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The Rise of Resort Properties and the Basics of an Informed Real Estate Purchase

3 July 2017

Andrew Taylor, Head of Real Estate and Group Vice-Chairman, Henley & Partners

Demand for real estate outside one’s home country continues to grow as the number of high and ultra high net worth individuals increase worldwide. This trend is also being seen in emerging markets. It opens a new world of opportunities, as international real estate is an investment class that most people are comfortable diversifying into. The global rise of resort properties — master-planned residential communities with access to various resort or lifestyle facilities — built and sold by developers to international clients poses particular questions and risks to buyers beyond the traditional (and fairly uncomplicated) purchase of real estate.

Generally, acquiring real estate in a country you are not familiar with and from a seller or developer or via an agent you do not know, comes with various risks. For resort properties, in particular, there are additional aspects to consider due to the fact that many developments are conceptual and promise master-planned resorts or communities, the construction of which has not begun or is still under way.

How do you navigate a foreign real estate market under such circumstances? Regardless of the country, making an informed decision requires the collection and analysis of information. In all cases, if a developer does not provide clear answers to questions or does not provide sufficient documentation, a red flag should go up immediately.

Will the Project Actually Be Completed?

Once you’ve identified a development that you like on paper, you need to ask, “Who is carrying the greater part of the risk related to this project?” In other words, who is funding the development? The most common answer is either a) the bank or financing partner, b) equity from the developer or owner, c) the buyers (you), or d) a mix of the above.

It is always important that a developer invests some of their own capital — the more, the better, as it shows they are committed and confident enough to put their money where their mouth is. If a developer contributes nothing, then the historic performance of the developer may be questionable or they may be new to the industry. Either scenario should prompt you to ask further questions.

If a financing partner is funding the build, it is important to consider whether there are any conditions attached to this capital. If yes, what are they? Financing will typically be conditional on the project being partially capitalized. Many developers will try to raise this capital by securing off-plan sales. Buying before these funding conditions are reached comes with a heightened risk, as these thresholds may potentially never be met, or may only be met in the distant future. Ultimately, you must be aware that if the money is not available today, it may not become available in future either.

As conceptual projects promote promises, it is important to know what is being proposed versus what is firmly in place. For instance, a hotel operator can exert significant influence on the success or failure of a resort. If the involvement of a world-renowned operator has been promised, it is important to confirm that the operator has actually signed and is committed to the project. If not, this may never happen, potentially jeopardizing your investment.

Depending on the risk-reward ratio you are comfortable with, these additional risks may be advantageous, as they give you more room to negotiate with the developers in the early stages of development. In general, the more risks you take, the higher your potential capital gain (or loss).

Adding Up the Numbers

Aside from feeling confident that the project will happen, you should also take a close look at the finer financial details. Once you’ve identified a property of interest, it is vital that you ascertain the future carrying costs of the property. Many buyers are distracted by offers that boast a period of no fees or a guaranteed lease-back period. This is not a problem if they will have funds available in future to pay the guarantee; however, it is still critical to know what the annual holding cost will be once this period is over. This is important because your future buyer will need to accept these costs and, if you do not sell or cannot sell, you will eventually be liable for the payments. It is important to comprehend all the costs involved, including annual taxes, insurance, maintenance fees, homecare services, homeowners’ associations, utilities, etc. Nothing should be overlooked.

Once you know the full holding cost, understanding the income potential is equally important. A good starting point is calculating the estimated annual rental value. Begin by estimating the average annual occupancy rate — this is a projection of how many days out of 365 you estimate the property will be occupied by paying guests. Work on an annual percentage basis. This number should be multiplied by the estimated revenue if the property were occupied all 365 days, giving you a projected annual revenue amount to help you determine if the potential revenue is reasonable in comparison with the potential annual expense.

Estimating the rental value and occupancy rate requires research; keep in mind that your property may not benefit from the general hotel or resort occupancy rate. You must identify or estimate the rental and occupancy rates of the property category you are purchasing. For instance, villas typically have lower rental occupancy rates than hotel rooms. Also, some developers will hold back a primary block of rooms or properties which will enjoy priority rental, utilizing all third-party property as spill-over only. In this case, unless the full hotel or resort rental revenue is pooled, you must use the estimated occupancy rate of the spill-over.

You also need to factor in the rental revenue split with the hotel or rental management company. For instance, are they taking 60% or perhaps 40% or 30% of the gross revenue? This makes a big difference. Once you have established the rental revenue split, be sure to clarify the smaller details. For example, is it calculated on gross revenue before or after certain deductions? You must also confirm whether there are any unique deductions from your share after the rental revenue split is applied.

Once you have estimated the net income, ask yourself if it will cover your expected holding costs. If not, it is going to be hard to resell the property to an investor. If this is the case, and there is not a strong lifestyle or primary residence market, it may be better to pass up the opportunity. On the other hand, if it does cover the costs, what type of net yield is calculated? If you are looking at multiple projects, you should compare all the calculations and information for each project in order to make an informed decision.

Finally, it is important to understand how much of your purchase price is going towards the property or common areas versus overheads and fees. Moreover, is your money protected by escrow? It probably is, but how much money does the developer propose to withdraw from your escrow and at what stage(s) of construction? Additionally, question who authorizes the escrow agent to release funds. It is important to ensure that the developer will always have enough money in your escrow account to complete the construction of your property, and that authority over the escrow account does not rest with the developer or a representative of the developer.

The list of considerations is longer than what can be covered in this article, yet understanding the key points reviewed here provides a good starting point. Overall, the importance of working with reputable and knowledgeable professionals is paramount when you are considering purchasing property in a foreign country, and especially when you are looking to buy resort property from a developer.

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