Peter’s Rule for Buying Real Estate: Lessons from the Trenches
Property is the most valuable asset you will likely ever own.
Despite the odd deal I’d rather forget about, the bottom line is this:
I have created more personal wealth through investment in real estate than all the salary and income I have earned in my lifetime.
Real estate investing is unique. It can give you many multiples of return on investment. A mort-gage lets you build wealth using other people’s money. Property can be a safe and secure long-term store of capital. It can spin off a stable income for you to retire on. And if all else fails, it can be the roof over your head.
For anyone looking to build long-term wealth, your first step should be real estate.
But where do you start? Well, it’s simple really. With this short guide I’ve written for you. Whether you’re a veteran, or just trying to get a foot on the property ladder, I guarantee you’ll find value in these pages.
I’ve taken some of my key lessons learned over 35 years of investing in real estate markets all over the world. And I’ve included a few stories that illustrate these lessons.
However, this is no ‘get-rich-quick’ guide to flipping properties.
But know this: anyone can make big bucks in property. You don’t need a university degree. You don’t need special training. You don’t need to be a maths whiz. You just need a bit of common sense, and a basic framework to follow.
These are a handful of rules I always try to follow when making real estate investment decisions.
I hope they bring you as much success in real estate as they’ve brought me.
Location, Location, Location
Rules Number 1 to 3
It’s a cliché. But it’s true, for all types of real estate. There are thousands of things that differentiate one property from another, but location is the most important.
Location has a bigger impact on property price than any other single factor.
You can buy the grandest house in the world. But if it’s next to a factory or in the middle of a rundown neighbourhood then forget it.
Prices can vary significantly at a very local level. The position of a property on one side or one end of the street matters. Prices can differ enormously within and across neighbourhoods, suburbs, and districts. Access to transport, schools, shopping centres, and jobs all influence property prices. Often more than you think.
This is a key factor that makes real estate investing one of the most fun and rewarding activities in the investment world. When you get it right, the rewards can be huge.
The secret is it’s up to you. Not an agent. Not the real estate section of the local paper. You. It’s your judgment and analysis that makes the difference. But it does require the discipline of really understanding the locations and understanding the factors that do and will drive differences in price over time.
This rule is about judging the popularity of one position over another. It is about judging human nature, and what drives people to pay more for the same piece of property in one location versus another. It’s about judging what’s driving the price in a location now, but also what is likely to drive it in the future.
It can take some time to understand all the subtleties of price differences according to location. But the big pic-ture is rarely too difficult. A casual observer can see that apartments overlooking Central Park in New York are highly prized. That apartments in Knightsbridge, London are amongst the most expensive and sought after in the city. Properties with views of Sydney Harbour and Auckland Harbour fetch premium prices in those markets.
But the subtleties are not always so obvious. For High Rise buildings in Hong Kong there is a very clear price pecking order. The price per square foot typically goes up by a closely defined amount for each floor going up the building. For example, the price may rise by say US$15 per square foot for each higher floor. Apartments with “green views” may sell at a 15% – 20% discount to those with “sea views”.
In some societies, personal taste may not accord high floors with such a price premium. Living on high floors in some societies may be seen as a negative rather than a positive due to perhaps say fire safety concerns, time to get in and out of the building, distance from apartment to car park, and so on.
Cities like London, and to some extent New York are basically an agglomeration of villages connected by transport infrastructure. Each village has a different character, a soul that appeals to different people in different ways.
Age and family position influence popularity for different locations. Families are concerned about education, ac-cess to schools, sports facilities, and ability to enjoy a back garden for kids to play in.
Singles and young couples are often more drawn to areas with trendy bars, restaurants, and night clubs.
Older folks may be focused on access to medical and health facilities, and the ability to walk to shops rather than be forced to drive. Lower maintenance apartments rather than houses with gardens begin to appeal to older people.
And all these requirements results in a layering of prices. Those heading to the trendy bar areas are often renters, not yet on the housing ownership ladder. They may not be in the peak of earnings yet, so lower price may be a big factor in the location decision.
I find it fascinating to try and figure the demographic factors and drivers of property prices in different locations within any city I am looking at. As an investor I am always trying to understand these forces as they will help me focus on what is important in securing good value and avoiding mistakes.
