Spotting the scam
So much is being touted around about US property being a great investment but does it really stack up and offer investors the truly great return that salespeople would have you think? And how is the investment likely to look in 3 to 5 years?
Now let me start off by saying that I don't sell US property and I never have. However, I am an expert in building investors property portfolios regardless of where the asset (or property) is situated, including the US. I have hundreds of clients who have property in the US, so you might say that I am qualified enough to comment on them.
Whilst many of my comments throughout this article may seem negative towards US property investment I make these points in order to get you thinking about the possible risks, sales person tricks and their deceptions to arm you for the barrage of opportunities that will no doubt continue into the coming years.
This article is not meant to provide a solution or sway your thinking. Rather is it meant to make you realise that the US is a massive marketplace with some excellent investment opportunities; but there are also many money pits. What I want to emphasise is how easily it can all go wrong; with 10 lessons – things to consider before investing.
So let's begin with a story.
Malcolm was a client of ours who had just started investing, he'd bought one UK property off plan and before we could get him the second he had discovered the ‘amazing' property market of Detroit. In fact it was so good that he had tried to pitch me into selling it to my property investors. I discussed many of the points we will discuss here, in fact maybe I wasn't hard enough with him. Irregardless his mind was made up and he bought two properties at $30,000 each. They came with 2 year rent guarantees and he was over the moon.
About a month later he actually called me to ask how he could get hold of $100,000, actually asking me if I would lend the money to him. Of course I declined asking him to be careful and consider his risks.
He didn't listen instead he used his credit cards and a loan from his mother to buy the properties, 5 in all and for a time he was over the moon. At one stage he compared how much better his US property was than UK.
Anyway everything went along great for about 9 months until one month the rent wasn't paid, he phoned the sales agent but the phone was dead, he eventually spoke to an agent in Detroit who said that pretty much no-one lived in the area.
Turns out that Mal had been taken for a ride on two counts. Firstly his $30,000 properties you could pick up for around $5-$7k at the time from a local agent if he'd just taken a trip. Secondly, there had never been any tenants, the houses were boarded up, not just the one house, the whole street and most houses in the area. The rental guarantees had just been the agent taking the massive commission they made and drip-feeding it back to him.
Lesson 1 – Take a trip to the US: If it's worth investing in then it's probably worth taking a trip to view the property, the areas and meet the people who will be managing the property. Make sure you do your investment research and due dillegence.
Lesson 2 – Don't buy through an agent in your country, they will normally not have your best interests at heart. They won't really know the property, area or the country.
Lesson 3 – Be careful with rental guarantees, where is the money coming from to pay for the guarantee? Don't trust a salesperson with a glossy brochure and a promise of a rental guarantee. This is especially true when bank lending is not possible, that should immediately ring warning bells in your wallet.
If you're not sure of what I am saying then go to Google.com.au and type in “US property scam” and also have a look at Neil Jenman's website, they both provide an interesting look at the lies, BS and overall mis-selling of US Property.
Another story, from Las Vegas this time:
Damas, a client, had bought a beautiful 4-bedroom house on the outskirts of Las Vegas, it was sold as being a sure thing, after all everyone knows Las Vegas!
The property was bought off plan through an agent in the UK. His first concern was that about 6 months after paying the initial monies to secure the property the agent went bust, that wasn't too bad as he had the solicitor and the developer contact details so he thought it would be alright.
Then the credit crunch hit, and it hit Las Vegas hard, prices dropped and sales didn't happen, the first letter he received stated there would be a 6 month delay, the second a further 12 months and finally the developer went into bankruptcy.
Despite 4 years and a further $12,000 in legal bills they still don't have the property nor their money back.
The problem here was they were buying into a brand new area, no shops, no infrastructure, no local demand for the property, so once the recession it, the area had no potential and no sales. To a degree Damas had been blind-sided by the name Las Vegas rather than researching the local fundamentals.
