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How rental property investment protects from financial crisis. – 08.09.2018

The last month of the calendar summer of 2018 can be described as calm for global financial markets. Indices of leading markets are near record levels. NASDAQ index, APPLE and GOOGLE, VISA and MASTERCARD stocks continue to grow in price.

However, there are signs showing the picture will change soon: emerging markets’ indices are slightly lower than a year ago, there are less stocks whose price has grown over the past year. In addition, it has long been known that most often financial crises begin in the fall. Market participants who are waiting for a negative scenario take protective actions, i.e., in other words, they are selling risky assets. Such tendencies will inevitably lead to supply excesses demand and, as a result, to prices decrease.

Will this decline be deep and long the time will show. However, one thing can be said quite definitely: in upcoming months the level of speculative income (from the growth of the market value of assets) is expected to be extremely low or negative. Sale of assets and capital encash is a bad decision for the investors because the Western world lives in conditions of negative interest rates.

In these circumstances, one has to consider investments in conservative assets such as coupon bonds and rental real estate to save capital and continue to receive passive income from investments.

If bonds investing is more or less simple (you need to choose the issues of reliable issuers with a suitable maturity), then the rental real estate market is a patchwork quilt: it seems to be a single whole, but each shred has its own properties.

The good news is that choosing a real estate market for investments for the crisis period is much easier than it seems.

First, let’s carefully formulate the selection criteria:

Despite all the charms of new housing (those who are interested can read our review of the primary real estate market in Sydney, Australia's economic and financial capital), it should be the secondary market property to provide the investor with immediate rental income.

Liquidity is an important factor that provides the investor an opportunity to sell the property at any time when he decides to change conservative assets for risky investments.

When most market features are equal the preference should be given to well-established markets with minimal price fluctuations.

Taking liquidity into account, the yield should be higher than the yield on bonds with instant liquidity.

There are few other factors affecting investment decision that should be mentioned. For example, "entry ticket price" (average value of transaction) set limitation on the volume of portfolio.

  1. Availability of secondary real estate for foreigners.
    Despite all the charms of new housing (those who are interested can read our review of the primary real estate market in Sydney, Australia's economic and financial capital), it should be the secondary market property to provide the investor with immediate rental income.
  2. Liquidity.
    Liquidity is an important factor that provides the investor an opportunity to sell the property at any time when he decides to change conservative assets for risky investments.
  3. Market Reliability.
    When most market features are equal the preference should be given to well-established markets with minimal price fluctuations.
  4. Yield.
    Taking liquidity into account, the yield should be higher than the yield on bonds with instant liquidity.
  5. Other factors.
    There are few other factors affecting investment decision that should be mentioned. For example, "entry ticket price" (average value of transaction) set limitation on the volume of portfolio.

Another factor is the opportunity to get a loan secured by the property being purchased. When the rates on the loan are low enough, and the yield from leasing is relatively high, there may be a situation where the return on investment will be higher than when buying an object from own funds. However, it should be noted that such situations are rather an exception than a rule.

All mentioned criteria, even without considering other factors, substantially limit the range of search. As a result, only four countries - the USA, Canada, Germany and the UK - fall into the short list, and not as a whole, but only the largest cities of these countries (remember ‘the patchwork quilt”).

To be accurate, these four countries would had been chosen if crisis happened one or two years ago. After cooling measures for real estate market were introduced in Vancouver in 2016, and in 2017 in Toronto, Canada should be excluded from this list. The other day, August 27, 2018, the German newspaper "Frankfurter Allgemeine" quoted the Mayor of Berlin, Michael Mueller. The essence of the quote boils down to the fact that German capital authorities (where 68% of all purchases of real estate in 2015 were made by foreigners) are in full swing working to prepare measures to cool the real estate market as well. Therefore, we should also exclude Germany from the list.

The main provisions of cooling measures, taking Toronto as an example, are:

  • the introduction of an additional tax on the purchase of housing by foreigners (in Toronto, its rate is 15%) and
  • limiting the growth of rent by 2.5% a year.

The notable results of cooling measures are following: shrinking of the real estate market (the number of transactions in cooled marked decreased 40% or even more) and drop of investment appeal of real estate compared to other instruments.

So, after our short-list is revised, just the United States and Great Britain comprise the shortest list. It's a good time to recall that we are looking for a substitution to investing in shares for the period of a possible financial crisis and testing investments in rental property as alternative to stock market.

We know that the markets of the largest US and UK cities in terms of liquidity are roughly comparable.

The entry ticket price is also approximately the same in both countries.

However, there is one thing that prompts us to make a choice in favour of Britain, the thing named "Brexit".

The vote on Britain's withdrawal from the EU and the uncertainty that arose after it caused the pound's rate to plummet against other currencies, making present rate of the British currency against the US dollar 25% less comparing with three years ago.

Consequently, comparing the dynamics of the US and UK property markets in the last three years, the nominal growth in property prices in the UK should be adjusted by 25% down to obtain a comparable result. It is obvious that the adjusted result for UK market will be much less than for US. Moreover, in 2018 property prices did not grow in the UK and they even fell in London.

This means that the British real estate market is calmer than the American one, and if our assumption about the forthcoming financial crisis is correct, the British market should also react more calmly than US market. In other words, the crisis price correction in the British market should not be so noticeable as in the American market.

At the same time, rental income from British real estate is almost absolutely guaranteed. Traditionally housing deficit is experienced by London. In addition to London, the population growth in Manchester and Leeds gives rise to the outrunning demand for rent. Since the province's cost of housing is much lower than in London, the rental yield as a percentage of the cost of housing is higher. It is easy enough to find rental real estate options with a return of more than 6% per annum outside London which is amazing for conservative investments.

All who want to protect their capital from the expected global financial crisis by means of investing in rental property in England, please contact us for more information. Thank you!

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