For example, I have often wondered about Manhattan as a place to bring up children. I have way fewer con-cerns about this in London. If Manhattan is a less child friendly environment, then this suggests that maybe the demographic profile of potential tenants is skewed towards singles, couples rather than families. This in turn might lead me to invest in a different kind of property in that market. Perhaps one or two bedroom apartments will be a better investment than a three bedroom. Why? Because there are more singles and couples looking to rent than families looking for more bedrooms.
“They aren’t making any more of this…”
You probably heard this old saying when referring to beachfront land. But it applies equally to land in the inner cores of prime cities for the most part. There is no new land being created in Central London. Old areas may be changing use and density, but there’s no new dirt being laid down in cities like these. What you see is what you have got. As cities grow there are often increasing pressures on existing land resources that make land increas-ingly valuable. Recognising this, municipal authorities may dramatically increase the densities that existing land can be developed to.
That zone of low rise warehouses in the middle of the city suddenly becomes zoned for high rise offices, or apartments, hotels, shops. Owning land or space in such areas can be a path to significant wealth. But again, it is all about spotting the location. It’s about identifying the forces that might drive major changes in land use and land value. Patience may be needed, as these things can often take years to happen. But not necessarily so. I have seen situations where major changes have happened in a relatively short space of time and valuations have gone up dramatically.
The 1997 Asian financial crisis crushed property prices in many locations around Asia, nowhere more so than in Hong Kong. Average prices for all types of property fell by around 60% in the six years to 2003/2004. Around that time I started buying some older industrial floor space. I spent a couple of years accumulating space in a particular building. Why? Well we had a business idea for that space which has tuned out very well. But equally importantly, there were two or three nearby developments I reckoned would have a big positive impact on the building. And it was a pretty run-down old industrial building.
Firstly I reckoned changes in town planning and zoning rules were in the offing. Most of Hong Kong’s manufacturing industries have high-tailed it north across the border into China. It was abundantly clear to me that two things would be likely to happen. First, the authorities would gradually allow higher value commercial uses to occupy these industrial buildings. They would be occupied increasingly not by dirty chemical, textile and metal bashing workshops but by office type uses, design studios, wholesale, retail, art galleries, sales and marketing functions (for the factories now in China). All of which would be prepared and able to pay much higher rentals. The buildings would be gradually upgraded and common area facilities improved.
Second, there would be pressure to simply redevelop many of these buildings to much higher quality buildings with much higher value uses located there.
Third, there were advanced stage plans to construct a brand new underground rapid rail system to the district, linking this area to the Central Business District in a journey of about 10 minutes. Transport infrastructure like this can be a huge value add proposition. Of course, this would take some time to build, but property values began to reflect this new infrastructure very early in the construction process.
End result. The space bought for our little business is now selling for five to six times what we started paying for in back in 2005/2006. The business is great, but the real bucks have been made in the real estate.
A Five Minute Conversation Can Save You A Fortune.
Rule Number 4
Whenever you’re looking to buy property, you have to take the time to ask friends, colleagues and acquaintances for their thoughts. Why?
People love to talk property.
What do they see happening in their neighborhood or city? What are their experiences, impressions, and knowledge? It never ceases to amaze me how two subjects constantly dominate dinner party conversation – air-line experiences, and property markets.
And because people constantly talk property, most people have a wealth of second-hand knowledge they’ve accumulated. Maybe a friend mentioned how noisy their old apartment was. Maybe a colleague raved about the new house he’s just rented because lots of great restaurants are opening up.
I lived in London for a number of years, and I have owned property there for a long time. I know the city pretty well. I certainly don’t know it all. Whenever I’m looking at potential investments there, I always contact a few people I know can give me an informed, un-biased opinion.
The cost of a phone call or a cup of coffee can be one of the best investments you ever make. Always, always ask for opinions…. Chances are you’ll receive plenty!
Recently I was doing the rounds of Central London residential property and visited a development. It was in a favoured, well sought after area of central London. The apartments were big, and seemed well priced for that district.
I called up a friend of mine who works in town planning…
Straight away she pointed out that a very large infrastructure scheme was about to begin construction, right next to this development. It would clearly be disruptive, noisy, unsightly, dirty, and persist for several years. I’d need to discount the rent to get it occupied. She also pointed out that the low rise buildings in front of the property were slated to be redeveloped into high rise blocks. This would obliterate the lovely views of the Thames that my potential purchase now enjoys. Not surprisingly, the Agent failed to mention any of this…
This property quickly left my potential buy list.
