How to Invest Successfully in Emerging Market Real Estate

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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.

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 Daily Reckoning Australia

Editor’s Notes: With decades of globetrotting experience under their belt, the International Living team recently launched Alpha Hunter, a service aimed at tapping the many and vast opportunities of investing in the emerging markets.

Ronan McMahon and Margaret Summerfield

Ronan McMahon and Margaret Summerfield

Ronan McMahon and Margaret Summerfield

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8 Comments on "How to Invest Successfully in Emerging Market Real Estate"

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Richo (the Second)
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So hang on – is this person advocating buying off the plan in some emerging exotic market? I’ve bought off the plan myself many years ago in Melbourne so have nothing against it but this article is financially irresponsible – concepts such as flipping properties in Mexico don’t sound a great idea if the sovereign debt/US deficit/Euro contagion eventuate – isn’t that why there are now so many UK investors with negative equity who also had the plan to flip properties on the coast of Spain but got whacked by the GFC v1?

Steve
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Steve’s quote of the day:

“Last year the Australian tax payer was ripped off a staggering $8.6 billion to help keep Australians out of reasonably priced housing and to keep the scum (property investors) happy and filthy rich,
How about we remove this rort, and within the year 2011 that approx $8.6 billion will go along way in covering the cost of the Brisbane floods that will cost about %11 billion”

smallcap
Guest

Steve,
Not too keen that I risk my shirt in shares and don’t get the tax deductions that property investors are allowed, but I think the term “scum” is a bit harsh. We all want to secure our retirement the best way we can. Keep it sensible.

Steve
Guest

yeah it is sensible thank you very much smallcap.
When people like you invest in property it makes us worse off it doesn’t take a rocket scientist to work that one out does it?With property investors it al about ME ME ME and stuff everyone else.

Whats a house there for?
A shelter for people to live in
Or for someone like you to F*%^ others over with and make their lives difficult?

smallcap
Guest
Now you definately need to tone it down a bit. I think you have a problem Steve. As I said, I don’t invest in property, I don’t even own my own house. It’s a free world (or didn’t you know). I am not keen on property investors either, but there is no need to be hysterical aboout it. Mate, a house, gold, shares, vintage cars, people buy them for their own reasons, it’t not up to you. In the end, the market will decide, I think the property investors in the US and the UK got the message in the… Read more »
Ned S
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Unless Oz decides it is going to supply public housing to all of the 30% who aren’t home owners rather than just the 5% that it does, Oz will continue to have private residential property investors.

Richo (the Second)
Guest

I’m a property investor but am certainly not filthy rich – I wish!

Biker
Guest
Richo, for several years now we’ve read in DRA that property investment is a major mistake… a losing proposition. Finally we’re seeing a change. Bill 5th Oct 2010: “What to do now? Find solid businesses at bargain prices. Invest in real estate with good cash. Buy collectibles… jewelry…art – things you want to own no matter what the price.” Ronan McMahon and Margaret Summerfield recently recommended buying-off-the-plan(!) Chris Mayer tells us, 11th Jan 2011: “Real estate, after a long absence from the menu, is back on.” Heck :D even Skayce, 15th Jan 2011, commented: “You should start doing the groundwork… Read more »
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