Chapter Two: Location, Location, Location
Before buying an investment property you should be clear about your objectives and act accordingly. However cheap the property and small the amount of money you put in upfront, this is still a major financial commitment; in the case of most people, the second biggest commitment they make after buying their own home. For that reason, it is not something to enter into lightly or without doing some home work first.The reason most people are getting into Fly to Let is making money. Some have done well from the housing boom in Britain (or Ireland) and want to replicate their experience abroad. Others have missed out at home and see the booming foreign markets as a chance of making up lost ground. But what kind of money are you trying to make? Are you looking primarily for something that will generate income – as an alternative to a deposit account in a bank? Or maybe you are not so bothered about income but are more interested in capital gains. But what kind of gain: a quick speculative one or are you looking at 10 years or more? You may perhaps see your investment as an alternative pension. There are other questions, too, like how much risk you are prepared to run and, perhaps more importantly, how much effort you are ready to put in. The answers to these questions will inform both the location and type of property you buy.
So how do you choose? Some people may have already decided on a particular country or area because they have links with it or perhaps intend to live there in the future. It is an attractive idea: buy a house in France or Spain, let it out for 20 years while the tenants pay off the mortgage and eventually retire there. If you are one of those buyers, then you probably know already where you want to buy and might be tempted to skip the rest of the chapter. That may be a mistake. However much you may be wedded to a country or a region, you will regret your decision if it is a bad place to invest. Indeed, if the place you plan to live in has a sluggish or falling property market, you may be better renting there and investing in a more dynamic market elsewhere. It might be a little bit more complicated, but could ultimately be a lot more profitable.
With international property, just as with domestic property, location really matters. In fact, it is even more important, because if you compare different countries rather than different parts of Britain, you have to bring in factors like exchange rate movements, different interest rates, varying economic performances and so on. Make a bad choice of city, or worse, country, and however perfect your house or apartment, you will have made a bad investment.
It is not simply a matter of taking the best performing country and assuming it will continue doing equally well. As the small print always says, past performance is not always a guide to what will happen in the future. One way of using the past, though, is to study the factors that influenced previous rises in a place and see the extent to which they are present in a particular location today. Although only an imperfect predictor of future performance, it will at least lead you to ask the right questions before you buy.
If we are looking at emerging – rather than mature – markets, which is where most people agree the real money is made, then they will tend to follow a similar trend line. Prices will first be relatively stable and then start to pick up at an accelerating rate. They will continue rising, but the rate of climb will gradually lessen, until eventually they are going up at a moderate rate, perhaps in line with the overall growth rate. No single market will perform in precisely the same way and prices will oscillate around the line, often quite dramatically. But the message is clear: as a buyer keen to maximise capital gains, the time to be in the market is when the curve is beginning to become steeper.
Alise Crossick, who with her husband, Jonty, has been a highly successful investor first in the British buy-to-let market and subsequently abroad, uses the analogy of a party. No-one wants to be the first one to arrive because there will be no-one much else to talk to; but get there too late and you could be left with the washing up. The ideal time to be there is in the middle when the party is in full swing. The only problem is timing your arrival correctly. And so it is with the property market.
All this theory is fine, but before actually deciding what to buy, you must make an important decision: are you intending to buy a property in a town or city that is suitable for continuous all-year round use or instead something by the sea, in the countryside or in the mountains that is intended as a holiday let. The distinction is not a black-and-white one, especially given the growing popularity of cities as destinations for long weekends. A small flat in the middle of Prague, for example, might offer good returns if let out all the year round to a young Czech couple. The same property could also be let out by the week or even the night to British or American tourists. The same is true in a number of other places. For simplicity, though, let us initially consider the two categories of property and the kind of factors that influence them separately.
Properties for long-term lets
In a market-based economy, the price of everything – property included – is influenced by supply and demand. If the demand grows for a particular kind of property, then its price will go up, while if the supply of that kind of property increases, then, provided demand remains the same, its price will go down. In reality, matters are much more complicated than that. In most cases, too, we are talking about increasing and decreasing rates of price growth rather than absolute rises and falls. It nevertheless provides a simple framework that might help you opt for one place over another.
So what kind of factors influence demand for property? The following is not an exhaustive list, but rather a selection of the most important. Their relative importance will vary from time to time and place to place.