That one (free!) conversation potentially saved me a lot of money. I have had many, many like it over the years. And I always share my knowledge with those who have asked my opinion.
Buy the Worst House on the Best Street, and Add Value.
Rule Number 5
You’ve heard this one before
The good location will underpin the price over time.
But crucially, taking on the worst house in a good neighbourhood can give you lots of upside.
You can give the property a makeover to bring it in line with its peers in terms of quality. Done right you can really add a lot of value here. This is where big gains can be made. It’s where I’ve made many multiples of my initial investments. By adding value.
It can be via renovation of the entire building. It might be just a case of repainting the property, maybe cleaning up the gardens. Sometimes it is possible to add to the building – installing a pool, an attic in the roof, a sun-room/conservatory, a new garden, “granny flat” over the garage, an underground wine cellar.
The trick though is not to over-capitalise the property by spending more than the uplift in value is likely to be. It is easy enough to make this mistake, so be vigilant on cost of upgrades and assess what the likely upside on the price is going to be in relation to the cost of the work. The increase in value may be tied to an expected in-crease in rental income potential.
Adding Value – “The Second Leverage”
The “First” Leverage is your mortgage debt. It’s Rule number 8 (we’ll get to that). It’s putting $20 down for a $100 house. I call the process of adding value “The Second Leverage”. Why? Because you can make big capital gains on a small investment.
I have deliberately tried to keep this little guide ‘short’ on numbers. But we need to do a little bit of math here so please bear with me. It’s a simplistic example, but the figures speak for themselves.
Let’s say you have 2 near-identical apartments in the same area. Owner A puts his on the market for rent asking US$1,000 a month. You, Owner B, decide to invest $10,000 to upgrade your apartment. You put in a new kitchen, some good lighting, and an elegant paint job. You list it for US$1,150 a month.
Let’s assume residential property yields are 5.00%. This basically means if a real estate investor wants to come along and buy your rented property, he’s looking to receive 5.00% of the purchase price per year in rent.
Owner A’s apartment rents for $1,000 a month. Or $12,000 a year.
$12,000 a year is 5.00% of $300,000. So this is his selling price.
You, as Owner B, have given your place a real facelift. You’ve invested money to do so. And you’re get-ting $1,150 a month. Or $13,800 a year.
13,800 a year is 5.00% of $345,000. This is your selling price.
You invested $10,000 into your value adding renovations. And now you are looking at a $45,000 return on that investment.
Adding value can magnify your initial investment many times over.
Whenever I’m looking at potential properties, the questions are automatically on my mind… “Where can I add value here?…. How can I improve this property?…. How can I make someone happy to pay more to live here?…. And how can I do that for a minimal cash outlay?”
A subtle variant of this theme is to buy a real dingy property in an area that is not necessarily yet at the top of its game, but is up-and-coming. New transport infrastructure is often a big value add to an area. I have seen exam-ples where the development of a new underground rail link can produce an uplift in value of 20% to as much as 40%.
Development of a new large scale comprehensive development in a neighbourhood can also drive values of nearby properties skywards. Property developers know this and will often buy up smaller properties sur-rounding their own projects in order to upgrade the use and physical condition of these which in turn adds value to their larger project.
I have seen numerous examples of low rent, low value uses being replaced by much higher value uses as a result of the development next door of a major new shopping centre, office building, multi-use complex. The car re-pair workshops and air conditioner maintenance shops give way to fashion outlets and Starbucks outlets.
Large scale public sector driven urban renewal projects very often result in upgrading of nearby areas. Yes, these can often take a long time to get done, but the value add will accrue, often without your doing anything much yourself.
We see how some neighbourhoods undergo a “gentrification” sometimes simply due to the pressures of demand placed on a desirable nearby neigbourhood. The up-and-coming district simply experiences the spillover effects of pressure on existing popular locations. Bar and restaurant districts can be great targets for the “spillover ef-fect” concept. They have a habit of spreading outwards from their core.
Don’t Buy Property Sight Unseen.
Rule Number 6
I did this once. It was a small property. I ended up getting an adequate return on my investment. But I was lucky.
I have lost count of the number of friends and acquaintances of mine who’ve been bad-ly burnt doing this.
It happens a lot in Asia. This is a juicy market for developers in cities like London, New York, San Francisco, Vancouver, and Sydney. Asian buyers are cash rich and love luxury new-build property. They love owning real estate – full stop. And they like to buy properties in countries that have lower political and legal risk than they experience in their own countries.
