You hear a lot about currency risk in the world of overseas property investment. In fact, we often mention here that your property’s price—or your rental income—will vary with current exchange rates.
But there’s more to the issue than meets the eye when it comes to foreign exchange rates.
I thought I understood the concepts of currency exchange rates when I first started buying property abroad. But the reality of what they can do only hit home when I experienced a dramatic rise in my cost of living in Uruguay…and a windfall profit when I sold my house in Brazil.
My property taxes in Uruguay went from US$800 to US$1,470 per year, thanks to a weakening dollar. In Brazil, a strengthening U.S. dollar lowered the price of the beachfront house I was buying to around US$62,000…and then just eight months later, a weakening dollar raised the sales price on that same house to about US$110,000.
It was only then that I understood, first hand, the impact of exchange rates on my personal finances.
For this discussion, I’ll assume your base currency is the U.S. dollar, so everything here will be expressed in dollar terms. But the same principle will apply no matter what your base currency is.
Exchange Rates Will Affect More Than Just The Purchase Price
When buying a property in a foreign currency, we all know that the local currency’s exchange rate will affect the sales price in dollar terms.
For example, a house costing 100,000 euros will cost US$133,000 at an exchange rate of US$1.33 per euro and only US$120,000 at US$1.20 per euro.
Generally, a weakening dollar is best for someone who already holds a property that will sell in a foreign currency.
But there’s more to your overall currency exposure than this. Here are three things to consider when assessing your overall currency risk.
What Currency Is Used For The Property Transaction?
When properties trade in the local currency, the most-obvious effect of exchange rates is the cost of your property in dollars. A strong dollar will buy more of the local currency, so you’ll need fewer dollars to come up with the purchase price.
When it’s time to sell, a weak dollar is your friend because the price you get (in the local currency) will buy more dollars back home.
But not all properties in foreign countries trade in a local currency. Sometimes they trade in dollars.
Of course this is true in countries that use the U.S. dollar, such as Ecuador, El Salvador, Panama, British Virgin Islands, or Turks and Caicos. It’s also true for countries that have their own currency, yet still trade real estate in dollars. I’ve encountered this in Uruguay, Peru, Nicaragua, and Costa Rica, although there are many others.
If your foreign property transaction is in dollars, then the exchange rate will have no direct effect on the purchase or sales price.
Do You Plan To Live Or Spend Significant Time In-Country?
If you live in the country where your property is located, you’ll find that the exchange rate has the opposite effect on your cost of living as it does on the property value.
So while a strong dollar will lower your eventual resale profit in dollar terms, it will also lower your cost of living, since your dollars are buying more of the local currency. Depending on how long you’re in the country, your lowered cost of living could completely offset any depreciation in resale price caused by a strengthening dollar.
A weakening dollar has the opposite effect. I’ll have an example in a moment.
Are You Managing The Property As A Rental?
Like the local cost of living, your operating expenses for managing a rental will go down as the dollar strengthens. Your utilities, homeowner association fees, and taxes will all cost less in dollar terms.
If you rent your property in dollars, then your rental income will buy more of the local currency. So a strengthening dollar gives you a “raise,” helping with your local expenses. A weakening dollar gives you a pay cut…even though it’s raising the dollar value of your property.
Here’s A Real Example Of How The Big Picture Can Work
This example is from my own property in Medellin, Colombia, using today’s approximate exchange rates and values. And remember, the opposite will happen if the dollar declines, except that it would be more in my favor.
The value of the property is about US$170,000 and it rents for an average of US$2,000 per month, which is converted into pesos in my local account. My operating costs (utilities, HOA fees, and taxes) are about US$450 per month.
So if the dollar gains 10% on the Colombian peso, the value of my property immediately goes down by US$17,000.
But on the other hand, my cost of living (US$2,000 per month) goes down by US$2,400 per year, my operating costs (US$450 per month) go down by US$540 per year, and my rental income (US$2,000 monthly) goes up by around US$2,400 per year. My total savings is US$5,340 per year.
So in about three-and-a-half years of ownership I’d break even on the loss in value. It’s not perfect, but it’s a pretty good hedge against most of my potential loss.
And it’s also a good demonstration of how the total currency exposure paints a far different picture than simply calculating the change in property value.
A Local Bank Account Can Provide A Partial Hedge
I realize that not everyone wants to move to another country just to hedge a foreign currency transaction. But simply having a local bank account can do some of that for you. You can store the local currency in your bank and use it to pay local expenses and then you can exchange it for dollars when you feel the rates are in your favor.
Uruguay made this easy for me because the bank offered dollar, peso, and euro accounts so I could move funds among the three when I felt the time was right. Crystal balls being what they are, my timing was never quite right. But it gave me an element of control that I wouldn’t have had otherwise.
Here Are A Few Simple Axioms To Remember
All technical jargon aside, here are a few basic things to keep in mind.
- You can avoid all currency risk by purchasing property in a dollar-based market.
- A strong dollar is always good when buying in a foreign currency, and a weak dollar is always good when you’re selling.
- If you’re operating a rental or living in the country where your property is located, your overall risk (or reward) is hedged by property costs and/or living expenses.
- A local bank account can provide you a reserve to use for hedging.
- No one can predict currency movements. Hedging and diversity among currencies are the only way to minimize overall exposure.
Buying property that’s priced in another currency can present additional risk, but it can also enhance your profits when buying property abroad. And understanding your big-currency-picture will help you to accurately assess your overall potential for risk and reward.
Lee Harrison is a correspondent for Live and Invest Overseas. The following is an excerpt from his weekly Overseas Property Alert.