Income and unemployment: This could be the most important one of all. If you want to know why house prices are higher in Britain than in Bangladesh, then it is largely because the the average Briton earns much more than the average resident of Bangladesh and is both willing – and obliged – to pay more for somewhere to live. It is as simple as that. It will also account for differences over time: the faster a country’s economy grows, then the faster incomes and house prices will go up, too. For this reason, a country like Latvia, whose economy has been growing at a blistering 7-8% a year, is an especially attractive proposition. Closely linked with this is the level of unemployment: any rise in the jobless figures will push down incomes, and this, in turn, will have a depressive effect on house prices. Both income and employment levels can vary widely within a country, though. Typically, those living in the capital will be the most affluent and property prices will be the highest. (Exceptions to this are countries like Germany and Italy, where the respective capitals of Berlin and Rome are not also their commercial or financial capitals). Britain has been a good example: the boom in London’s economy pushed up prices there in the mid to late 1990s, widening the differential with less economically vibrant parts of the north. As the British example shows, though, a ripple effect out from the capital meant other areas subsequently played catch-up. Such a phenomenon is also to be expected in the emerging markets of Central and Eastern Europe, which are still clearing up the problems left behind by more than 40 years of Communism. While much of the action still appears to be in the capital cities, where the money and jobs are concentrated, property prices in secondary cities could begin to grow faster as they develop too.
Population Changes: Property is not just a financial asset. It is also somewhere to live! If the population of a country is growing, then this will push up the demand for housing, and so prices, and vice versa. The effect can be quite localised: while the total number of people may be stable, there can still be considerable movement into some areas, cities or districts. London, again, is a good example (even if the inward movement of young people in search of well paid jobs in recent years has been offset, to some extent, by the departure of older people with families). Equally important are changes in the structure of society: much of the rise in demand for property in developed countries is due to the gradual disappearance of the traditional extended family of grandparents, parents and children living under one roof. Young people these days strike out at an earlier age to live on their own; the divorce rate has risen and there are more and more elderly people living alone. This increases the overall need for housing, but tilts the demand away from large family homes towards smaller units. As the number of elderly people rises, so too will the demand for bungalows, ground floor flats and buildings with lifts!
Interest rates: Given the price of housing, most people in countries with developed banking systems do not buy for cash, but spread out the cost over 15, 20 or more years with a mortgage. For this reason, any small changes in interest rates is important – not just in affecting monthly mortgage repayments – but also in determining property prices. A cut in interest rates will push up prices (by making debt more affordable) while a rise will have a depressing effect. It will also affect the relative attractiveness of buying and letting: if it costs less to borrow, many people previously happy to rent will buy instead.
One of the clearest example of the effect of falling interest has been the southern European countries that joined the euro in 1999. Italy and Spain traditionally had relatively high inflation and interest rates, but had to cut both in the run-up to the launch of the single currency. It is no coincidence that prices in both countries have been booming since the late 1990s, but have been stagnant in Germany, which already had low interest rates. Price rises in the new EU members of Central and Eastern Europe have also been driven by the fall in the cost of borrowing there which, until recently, was in double digits. In Britain, by contrast, the rises in interest rates that occurred from 2003 to 2005 helped slow the market. Prices in Britain, in fact, are especially sensitive to rate changes, not only because so many of us are mortgaged up to the ears – but also because mortgages traditionally have a variable rate. The effect is not so immediate in countries, such as the United States or much of Western Europe, where fixed rate loans are more common.
Availability of Mortgages: In Britain, we take it for granted these days that almost anyone can take out a mortgage: 90-100% loans means you don’t have to spend years saving for a deposit, while self-certification means you may not even need a regular job. The amount of money you can borrow relative to income has grown substantially, while specific buy-to-let mortgages allow you to buy second, third or even fourth properties. A generation ago all of this would have seemed very exotic indeed and there are few countries that have gone as far as Britain. Most, however, are moving in this direction: according to a report (*) in September 2005 by Citigroup, Europe’s mortgage market almost tripled from €1.5 trillion in 1990 to €4.4 trillion in 2004, with the figure likely to rise to €6 trillion by 2009. Substantial differences remain, even between developed countries: while mortgage debt is around 76% of GDP in Britain, the figure drops to 53% in Germany, 27% in France and just 15% in Italy, where traditional attitudes to debt still prevail.