Asian buyers are also used to a fast market. Hong Kong property investors will sign sales and purchase agree-ments within 24 hours of a viewing. Often they’ll sign there and then. Overseas developers and agencies love to tap into this trait.
Cities in Asia are constantly hosting agents and developers flogging shiny new properties “off plan”. Investors may have a general idea of the area they are buying into, but many don’t. They become victims of a sometimes sophisticated and fancy sales exercise.
The glossy brochures don’t show what’s happening on the ground.
They don’t mention that smoke belching factory just down the road, or the noisy freeway running past the end of the block, or the rail line rattling past the back window.
Just think about it. Why is the developer peddling his new building off-plan to buyers located thousands of miles away? Simple. He doesn’t want you to visit the site. Why go to all the expense of advertising his Lon-don or New York property in Hong Kong, Singapore, or Beijing? Because he reckons the overseas punters will pay a price that the domestic market won’t, often because of location issues.
Judging by London property advertisements I see in the local media in Asia, I’m amazed at just how big “Prime Central London” has become!
If it looks too good to be true, it usually is.
Beware of Real Estate Agents
Rule Number 7
Before I get accused of agent-bashing, I will say this. I know a handful of good ones. By “handful” I mean I can count them on one hand. (Full Disclosure! I do have a personal stake in a small agent company because I like the management and their business approach.)
But I’ve met and interacted with hundreds over the years and most aren’t worth my time or yours.
The problem is the agency business attracts a lot of people looking to make a quick buck. The barriers to entry are low. Sometimes it’s just a case of pass a multiple-choice exam and you’re done!
But I don’t envy these guys. It’s hard work. The base salary is terrible, often near-zero. The hours are tough. It’s not an easy way to make a living for most of them. The industry is highly cyclical and you never know when that next good pay cheque is going to come.
Real estate agents are not acting for you, or in your interests.
Their one goal is to get you to sign “on the line that is dotted”, and get their commission. Their ultimate respon-sibility is to the seller, not to you the buyer. They don’t care if the deal is good for you because any deal is a good deal for them! Only the very best agents will steer you away from a deal because they don’t believe it to be a good investment.
It is essential to keep that front and centre in your mind.
Recently there have been agencies marketing properties in the UK, USA, and even some Asian cities where the “agency” is not just acting as a broker. These companies act like agents. Talk like agents. Advertise like agents. But in fact they actually own the properties that they are selling and they are deliberately vague about this. They have gone into certain cities and either bought properties off developers or individual sellers and they want to on-sell to you the punter in some remote location. Or they buy up individual second hand properties, sometimes from distressed sellers, and aim to on-sell to you at a significant markup.
While there is nothing illegal in this, these “agents” are often less than transparent about where the actual owner-ship lies. Maybe you will get a bargain (I’d say unlikely), who knows? But you might feel more comfortable to know who you are actually buying from.
My experience is that these “brokers” don’t want you to go and visit the property. In most cases they won’t even allow you as a buyer to even go inside the building and inspect the unit!
That tells me all I need to know!
This is a very recent example of an encounter with one of these “agencies”.
The “agent” sent me details of an apartment for investment in a supposedly good location in London. I knew the general location, but not the details. He sent me a plan of the floorspace, as well as photo of the building facade. I knew the apartment was on the 4th floor, but not where it was within the building.
Following my own rule, I asked my wife and our friend the town planner to go and take a look at the building. The “agent” was in Hong Kong, and there was no one who could show us into the block and into the apartment. Given we could not get inside at this stage, I asked the agent to send me some interior shots of the apartment so we could get a feel for the space, and what upgrading we might need to do. I reviewed the photos in detail against the floor plan I had…
Things didn’t add up.
Doors were not where they were supposed to be. A whole separating wall seemed to be missing. I concluded that the photos were not pictures of the flat whose floorplans I had. Similar, but not the same.
I raised this with the “agent”. He was forced to admit that they were in fact different apartments!
The one showing the nicely decorated apartment was on a different floor, with a completely different outlook, and had already been sold. Under further questioning he admitted that the apartment we were considering was totally empty of all fixtures and fittings. It would need a total refit that would doubtless cost a great deal of money. Also, the apartment proved to be at the back of the block looking into what was in effect a ventilation shaft.
