How To Make Your Overseas Property Pay For Itself, Part 2

Today, I continue where I left off last month. That is, setting out the steps you should take to make sure you buy the best overseas rental property for you. Remember, in the right place, you can have an overseas escape and not only will it pay for itself, it can even make you money. You just need to find a place you love to spend time and then make sure it's the right rental opportunity for you.

Before you even start to make a shortlist of potential places, be very clear about how much work you are willing to invest in your rental venture. Do you remember the “3 Important Steps When Choosing Overseas Rental Property” from How To Make Your Overseas Property Pay For Itself Part 1? From last month's piece, you should know how to choose the type of rental that's right for you. Now you need to pick a market and run the numbers so that you can come up with a plan to purchase and make your overseas property pay for itself.

How to Pick an Investment Market Overseas

Buy Low

There's an old saying in real estate circles you make money when you buy, rather than when you sell. A smart buyer will always be ahead. The price you pay for your property determines your rental yield (gross yield is simply the annual rent, divided by the property price). You factor in running costs (maintenance, monthly fees, and taxes) to get the net yield.

The less you pay for your property, the higher the yield. It's that simple. This is where fire sales and distressed properties come into their own. You'll pay less for these properties than your neighbo and command similar rent levels.

Let's take an example: Prices in eco-chic Tulum, Mexico can be 30%-40% less than in the more established beach town Playa del Carmen only a forty-minute drive away. Yet, the rental markets are comparable. Tulum might offer a substantially stronger yield measured as a percentage of your investment.

Look for Multiple Sources of Renters

You never want to have all your eggs in one basket, right? For example, if you owned a rental in Natal, in northeast Brazil, your market was mostly northern European vacationers. Along came the economic crisis and your customers stopped visiting. You're a bit of a one-trick pony.

However, if you were in the rentals business just down the road in Fortaleza, you didn't have to worry about a drop-off in visitors from northern Europe. Fortaleza is Brazil's #1 domestic tourist destination. Fortaleza's target market is wide and deep, including domestic tourists, domestic retirees, foreign visitors, young professionals and executives in town for short- or medium-term stays.

Always look for multiple sources of renters so that you have a cushion if one of your target markets disappears or dries up.

Look for Shortages in Hotels and Short-Term Rentals

In my experience, the best signal for a white-hot, short-term rental market is a chronic shortage of hotel rooms. You can check out official statistics to get a macro view of hotel occupancy. You should check how hotels are faring in the area or level of the market you are competing with.

Getting this information requires a bit of detective work. Ask the right questions of as many people in-the-know as possible. Ask rental management companies. Ask local taxi drivers. Go to hotels and talk to the reservations manager. Shoot the breeze then drop into the conversation a question about how busy they are. Draw it out, and you will get specific information.

Of course, sometimes it hits you like a lightning bolt. Like last year in Fortaleza, Brazil. It was April (a low month for tourism) and I needed a hotel room on short notice. Each of my first three choices was booked. Hmmm! That told me something.

Watch the Supply Pipeline

Look for hotel and condo shortages, but watch out for future supply. If a huge bunch of new hotel rooms and/or short-terms rentals come flooding onto the market, it could flip the supply-demand balance against you. Look for a scarcity of developable land. It will limit future competition from other condos or hotels.

Match Unit Type with the Market

You need to make sure you buy the type of unit that renters want. We'd all prefer to stay in the penthouse, but most likely you won't be able to charge a high enough price to justify the high investment. In most markets you will find that smaller one- and two-bed units will maximize your yield (the percentage of your investment you recoup each year) and provide the broadest appeal.

Remember though that smaller units work best for short-term rental. If you plan on renting longer-term, most renters will want something bigger than a 40 square meter (430 square feet) condo.

Look for Growth Markets 

For example, today there is a shortage of quality rentals in the Tulum area of Mexico. A new airport is slated to be built nearby and is expected to land three million visitors here in the first year of operation. A government plan calls for the increase of tourist numbers from three to 11 million. Sounds like a place you could fill a rental, right? Likewise, a fast growing economy in a place like Fortaleza, Brazil will also drive demand.

How to Calculate Overseas Investment Numbers

The final step is to “Run the Numbers” – to craft the business plan for your investment. Before you do this, you need to decide what you consider an acceptable yield; the percentage of your investment you expect to generate in income each year. Decide this in advance so you don't get swayed by the margarita effect. That is, you don't decide to bend your investment rules because you develop a strong personal attachment to a place.

This is how I calculate how much I'm into a property for. I include all of the following:

Purchase Costs:

1. Purchase Price
2. Closing Costs
3. Legal Fees
4. Furniture Package
5. Total Costs

Then, I calculate how much rent I expect to generate. In the example below, I'm running the numbers on a short-term rental. It's in a market with a high and low season. (I am showing just the high season figures, but you need to run low season figures, too, and get a total.) Occupancy and rental rates differ by season.

Rental Income:

1. Number of days
2. Daily rate
3. Occupancy %
4. High season rent
5. Total annual rent (high season and low season)

Then, I deduct my expenses. In most overseas investment cases tax is a flat percentage of all income so tax is figured from income not profit. Rental management fees are also a flat percentage that comes off the top. My condo fees and property taxes are fixed costs.

Property Expenses:

1. Tax
2. Rental management fees
3. Condo fees
4. Property taxes

Finally, I input the numbers into my excel spreadsheet and it spits out my expected yield, and the property either meets my criteria or it doesn't. The numbers don't lie.

I'm off to the beach, until next time – Invest Wisely, Ronan McMahon.