In many Central and Eastern European countries, where mortgages are a relatively recent phenomenon, it can be as little as 5%. Although it could be years before these countries reach Western European levels, the growing availability of home loans will encourage people to buy, pushing up prices. Indeed, the rise in the market in the Baltic states of Estonia, Latvia and Lithuania is due not only to strong economic growth but also to the mortgage boom. An investor who gets into a market before loans are widely available or when the process is only just beginning will therefore be in line for handsome gains (even though he or she will have to raise their own finance elsewhere). The flipside is that this will eat away at the long-term rental market and push down yields; why would an Estonian family, for example, want to rent a family house in Tallinn from a foreign investor when they could buy one with a cheap mortgage – and benefit from any capital gains? The rental market will not disappear completely, though: in Britain, for example, although there is not much long-term letting (apart from of homes owned by councils or housing associations) there are always people who want to rent, perhaps because they are only staying in an area for a short time or have had a change in domestic circumstances like a divorce.
Government: The actions of governments can do a lot to affect the demand for housing. The most basic way is the extent to which they create a stable, peaceful environment with respect for the rule of law. If a country appears on the brink of a Communist revolution or property there can be confiscated by the whim of a state official, then foreign investors will be wary of putting in their money – or demand a hefty risk premium before doing so. One useful indicator of whether a country is really politically stable – or just gives the impression of being so – is how often and how smoothly power has been transferred from government to opposition in recent years. The more times this has happened, the better.
The former Soviet bloc countries are a good example of this: investing in Poland or Hungary just after the fall of the Berlin Wall seemed perilous to many people. Now they and their neighbouring countries are fully fledged members of the EU, it does not seem much riskier than putting your money in France or Spain. Part of the massive rise in property prices that has occurred in these countries since the 1990s can be attributed to these changed political circumstances. For the same reason, many will still be wary today of investing in countries deeper in the former Soviet bloc such as Moldova or Georgia or in the Middle East or Latin America. EU membership itself is vitally important. While Brussels may be viewed with scepticism by many in Britain, for those on the outside membership looks like a ticket to the promised land. Large amounts of EU and private investment money flow into a candidate country in the run-up to membership, followed by even more during the years after it has joined. Merely preparing for membership can force countries to make beneficial changes to their economic and legal systems; the setting of a membership date can also have a strong psychological effect. Property prices surged in all 10 countries which joined the EU in 2004, while the prospect of membership is underpinning strong rises in Bulgaria and Romania, which are due to join in 2007, and in Croatia, which will follow shortly afterwards.
The actions of government will have an effect on property prices on a day to a day level, too. The most direct way is through the tax system. This can impact property prices indirectly through changes in income tax or VAT, which, in turn, will influence economic growth. Governments can also change the way property is taxed or alter rules governing the tax treatment of mortgage interest. In Britain, for example, it was widely assumed that the government’s apparent intention to allow people to buy residential property with their Self-Invested Personal Pensions (SIPPs) from April 2006 would have given a boost to the market, until Gordon Brown, the Chancellor of the Exchequer, unexpectedly ruled it out four months before. Other kinds of government policies can also have an effect. A decision to push the development of a particular region – or particular city – can boost demand for property there, by encouraging business and workers to move in. This is especially the case if it is accompanied by an investment of public money, which, in turn, brings improvements in infrastructure. In Europe, this means not only watching national government policy, but also European Union policy. A decision by Brussels to grant an area so-called Objective One Status will typically be followed by large injections of public money. On a more local level, the building of a university will boost demand for property suitable for students.
The Olympic Effect and other Special Events: The residents of London’s East End are already salivating at the effect that the 2012 Olympics will have on property prices, not just because of the Games, themselves, but also because of the investment in transport and other infrastructure in the run-up to the competition. The Bulgarian ski resort of Bansko is hoping for the same if it succeeds in its bid to host the 2014 Winter Olympics. Indeed, with the possible exception of Athens, which comprehensively mismanaged the 2004 Olympics, property prices have increased in most cities that have hosted recent Olympics. Valencia in southern Spain has already benefited from the decision to stage the Americas Cup there. Other major sporting events such as the World Cup can also have an effect – which could bode well for Germany, which is hosting the competition in 2006. As shown by the experience of Liverpool, so, too, can a decision to designate a place as a European City of Culture.
Local factors: You may start your property search by looking at countries, but do not forget that, ultimately, you are buying an individual flat or house in a specific place. This means looking not just at broad issues like government economic policy or interest rates, but also at things specific to the region, city or even district in which you are buying. The opening of a new underground station near your apartment block will boost demand; a new motorway or high speed railway line will open up an inaccessible part of a country and turn a sleepy village into a booming commuter town. Conversely, plans for a nuclear power station in the neighbourhood may put off buyers. Sometimes these will already be factored into the price by the time you come to buy, but you should still do as much research as possible.