To cap it off, the apartment was actually owned by the “agent’s” company. This was not an agent acting as an intermediary, but as a principal. My wife and friend took a look round the area, and yes, the block was a nice art deco structure but located in what had become a very unlikable neighbourhood in recent years.
I asked the “agent” to do me a favour. Never call or contact me again.
Use Debt. But Use it Wisely.
Rule Number 8
Leverage is a powerful weapon, but must to be used prudently.
Leverage allows you to create wealth and income using someone else’s money.
Real estate is one of the few assets where us mere mortals can build wealth by borrowing. Moreover, we can borrow for long periods. There are not too many other investments where investors can get the comfort of 20 to 30 year mortgages.
For example, you buy a property for $100,000 with a 20% down payment ($20,000) and borrow the rest on a long term mortgage. Let’s assume that the value of the property grows on average about 5% annualised over a 20 year period.
That is not an unreasonable assumption for western markets. Many have done much more than this.
At the end of 20 years, the property is worth $265,000. This represents a thirteen fold return on the initial $20,000 investment.
And as an occupier the monthly mortgage payment is probably similar to the rental that you might have had to pay to rent a similar property. So, as an owner you have paid “rent” that you would have had to pay a landlord anyway. But your “rent” has produced a very nice return for you in the form of considerable capital gains.
Personally, I have made between 200 and 800 times my initial investment in some properties bought and held over the long term. Yes, 800 times my investment! The mortgage has long been repaid.
I’m not here to boast. The basic principles I followed are the ones I’m laying out here. There are no guarantees but by keeping to these rules when you buy property you GREATLY increase your chance of getting big gains and building substantial wealth.
My first ever real estate acquisition in London was made using a 90% mortgage and was sold 25 years later, mortgage repaid, giving a return of just over 200 times my initial down payment.
One current property still in the portfolio, bought nearly 30 years ago, again with 90% mortgage financing, if sold today would likely return my initial equity investment more than 800 times.
Most disaster scenarios in real estate are debt related
Debt carries its own clear risks. The key risk is the ability to service debt out of income, either personal income, or rental income for investment properties. Debt repayments are a function of interest rates and length of repayment. A longer repayment period reduces the monthly repayment amount, but means paying more interest over the life of the mortgage. It also means increasing your interest rate risk substantially if you have a floating rate mortgage.
Please be very clear on your interest rate risk. Most countries do not have long dated fixed mortgages available like the U.S. There are plenty of mortgage calculators on the internet. If you have a floating mortgage, you must allow for some breathing space, especially with interest rates as low as they are today. Could you afford to make the payments if my monthly mortgage payment doubles? It sounds like a stretch, but believe me, it can and does happen. I’m not saying you should only pay half what you can afford, but you must have a good understanding of your interest rate risk.
Stay in your financial comfort zone.
The table below shows some basic sensitivities of a 20 year mortgage of $150,000 you would face on day one.
An interest rate rise of 5% (not an unimaginable scenario) would increase your monthly mortgage repayment by 50%. And it would triple your total overall interest repayment.
In fact over 20 years the interest repayments would exceed the original price of the property!
Don’t just opt for the longest mortgage tenor you can get just to maximize your buying power (assuming you can’t get a fixed rate mortgage).
Lengthening the mortgage period results in lower monthly repayments but a great deal more interest paid over the mortgage period. And a great deal more interest rate sensitivity. The table below takes our $150,000 mort-gage and changes it from 20 years to 30 years.
Note that the percentage increases in mortgage repayments for each percentage point increase in interest rates is that much higher.
In the 20 year example, it took a 5% interest rate increase to take our total interest repayments to approximately $150,000…. In the 30 year mortgage, this takes an increase of just over 2%. That’s a big change in sensitivity.
Always run the numbers.
It only takes a few moments to do the calculations. Is it worth taking a shorter mortgage and paying a bit more on the monthly repayments? By paying it back over a shorter time frame the amount you save can be substantial. If you can afford it, might it not make more sense to save the interest and use the savings for another invest-ment?
When I bought my first property I calculated that I could easily service the mortgage at the current rates.
In fact, I could have bought a much nicer, more expensive property. But this was the late 70’s in London. I could see inflation looming, bringing with it the likelihood of my bank raising the interest rate on my mortgage.
Rates went up sharply. My monthly mortgage repayment almost doubled.
I was able to continue to service the mortgage, but if I had pushed the purchase to the limit of my affordability, the rising interest rates could have been dangerous to financial health.
