The Pros and Cons of Distressed Real Estate Markets for Investors

For Investors seeking income outside of traditional financial instruments, property offers a viable alternative, and the distressed nature of property markets in a number of developed economies present some interesting opportunities for the income investor.

There are two primary entry points for Investors seeking to take advantage of prevailing market conditions and draw financial benefit from the glut of heavily discounted properties available in these markets – which include the United Kingdom, United States and others. The first and most obvious is the simple buy to rent strategy popular amongst private Investors and institutional investors alike. Income is derived from rentals, and careful property sand tenant selection can significantly reduce the risks associated with owning and operating property assets. For the Investor seeking to penetrate overseas markets, most will source local partners already operating in the target market and with a track record of identifying, acquiring and managing property assets.

For the more adventurous Investor, acquiring properties at a discount and selling on very quickly into the local market can also generate a significant short term profit, and taking this approach also reduces the long term risks associated with property maintenance, tenant management, taxes and other financial liabilities that go hand in hand with property investing.

Both of these strategies can generate income that one simply cannot find in traditional financial markets, and both carry advantages and disadvantages over the other. This article focuses primarily on the buy to let model, with a further article to be published that will focus on the property trading model.

The main advantages of buy to let are evident; the Investor owns freehold title to tangible property assets in a relatively stable market which in turn generate significant yields. However, one must also consider the risks. The Investor retains sole financial responsibility for the asset; including payment of all annual property taxes, and more importantly all property maintenance, which in the case of a majority of such low-value properties can become very significant very quickly, and it should be noted that rental income may be quite insufficient to cover future repairs outside of a large collective investment where multiple income streams can be sufficient to cover repairs to single properties within the portfolio as they are required.

One must also consider the business model; particularly the agents’ margins added to properties sold to Investors, which have ranged from 20 per cent per transaction, to over 100 per cent per transaction, essentially doubling up on the property value. It is important for the Investor to retain at least some of that discount as a buffer and hedge against a falling market, even if they are primarily searching for investments for income.

In reality, many agents are acquiring properties at a discount and then selling on to Investors at the appraised value, effectively removing all of the inherent profit at the point of sale, and exposing the Investor to potential capital loss in the event of property values falling. This in part defines the counterparty risk associated with investing in property.

Finally one must obviously consider an investment exit at some point, and many reputable real estate agents state categorically that in the case of lower value properties, this type of investment is a long-term play, which will require financial upkeep for repairs, taxes and management, and is unlikely to be sold on without the aid of specialist mortgage finance within five years, although the chance of an exit after that point look more marginally promising.

Of course, comprehensive due diligence in order to properly assess the quality of assets being acquired, the competency and track record of counterparties, and independent legal advice relating to the conveyance process can mitigate all of these risks to a great extent, and we did locate a small number of agents offering fair value to Investors.

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