Tastes, fashions and expectations or the ‘X’ factor: Any economic theory based on treating humans as entirely rational beings is bound to have some serious shortcomings; this is especially the case with property. Demand in a certain area rises sometimes simply because that area has become fashionable, often for reasons that are not entirely clear or logical. Look at Notting Hill in West London, which in the course of a couple of decades or so has gone from being a virtual no-go area to one of the most exclusive parts of the capital. The same is true for districts of Paris, New York or any other major city. Once an area has become fashionable in this way, it can quickly take off and other people move in for the simple reason that they are convinced prices must go up. Trying to make sense of the swings of the British housing market would sometimes require the skills of a psychologist rather than an economist. Indeed, with time, the mere expectation of rising prices can create demand of its own. The boom on the Bulgarian Black Sea coast is an example of this: many of the Britons eagerly snapping up flats in Sunny Beach and the other resorts are doing so not because they are especially keen on Bulgaria or want to spend their holidays there, but because they have seen how prices have already risen and expect them to continue to do so. There is always the danger that investors will put their money into what is little more than a pyramid scheme. There is sense in moving with the herd – or at least being aware of what the herd is up to – but warning bells should start to sound if you are too close to the back. If they suddenly change course, it may be too late before you realise what has happened.
As any economist will tell you, demand is only one half of the equation. You must also look at the supply of property as well. In any market based economy, developers will respond to increases in demand – and consequently of price – by trying to build more properties. The more they are able to build, the less prices will tend to rise in response to any given increase in demand. So which factors influence supply?
Availability of Land: As the old maxim puts it, buy land – they are not making it any more. That being said, there are important differences between areas. Compare Texas and Manhattan. If demand for property rises sharply in Texas, there is little to stop builders from building more houses, thereby dampening price increases. Space in Manhattan, however, is finite, meaning those who want to buy there will have little alternative but to outbid rival purchasers, driving up prices. The same is true of the beautiful historic centres of many continental European cities, such as Venice or Prague, and of front-line seaside property. Once the sea front has all been built along you cannot create any more – except in Dubai, where they got round the problem by constructing giant man-made islands.
Planning Law: Government policy will affect the supply of property as well as the demand for it. One of the main ways is via planning laws: soaring real estate prices in the London area have been due in part to the successive governments’ maintenance of the Green Belt around the city. Relaxing the rules would lead to more building. The same effect is at work in resort areas. In Bulgaria, for example, local authorities have introduced restrictions on building too close to the sea shore in a belated attempt to prevent a repetition of some of the worst excesses of the Spanish Costas. There have been similar moves in Croatia. The more effectively this is policed, the more of a premium it will put on the price of property already been built in these restricted areas.
Government Policy: Beside changes in planning laws, there are a number of other ways that authorities can influence the actions of builders, principally through the tax system and provision of subsidies. By manipulating Value Added Tax, for example, they can also change the relative attractiveness of building new home from scratch or renovating existing ones.
Properties for holiday lets
Holiday properties will be influenced by many of the above factors, although their relative importance will differ. A booming economy in the destination country will drive up the cost of flats and houses along with the general price level. As the locals become more affluent, they, too, might start buying or renting second homes in holiday destinations. Indeed, this should be the profound hope of British investors buying on the Bulgarian Black Sea coast. An emerging Bulgarian middle class might provide some – although not many – of the much-needed end users for the myriad of new developments.
Important, too, is the economic situation within the country from which second home buyers and holiday makers come. A slowdown in the British economy, for example, can have a dampening effect on property prices in regions of Spain or France popular with British second home buyers. It will also reduce the flow of tourists ready to rent those properties. The continuing woes of the German economy, meanwhile, appear to have had a dampening effect in some southern European markets, both by reducing the flow of potential new buyers and prompting some Germans who bought a few years ago in Croatia and Spain to sell.
Transport links are also of crucial importance, given that the attractiveness of a particular area as a holiday or city break destination is highly dependent on the ease and the cost of getting there. The explosion in the buying of foreign property by Britons in recent years has coincided not only with a sharp drop in the price of air travel but also with the opening up of direct routes to provincial airports in destination countries.
France provides probably the best example of this “Ryanair effect”: the decision by that airline to fly directly from Britain to little airports like Carcassone, Pau or Rodez that had hitherto been served only by domestic flights has led to a mini-boom in such areas. Important, too, is the growth in flights originating not only in London but also in provincial British airports such as Liverpool or Southampton. There have been claims that the opening of such a route could add as much as 20-25% to prices in an area in a year. For the same reason, the eventual arrival of low-cost carriers in Croatia and on the Bulgarian Black Sea coast, hitherto relatively poorly served by scheduled flights, is bound to have an effect on tourist numbers and property prices.