Maybe I would have been forced to sell?
Making a more conservative decision allowed me to stay on the property ladder.
As it turned out, I held onto that London property until a few years ago by which time the annual rent I received for it was 125% of my purchase price.
Recreational Real Estate? Let the Head Rule the Heart.
Rule Number 9
I’m sure all of us have had great holidays and fallen in love with an area. “I can really imagine myself hanging out in my dream house here” you think to yourself.
It could be a cabin by the lake, a house by the sea, a fishing lodge on a river, or a chalet in the snow. We have all been enticed….
I have been tempted on numerous occasions in different parts of the world.
A villa in Tuscany, a chateau in Provence, a chalet in the Trois Valées (The Alps), a beach house overlooking the Pacific Ocean. On many occasion I have nearly been seduced, but fortunately I have resisted. I made a cheeky bid made on a beautiful two thousand year old hilltop chateau in the south of France a few years ago. It was re-jected by the seller.
I have been grateful of that ever since!
Here are the questions to ask yourself before committing to purchase of that vacation dream house…..
- Do I want to commit to spend every holiday here for the foreseeable future? Do I no longer want to visit other countries or regions? Will my kids want to hang out here?
- Do I really understand the maintenance and management bills coming my way? Especially if it’s an area you are not familiar with. And especially if you haven’t followed my Rule #4.
- How do I manage the property given it’ll be mostly vacant while I’m slaving away in New York, London, Tokyo or Hong Kong? Who is going to ensure the place is not robbed. What happens if it leaks? Who’s going to mow the lawn? Who’s going to clean the place?
- Do I fully understand the tax regime where I’m buying? Not just local taxes, but capital gains tax, income tax (if you rent it out), and a myriad of other fees and charges. These can be both substantial and opaque. (Ahem… France). More effort, energy and cost.
- Do I want to rent this property out when I am not using it? Holiday rentals can often prove quite lucrative but there are costs. Agents who specialize in such rentals often take a very large slice out of any income. There are no guarantees that tenants will be found. Short lettings require an efficient local manager to clean up and prepare it for the next tenants. They may need to fix the fridge, clean the pool, do the laundry, and mow the lawns. Finding someone to do all of this can be difficult and expensive.
- Am I buying for investment? Or am I simply treating this as consumption expenditure? Such properties might be good investments, but they are usually the first property types to suffer in a downturn.
There are currently HUGE numbers of recreational properties on the markets in Europe, UK, Ireland, Australia, and New Zealand right now. Spain is simply awash with holiday homes.
There are simply NO BIDS for huge swathes of recreational real estate in many markets right now. If you want or NEED to sell, you’re in trouble. You’re stuck.
I can sell a London one bedroom investment flat tomorrow if I need to. Maybe I’ll have to discount it 5 to 10% to get it done fast. But I can unlock my money promptly if required.
The 2,500 square foot lake house in Queenstown, New Zealand? Forget it. That money is frozen. Unless I take an axe to my asking price. And even then it’s going to take a while to shift it.
Recreational property often has limited or zero liquidity. And the more you’re likely to need the cash (like in financial crisis), the less likely you are to get it.
A very good friend of mine has a beautiful beachfront villa in Thailand. It’s sensational. She oversaw the de-sign and the build herself (with great personal effort!). We have rented it from her in the past. So it does earn income, but the villa management company takes a lot.
But her husband now prefers they no longer holiday there because when they do, she spends the entire time with the management staff fixing problems!
If you are buying a seductive piece of recreational real estate, be honest with yourself. If it is a case of head ruling the heart, admit it from the outset. In today’s market you may indeed find some great discounted bar-gains, but remember, they may stay bargains for a long time, and ability to on sell is usually much worse than that inner city apartment or house.
And be prepared to sit on it for a long time!
Do Your Homework! Transparency, Law & Property Rights.
Rule Number 10
This stuff can be tedious. No doubt. But it’s so important.
Every country has different legal rights and obligations attached to real estate ownership and leasing.
Every country and even cities within countries have different practices for such things as simply signing a sale and purchase agreement.
There are so many issues that it is difficult to know where to begin.
But firstly, always examine the land title. Although there are many variations to the theme, there are generally two different ways in which land rights can be held. The best, and probably most common in most western countries is a form of freehold title. This is where the buyer owns the interest in the land in perpetuity. It is yours for good.
