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Financial Expertise

The rise of resort properties

Financial Expertise

The rise of resort properties

Demand for real estate outside one’s home country is continuing to grow. The global rise of resort properties – master planned residential communities with access to various resort or lifestyle facilities – which are built and sold by developers to international clients, poses particular questions and risks to buyers, beyond the traditional simple purchase of real estate. How, then, do you navigate a foreign real estate market?

Generally speaking, acquiring real estate in a country you are not familiar with, from a seller or developer and via an agent you do not know, comes with numerous risks. For resort properties, there are additional aspects to consider due to the fact that many developments are conceptual and promise master planned resorts or communities that have not been started or are still under construction.

Regardless of the country, making an informed decision requires you to collect and analyse a great deal of information. In all cases, if a developer does not answer questions clearly or does not provide sufficient documentation, a red flag should be raised immediately.

Will the project be completed?
Once you identify a development that you like on paper, you must ask “Who is taking the majority of risk in this project?” or in other words, who is funding the build of the project? The most common answers are 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 the developer invests some of their own capital. The more the better as it shows they are committed and confident enough to invest their own money. If a developer contributes nothing, then the historic performance of the developer may be questionable or they may be new to the industry. Either alternative should prompt you to ask more questions.

If a financing partner is funding the build, are there conditions attached to this funding? If yes, what are they? Financing will frequently be conditional on the project being partially capitalised. Many developers will try to raise this capital by making off-plan sales. Buying before these funding conditions are reached comes with a heightened risk as these thresholds could potentially never be met or 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 the future.

As conceptual projects promote promises, it is important to know what is proposed versus what is firmly in place. For instance, a hotel operator can have significant influence on the success or failure of a resort. If a world renowned operator is promised, you need to check whether or not the operator has actually signed something that commits them to the project. If not, it may never happen.

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 risk one takes, the higher the potential capital gain (or loss).

Adding up the costs
In addition to being comfortable that the project will actually happen, one must also take a close look at the finer financial details. Once you identify a property of interest, it is vital to know the future carrying cost of the property. Many buyers are distracted by offers with a period of no fees or a guaranteed lease back period. This is fine if they will have the funds available in the 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 mainly 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 understand all of the costs involved, including annual tax, insurance, maintenance fees, homecare services, homeowners’ associations, and utilities.

Understanding the income potential
You can start by multiplying the estimated annual rental value by the estimated average annual occupancy rate. Estimating the rental value and occupancy rate will take some research. Keep in mind that your property may not benefit from the general hotel or resort occupancy rate. You should identify or estimate the rental and occupancy rates of the property category you are purchasing. For instance, typically villas have lower rental occupancy rates than hotel rooms. Also, some developers will hold back a primary block of rooms or properties which will be rented in priority, utilising all third party property as spill over only. In this case, unless the full hotel or resort rental revenue is pooled, you should use the estimated occupancy rate of the spill over.

You should also factor in the rental revenue split with the hotel or rental management company. For instance, are they taking 60% of the gross revenue, 40%? 30%? It makes a big difference. After you have identified how much they are taking, you need to clarify what their percentage and your percentage are calculated on. Is it on gross revenue before or after certain deductions? You should also check if there are any unique deductions from your share after the rental revenue split is applied.

Comparing net income and expected holding costs
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 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. 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 in order to make an informed decision.

Keeping track of your escrow account
Finally, how much of your purchase price is going towards the property or common areas versus overheads and fees? And is your money protected by escrow? It likely is, but how much money does the developer propose to pull out of your escrow and at what stages of construction? And who authorises the escrow agent to release funds? It is important to ensure the developer will always have enough money in your escrow account to actually finish the rest of your property, and the authority over the escrow account is not with the developer or a representative for the developer.

The list of possible questions of course is longer, yet understanding the key points reviewed here provides a good starting point. Overall, the importance of working with reputable and knowledgeable people is paramount when looking at purchasing property in a foreign country, and especially when you are looking to buy resort property from a developer.

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