Lesson 4 – Be very careful when buying in a new area without established fundamentals: If there is a downturn, these are the first places to get hit.
And another story,
I have a mate, we went to school together, he was the guy that apparently made a million in property after a few years out of school but interestingly by five years was suspiciously MIA. Then the stories started to emerge about how he had run up massive debts and taken people's money.
Anyway he turned up selling property in Florida some years later, he contacted me as I also was in real estate and wanted to sell me his property. Of course I declined, but we have kept in touch regardless.
About 3 years ago he called me to talk about these great properties he has and that I should sell to my investors.
They were worth $300,000 odd at the height, now we could sell them for $150,000. Great deal you might say… Well not… Dave was able to buy these for between $50,000 and $75,000 and the difference he would split with me. I would be a gazillionaire overnight he implied.
Now the price wasn't even the biggest problem with these properties, it was the service charges that you had to pay each month, around $2000, they were mostly in gated communities so they had pools, tennis courts, and onsite managers and for a lot of them they were apparent ghost towns, the overseas holiday makers had all gone home and left deserted streets of empty houses. Not exactly the picturesque Florida sunny dream that one would have in mind.
Again, read the fine print and prepare a full cash flow for your investment. If you don't have one then speak to the team and get one from us, it could save you thousands.
Lesson 5 – research: Research the local area, Prepare a cash flow and most importantly Read the fine print if the bank won't lend, don't buy the asset. My general rule is if a high street or normal retail bank won't lend then don't buy the asset. There is always a reason why they won't lend and it's normally because the asset is overpriced. Or it could be that the security (in this case property, hotel room, student rental etc.) is far too risky for them to lend.
Don't be fooled into thinking that vendor finance is a good thing, many times it's code for ‘I'll transfer the asset to someone else'. Sorry, let me be more blunt, ‘I'll transfer the problem to someone else and make a pretty buck doing it'.
Lesson 6 – If the banks won't lend you have to ask yourself if it is really worth buying: Vendor financing doesn't count.
Hermetically sealed and boarded up…
We had the partner of our building inspector in the UK move to the US to expand the business there. Their initial thoughts were positive until they moved and realised that there was no new homes being built, in fact most developers had simply stopped or gone out of business. So they changed the focus of the business. They decided to work with banks and offer a hermetic sealing service. What is that? I hear you ask…
Well that's where the bank repossesses the property and then after holding onto the asset for a long time they will take the decision to hermetically seal the property. It goes beyond boarding up windows, this service makes the property airtight, they pump out any water in the taps that may freeze and bust pipes, the sewerage, they seal every window with plastic and boarding and they pump the place full of pesticides so nothing decides to take up residency in the long wait for a buyer.
Selling taxes
Another client, Mary had been advised to buy her US property in a company name because of the additional deduction benefits. Her property in Florida was looking good for a while but as the market overheated I advised her to consider selling it. The cash flow was costing her $2000 per month to hold which was unaffordable.
It was 2006 and she found a buyer quite quickly and at a price that would cover the mortgage, costs and agents fees. However, because she had bought in a company name she was subjected to a selling tax she wasn't aware of, it meant that she lost $25,000 on the transaction.
Lesson 7 – What is your Exit Strategy? What are the Implications and costs of selling and who will buy the property when you sell?What's the true value really? It certainly isn't what it was!
The recent recession has decimated values all across the United States, I've heard more stories than I can count of million dollar mansions selling for more than half price. It's no longer enough to assume that just because a property once was worth a million that it still is.
The fact is whatever the property company or salesperson tells you ignore the old value, its a made-up number and reflects a bubble (in some cases a massive bubble) and the reality is it may not get back to that number for many years. Instead focus on finding what the current market value is, that's the amount it will sell for in todays market.
Buy based on current property investment fundamentals rather than what it was!