Before investing in an area, therefore, it is worth spending a little time poring over airline schedules, almost all of which you can find on-line these days. Remember, though, that a route can be axed from one day to the next – as some British second home owners found to their cost when Ryanair took over its smaller rival, Buzz, in 2003. The disappearance of a route may be merely inconvenient for those using the property themselves; for those relying on rental income, it will be nothing short of disaster, since many potential holiday makers will simply book somewhere more easily accessible. In the longer term, the economics of the air travel industry could also be affected by changes in oil prices or by long mooted plans to tax aviation fuel as part of efforts to combat global warming.
Climate change can itself have an effect, at least in the medium to long term. Low lying ski-resorts could be especially at risk if the planet is getting warmer: average temperatures need go up only slightly to shorten the season in some resorts, reducing the potential rental income from your apartment or chalet. Extreme weather, such as the Boxing Day Tsunami of 2004, earthquakes and hurricanes can also have a dramatic effect, not only in terms of immediate death and destruction, but also in influencing people’s holiday decisions for years afterwards. Geo-political shocks can have a similar impact: the 9/11 attacks on the United States in 2001 had a devastating effect on world tourism. The American-led invasion of Iraq in 2003 strongly impacted on travel to Turkey, Egypt and other Middle Eastern countries.
Even more than with long-term city lets, tastes and fashions are also important. For reasons that are not always clear or easy to predict, some countries and areas suddenly become fashionable, pushing up property prices and providing a windfall gain for those who have already bought. Others drop out of favour. Changing holiday patterns can play a part in this. The average Briton or other Western European spends far more time on holiday than his father or grandfather did. Increasingly, people go on long weekend city breaks or head off on adventure holidays in addition to the traditional two weeks by the sea, affecting the pattern of demand. Demographics, and, in particular, the ageing of the population, can boost demand for certain kinds of holiday properties and reduce it for others.
Other, more specific considerations apply when choosing between particular properties to buy as holiday lets. Ease of access is one of the most important. While you may be prepared to travel for a whole day to reach your beloved cottage, those booking it for a week may not be ready to do so (unless they are specifically looking for something remote). Proximity to an airport with regular flights is therefore all-important. Location is important in other respects, too: if you are buying a property in a seaside resort, then the nearer the beach the better. If it is in ski-resort, then make sure you are near the lifts. A good choice of bars and restaurants within easy walking distance is also a bonus – after all, people are on holiday and are there to enjoy themselves. Supermarkets and grocery stores are important. So, too, other facilities, especially the all-important golf courses. These have long been a major selling feature for holiday properties in Spain and Portugal and are increasingly becoming so in the rest of the world. Indeed, the opening of a new course – or merely the prospect of one – in an area will do wonders for property prices there. If you hear one is being planned, then buy quickly!
Swimming pools are increasingly important in seaside areas. A house or villa will be much more rentable and ultimately sellable if it has one. If it doesn’t, then install one. It will probably more than pay for itself. If you are buying a flat, then make sure the complex has a pool or, better still, a fitness centre and other such facilities. Also, if possible, choose a pretty home – or at least one that photographs well. Most people will decide whether or not to rent a property on the basis of a photograph and a few brief lines of description. The more attractive it looks, the more likely they are to take it. All this will be reflected in the purchase price, but it will be reflected in the resale value too, though. A well-positioned property will also be easier to let if there is a glut on the market.
As a general rule, you should try and put yourself in the position of someone looking to rent and try and imagine what they would be looking for. This means ensuring that the style and size of property is appropriate to the location. If you are buying in an area popular with families, then don’t buy a studio. If it is in a resort popular with young people, then a cheap one bedroom apartment could well be ideal.
THE EXIT STRATEGY Before making any investment, pause to consider how easy it will be to liquidate it, either because you want to realise a profit or because you need the money. This is especially important in the case of property, which, in comparison with shares, is an extremely illiquid asset. When buying a flat or house, therefore, you should look to your exit strategy. This is just as true if you are buying for short term speculative gain as if you are making a long term investment to boost your pension. This may not seem too much of a problem if you are buying an existing flat in an established city such as Paris, Barcelona or even Prague. It does become a factor, however, if you are buying into a rapidly expanding tourist area, such as the Bulgarian Black Sea coast. However superficially attractive the deal on the new build flat you are being offered, you should still ask yourself a simple question: who will want to buy this from me when the time comes to sell? If you have any doubt, then think twice before buying youself.
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