you effectively pay tax twice?
• Is there a Wealth Tax and will you have to pay it?
• What if you lose your job?

• Environmental risk
• What if there is a natural disaster? Do you have all your eggs in one basket?
• Has your property been built on contaminated land?
• What other buildings are being built near your property and what is their purpose?

• Geographical risk
• Is your property in an earthquake zone?
• Is your property in a hurricane zone?
• Is your property in an area prone to flooding?
• Is your property underneath a pylon line or is there a mobile telephone mast nearby?
• Will a motorway be built in front of your property?

• Management risk
• Do you trust the management and lettings companies?
• Will they find suitable tenants for your property?
• Will they ensure that the property is well maintained?
• Will they be competent with regard to current legislation?
• If you have a holiday let, can you be sure that when they say the property is empty, that it truly is and is not being sub-let without your knowledge?

• Corruption risk
• Has your property been built illegally due to corruption in the local planning office or mayor’s office? What are the consequences?
• Will you be asked for money at any stage as a ‘backhander’?

• Tastes and fashions
• What will happen when the next cheap hotspot arrives on the scene?
• What happens if your location becomes unfashionable?

Ask the questions

Often jet-to-let investors overlook some of the most basic due diligence questions in their rush to secure the deal. You must make a thorough analysis of the risks as well as remembering the potential rewards before you sign any paperwork or part with any money.

This article is designed to arm you with the relevant questions to ask both yourself and the agent or developer. Its aim is to make you stop and think before you leap into the unknown. Those investors who get the answers to all of their questions before they buy are generally successful. This is the purpose here, to assist you in becoming a successful overseas property investor by highlighting some of the issues which may deflect you from that goal.

Firstly, you have to understand that there are risks you can do something about and others that you cannot. It’s difficult to hedge for international events such as war or bird flu.
A useful management tool is my risk management matrix, which is a straightforward way of making your risk strategy concrete. A few risk factors and examples are listed below to get you started.

Risk management matrix

Risk Number 1
Risk: Financial: what if interest rates rise?
Action you can take now:
a. Ensure that the property in which you invest has solid rental potential which is well in excess of your costs at the present level of interest rates.
b. Conduct a sensitivity analysis of your revenue and costs and determine your break-even point.
c. Check economic events. If you have a euro mortgage, look out for the press releases of the European Central Bank and the minutes of its meetings which may forewarn of any changes and the longer-term outlook.
d. Join a free property investment newsletter which will give you advance notice of any changes and possible changes in interest rates.
e. Create a contingency fund.
Remark:
You have invested using a euro mortgage and are relatively content that interest rates, historically, have remained low and that volatility (i.e. the frequency of movements up and down) is also low.

Risk Number 2
Risk: Geographical: your property is in an earthquake zone.
Action you can take now:
a. Ensure that you have comprehensive insurance which covers the risk.
b. Check that the construction of your property conforms to the latest building regulations with respect to earthquakes.
Remark:
a. Get a quote for a policy to cover the rebuild cost of the property.
b. If you are renting the property, enquire about contents and public liability insurance, which you will need anyway.

Risk Number 3
Risk: Opportunity: are you investing in the best possible country and location?
Action you can take now:
a. Conduct thorough research and analysis. Don’t invest in the first thing that crops up – you will not miss out on anything by being methodical with your investigations.
b. Gain knowledge by reading this book, attending seminars and exhibitions and meeting with other property investors.
c. Investigate options for yourself and use the knowledge you have acquired to make your own decisions on what is right for you.
Remark:
You are content that you have researched sufficiently to invest in an area which is suitable for you, your tolerance to risk and your goals.

Risk Number 4
Risk: Market: what if the market crashes?
Action you can take now:
a. You have a long-term view of property investing and as such you are not overly concerned.
b. You have other investments which are not correlated to this particular property market, such as property in the UK, a large stock market portfolio, bonds and cash.
Remark:
a. You have portfolio and asset diversification, so you are not too concerned about any one market or asset ruining your life.
b. There is nothing you can do to stop the market crashing.

Risk Number 5
Risk: Liquidity: what if you cannot sell your off-plan property on completion?
Action you can take now:
a. Consider your exit strategy before you buy and not after choosing your investment property.
b. Research the robustness of the resale market, the transaction costs and the supply side factors, such as the number of new-build properties.
c. Ensure that the property you purchase has unique features which will make it stand out from the crowd.
d. Do a lot of research!
Remark:
a. Before committing, research, research and research.
b. Also research the rental market because if you are forced to complete on the property, you may have to rent it to cover your costs.
c. Understand that some markets carry higher liquidity risk than others.
d. Be aware that the worst-case scenario means that you have to complete on the property or walk away losing your deposits (depending on the contract).

This matrix is a useful tool to consolidate your thoughts and concerns, to think through consequences and outcomes and to check that you have thought about all the potential downsides of your investment. The most successful entrepreneurs and investors are those who think not one, not two, but three steps ahead. This level of thinking is what you must strive for, and tools such as this one will force you to write things down and think through the solutions.

The ultimate aim is that you are so conditioned to think about the pitfalls, that eventually you don’t need to write your thoughts down as your reactions become instinctive.

As a jet-to-let property investor, you need to be so tuned in to the issues, factors, markets and yourself that very quickly you know what is right for you. Then, when investment opportunities arise, you can make a rapid assessment and act quickly before the opportunity passes by.

Fortunately, there are a lot of professional companies offering advice and investment services in the jet-to-let market that will have your interests at the top of their agenda too. Their ethos is such that the customer is right and that a happy customer is the best advert that they can possibly have. They are in the marketplace as suppliers for the long term, not just a few months.

However, not all sellers in this marketplace operate in the same way. In particular, there has been an explosion of one-man-bands on the internet and there are plenty of opportunists who will be here today and gone tomorrow – with your cash.

It is advisable to stick to established companies with a reputable track record of delivery and customer service, whom you can meet in their offices and who will be more than delighted to let you speak to previous clients.

Failure happens to people who don’t plan; success is for those who have spent time formulating strategy, plans and taking advice from professionals.

Key points summary

• Risk is all around us. Control it or it will control you.
• You control risk with education, knowledge and experience.
• Determine what level of risk is acceptable for you, your partner and your family.
• There is no such thing as a ‘risk-free investment’.
• Have a portfolio approach, mixing low-, medium- and high-risk opportunities according to your goals and acceptance of risk.
• Embrace risk, for it always comes with an opportunity.
• Use the risk checklist and risk management matrix to formulate a strong and considered risk plan.

© Lawpack Publishing 2006

“The Jet–to–Let Bible”, Dominic Farrell
Reproduced with the permission of Lawpack Publishing.

Further information on this topic can be found in “The Jet-to-Let Bible”, by Dominic Farrell, ISBN 1 905261 11 X

For information and advice on investing overseas, contact Bewarethesharks.com on +44 (0) 151 482 5525 or visit www.bewarethesharks.com

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