Lesson 8 – Always consider the current market value and the current fundamentals: and not what the valuation and fundamentals were in the boom. None of that counts now.Eating your investment one percent at a time…
Investing in the US, if you don't take into account all that we have been discussing, you will be a LONG road to recover, they are printing more Greenback (US Dollars) than ever and this will cause inflation within the country and you will see a gradual (perhaps even dramatic if they keep printing at the present rate) decrease in strength of the dollar.
So despite your investment growing 10% and yielding 10% the currency deflation against other currencies will mean you could actually be losing money in real terms. This is particularly true if you live is the Asian economies that are supposed to see their currencies strengthen against the dollar.
Portfolio planning considerations – what are your choices?
Ok so I am often misquoted as saying that I prefer capital growth to cash flow when in fact I like and encourage both. However, I do think the capital growth in US property is still a long way off and therefore the yields are what solely attracts people. There is nothing wrong with this as long as you go in with your eyes wide open.
However, many people that are expecting a high yield and early capital growth, but in terms of portfolio planning many of the properties being sold are almost purely cash flow assets and won't grow in any hurry so you're left getting your 10% yield less 10% inflation (and if you don't believe me look up the word ‘price hedonics' in Google and you may begin to understand how the US massages figures to get lower figures.)
The truth is that most people would be far better off aiming for a decent yielding asset in an area that is more likely to have capital growth. They will make more money this way and be able to buy more property sooner which would amplify their results.
Lesson 9 – Always consider how inflation and price hedonics are going to affect your investment long term. 10% growth with 5% inflation and hedonics adjustment of 5% is ZERO growth.
Commissions made on sales.
If all of the above doesn't convince you that the US is a steer clear territory for investment or at least follow my advice then maybe the next point is. In most sales jobs to earn really good consistent money you have to be disciplined, know your product, understand the client's needs etc etc. The problem I see with US property is that so many people selling it have never been there, have only just started selling it, don't own it and they make huge commissions which are clearly unsustainable.
In most markets that I consider mature markets (US included) an estate agent will earn around 2 to 5% of the price as commission. For companies selling US property abroad the scale starts at 10% and goes as high as 25%. A quarter of your investment could be going straight to the back pocket of your salesperson! Actually that isn't correct, most of it will go to the owner of the business.
Lesson 10 – Find out how much sales commission your agent is earning from you: Obviously don't expect them to tell the truth. You may need to speak to a few different agents to find out the truth.Good, so let's just recap the 10 lessons that I hope you avoid ever having to experience…
A round up of today's lessons:
Lesson 1 – Take a trip to the US: If its worth investing in then its probably worth taking a trip to view the property, the areas and meet the people who will be managing the property.
Lesson 2 – Don't buy through an agent in your country: They will normally not have your best interests at heart, they won't really know the property, area or the country (ask if they have been there or own property themselves).
Lesson 3 – Be careful with rental guarantees: Ask yourself where is the money coming from to pay for the guarantee and what is backing the continued payment of it.
Lesson 4 – Be very careful when buying in a new area without established fundamentals: If there is a downturn these are the first places where fundamentals go out the door.
Lesson 5 – Research: Research the local area, Prepare a cash flow and most importantly Read the fine print.
Lesson 6 – If the banks won't lend, you have to ask yourself if it is really worth buying: Vendor financing doesn't count.
Lesson 7 – What is your exit strategy?: What are the Implications and costs of selling and who will buy the property when you sell?
Lesson 8 – Always consider the current market value and the current fundamentals and not what the valuation and fundamentals were in the boom. None of that counts now.
Lesson 9 – Always consider how inflation and price hedonics are going to affect your investment long term. 10% growth with 5% inflation and hedonics adjustment of 5% is ZERO growth.
Lesson 10 – Find out how much sales commission your agent is earning form you:
Obviously don't expect them to tell the truth. You may need to speak to a few different agents to find out the truth.
Remember these before you jump into buying in the US (or any foreign country) and call the team for some qualified advice on +44 (0)207 923 6100.
Live with passion
Brett Alegre-Wood