It may be called other things in different countries. But the principle is simple. Your interest in the property does not end at a certain date. In the case of a block of apartments, office, shops, the owner may have a share in the freehold interest of the land that the block sits on.
The other form of land title is leasehold. This is where the title to use the land is limited to a certain period of time. It can be quite long – say 100 to 125 years, or quite short, say 25 to 40 years.
So what happens at the end of the lease? Well, in some markets and jurisdictions the procedures can be quite clear. The original owner of the land is required to renew the lease and there may be a formula that dictates how this is to be done and the mechanism for setting the price of renewal may be quite clear. In many cases it is not. There may not be any formula for lease renewal, and no formula for calculating a price.
In the UK a considerable amount of urban land is held under leasehold title and the process for renewal is quite clear and well documented. As a buyer you have a fairly clear idea of what is to be done and can establish how that renewal might be priced. In many countries this is NOT the case.
As a buyer, you need to be aware of first, whether the land is freehold or leasehold. If it is leasehold, what are the details of the lease? How much time is left to run? Is renewal automatic? What is the cost of renewal? How is that cost calculated? Am I totally at the mercy of the landowner, and open to being financially reamed?
You have to ask the right questions. And a good lawyer should be able to provide the answers you need. Real estate agents are frequently ambiguous on this. A poor or short leasehold is a negative for a property and it’s of-ten not advertised in property listings.
The Leasehold Trap: a Chilling Example of ignoring Rule Number 10…..but using Rule Num-ber 4 Helped Avert Disaster….
Recently a friend and his wife joined us for a weekend of sailing around the islands of Hong Kong. He is a senior regional executive of a household name Fortune 500 company. He’s a very savvy guy at what he does.
During the sail out to our favourite island restaurant he excitedly started to describe his new acquisition – a residential investment property in a city we both know well. A deposit had been paid. A sale and pur-chase agreement had been signed.
He was looking for a solid investment proposition that would spin off cash to help fund his kids’ education. Good thinking, I agreed.
He described the property, and most importantly told me of its location. He asked my opinion, knowing we have been buying property recently in that city.
His apartment was in an area I know well. My first question was “What kind of land title comes with the property?” His eyes glazed over and his brow furrowed. I asked if the property was on freehold land title or leasehold title. His reaction – “I don’t know, and why should it matter anyway?”
I know that most of the land in that area is leasehold land. Not freehold. It’s either owned by a quasi-government organisation or some “indigenous people cultural group”. These organisations own the land in perpetuity, but have sold development rights for the land typically on the basis of a thirty year lease.
Developers build the apartments, offices, shops and then sell them to the public on the basis that the buyer of the flat will be forced to cough up a substantial amount of money in thirty years’ time to renew the lease. The buyer has no idea if the re-grant of the lease is automatic. The buy certainly has no idea of the cost to renew the lease. And that’s assuming the land-owner even wants to renew!
The landowner might even have the right to simply re-possess the property.
Essentially the buyer does not own the property. He is paying an upfront rent that allows him to occupy the property for thirty years.
And it gets worse….
The ultimate land owners have the right to levy an annual “land rental” charge on the buyer at any time they might wish. You don’t necessarily know when or how much. But there are examples of this levy being so huge as to force the owners out of the property that they have bought under mortgage due to the inability to afford this new levy. In some cases the newly levied land fee has been many multiples of the annual bank mortgage amounts. It happens…
By this time my friend was going pale. He had no idea what he had bought. I knew the area and I sus-pected the worst. I gave him the details of my lawyer, a man I have trusted with my affairs for many years, and a man who is very much involved in the local real estate scene in his own right.
A couple of weeks later I met up with my friend again. He was gushing thanks and shaking his head. As I suspected, the property he had signed up for was on leasehold land. But thankfully my lawyer friend had been able to get him out of the agreement that he had signed.
Disaster had been averted.
A couple of weeks later, my friend appeared again, a beaming smile on his face. He had located another apartment, a penthouse, in a central downtown location with all the add-ons that he could want. The property was already tenanted at a good rental. My lawyer friend knew the development well, owned property there himself and had done the conveyancing for other clients in the development. As such he knew all the legal details, the management structure, the fees, and all the ins and outs that buyers might sometimes overlook. He was able to give the deal his seal of approval.
Buy When There’s Blood in the Streets.
Rule Number 11
How do you make a REAL fortune in real estate?
How do you go from a ‘pretty good deal’ to attaining full blown life-altering prosperity?
As Baron Rothschild, the 18th century British nobleman and member of one of the wealthiest, long lasting and powerful dynasties in modern history said: “the time to buy is when there’s blood in the streets.”
This is really just the essence of contrarian investing…. whether you’re talking stocks, bonds, or other assets.
But make no mistake, it’s difficult. To buy when all appears doomed, and when everyone is capitulating takes nerves of steel. If it were easy, everyone would do it! But sometimes it is just a case of following as many rules as you can, closing your eyes, and going for it.
Nobody knows when the market bottoms out. Until after it happens. Some are short and sharp “V” shaped. Others are long and painful “U” shaped.
In early 2003 Hong Kong was at the centre of a global pandemic. ‘Severe Acute Respiratory Syndrome’ or ‘SARS’ had turned the city into a ghost town. Restaurants and bars were empty. People sent their families back overseas. Everyone wore surgical masks. The slightest cough in public was met with icy glares. The property market continued to sag lower, down 20% from the year earlier. And bear in mind this was already down 45% from the 1997 bubble peak.
On one night during SARS the Peninsula Hotel, Hong Kong’s most famous five star establishments, had a grand total of one guest.
At the splendid new Hong Kong international airport you could have fired a shotgun down the departure lounge with little risk of hitting anyone. Cathay Pacific Airway, Hong Kong’s national carrier saw its “bums on seats” globally fall from more than 35,000 to around 7,000 per day. My employer, a US investment bank, saw fit to ban all personnel from Hong Kong entering offices in the US or UK. Only essential meetings were held and people suspended the habit of shaking hands on introduction.
This was a dire situation.
Given the mayhem in the markets I started to buy up some properties in the centre of the city.
We also started to buy up some industrial property at well below replacement cost to develop a small business we saw as having great potential. In some cases we bought before the bottom of the market and in others, as the recovery gathered momentum.
A Specific SARS Example…
In mid-late 2003 I came across a very interesting real estate opportunity. This was a chance to buy a whole house in the middle of Hong Kong’s famous art and antique district. There are very few whole houses anyway in the central part of Hong Kong and here was one for sale.
It was a small site, with a house that had been built in 1989 – not old given that many buildings in the area are 50 years old and more. The house was a complete tip. It was a mess of an order that one rarely sees. The ground floor was being used as a storehouse for urns of salted and oiled vegetables and food from China. It stank. The floor was swimming in spilt oil and unmentionable liquids. The rest of the building was a rabbit warren of rooms, corridors and stairways populated by what looked like a fairly large group of senior citizens.
On my second visit I took my son along. His only comment was “I would love to know where the rats live”.
I loved it.
The location was great. I had my Feng Shui advisor check the place out as there was a coffin shop near-by, and traditionally Chinese do not like to reside near anything related to ‘death’ (Rules Number 4 and 10!). But there were no problems, the place had great Feng Shui.
The ability to buy a whole house like this was and still is extremely rare in Hong Kong. I had never seen one before. The land lease was excellent. It was granted in the 19th century for 999 years and still had about 867 years to run. We would get vacant possession. And I could easily see huge renovation potential and value add possibilities.
We even managed to negotiate a decent discount on what I thought was already a pretty low price. The transaction took some time to complete as the owner had some difficulty in locating the old family docu-ments and title certificates. But I was in no hurry.
Eventually, many months later the keys were handed over and our architect team launched into a com-plete strip, gut and refurbishment of the entire building (Rule Number 3). From a labyrinth of rooms the team created a unique residential property that became a landmark in the area.
The annual rent it generated was over 20% of the purchase price. And we sold it recently for 7 times our original “blood on the streets” purchase price.
The Tip of the Iceberg
I hope that these few rules and examples have provided you with some insight or new ways of approaching property investing.
They are by no means comprehensive. And I make no claim to know-it-all…. I’ve just been at this for more time than most!
But the real reason I’ve taken some time to put pen to paper on these thoughts is that I see so many
friends and acquaintances make costly but easily avoidable mistakes.
And these are typically intelligent, successful and often very wealth people.
I know that if you if make an effort to follow even a couple of the rules that I’ve outlined here, you will be in a better position to successfully invest in property.
If you have any questions or comments, I’d love to hear from you.
Feel free to drop me a line at [email protected]
In the meantime, good investing.