In the summer of 2005, I took a day trip with friends and work colleagues to Isla Contadora—one of the Pearl Islands in the Gulf of Panama. (The setting here is important as it justifies my later actions.)
While most of the party were on the sand, sipping beers or trying to break through coconuts straight from the tree, I was waist-deep in warm water… talking property.
At that time, a bunch of us 20-somethings from Ireland were trying to scrape together hefty deposits to buy our first homes… and, with the Celtic Tiger in full swing, getting nowhere anytime soon.
But this trip to Contadora was the turning point for me. Because, in the middle of this water-based conflab, another Irish colleague doggy-paddled over and uttered the words I’ll never forget…
“You know you can get 100% mortgages in Ireland now?”
No, I did not.
You see, I’d been living under a rock in Nicaragua for the previous month… without any idea of this new banking development. But I didn’t need to ask questions. I was sold.
Weeks later, back home in Ireland after my Central American summer, my then-fiancé/now-husband and I launched into our property search. We figured that the money we’d been saving for a deposit could now be put into the important things—wood floors, tiles… and the honeymoon. We’d go ahead and sign ourselves up for all the money the bank would give us.
When it came to understanding property values, we were—like most Irish people at that time—completely deluded…
We’d watched friends before us snap up homes, flip homes… and buy apartments in Bulgaria with their spare change. And, so, we bought into the whole idea of the “property ladder.” This was, we believed, the natural way of Irish property. It could only go up… or, worst-case scenario, level off (mild warnings were starting to emerge that the current growth rates couldn’t last forever).
We decided to buy a 100%-bank-financed starter home (three-bedroom, semi-detached, cookie-cutter new-build) that we’d flip in the next two years for our dream home in the country (with plenty of trees to hang those two hand-woven hammocks I’d picked up in Nicaragua).
What could possibly go wrong?
As you know, just about everything.
Less than 12 months after we closed on our first Irish property, the market collapsed. That next round of first-time buyers that we’d hoped to offload our home to? They were busy being turned away by bank after bank. No mortgages here…
We paid 265,000 euros for our cookie-cutter home in 2007. Eight years later, when the first brave neighbor on our street stuck up a For Sale sign, she got 155,000 euros.
Today, 12 years on, based on recent sales, I estimate our value at around 185,000 euros. But we also have stiff competition. After a 10-year break, the developer recently picked up building Phase 2 and is flogging A-rated homes, complete with solar panels, from 170,000 euros. We’ll be hanging in another while…
That day at Contadora Island is my personal “Margarita Madness” story.
There I was in the perfect setting… the sun high in a cloudless sky… bathing in warm water… an ice-cold beer waiting for me back onshore. I heard what I wanted to hear.
And here’s the worst bit…
Among us at the beach on Contadora that day was Lief Simon. The same Lief Simon who, while I was signing my life away to Bank of Ireland… was selling off his Irish country home (for a handsome profit) and shipping out of Ireland with his family for a new adventure in Paris.
I’m sure if I’d asked Lief for his predictions on where the Irish market was headed… or his thoughts on 100% financing in that climate… he’d have given it to me straight. (Then again, these were desperate times for young first-time buyers. I may have ignored Lief and his sage counsel.)
Really, it hasn’t been the end of the world. My husband and I, now with four children, have built a good life around our home.
And we’ve gotten used to living with our fifth child—negative equity.
Plus, we are fortunate to have made this mistake in our home country. We have friends and family close by. I can’t imagine how things would have turned out if we had bought under these conditions overseas… and then found ourselves stuck thanks to shifting market conditions.
Of course, the Irish property crash is an extreme example. But I wanted to share my story with you today, because it raises a number of important things to consider as you look for your potential second home or investment property overseas…
First, are there typical warning signs to watch out for in any market that mean that now is not the right time to buy?
And, second, when it comes to financing, how deep should you get in? If full financing is offered, is it ever a good idea?
For your benefit, I went—tail between legs—to Lief to get his take on these issues. Here’s what he told me…
“One key sign that you shouldn’t get into a market,” Lief said when I asked, “is below average rental yields.
“When we moved to Ireland, rental yields were in the range of 2% to 3% per year. By the time we left, they were 1%.
“But people kept buying investment properties, ignoring cash flow and yield realities, because they expected values to go up 10% a year forever. They were sure they’d make their profits from appreciation.
“And they were leveraging those investment buys to the max. Banks obliged with easy mortgage terms.
“Buying a piece of real estate with little to no down payment, paying the mortgage with earned income because the rent isn’t enough to cover it, and expecting to make up the ongoing cash drain when you sell a couple years later? That is a formula for disaster.
“If you’re buying purely for investment purposes, you want to make sure that you can at least cover your mortgage payment and other direct costs from the rental income. Leverage can be your friend from a capital gains perspective, but prices are never guaranteed to go up quickly (or at all).
“Neither are you guaranteed tenants.
“Therefore, when sizing up a rental investment, you need to calculate how much you expect to make from rent at a minimum. That number tells you how much of a mortgage payment you can afford… and, by extension, the maximum amount you should borrow.
“Those numbers are easier to figure for a long-term rental in a strong rental market where you can expect a high occupancy rate. To be conservative and safe, I recommend assuming that your tenant will move out every year and that it will take a month to replace them—meaning you’re actually earning rent only 11 months out of 12.
“For a short-term tourist rental, look at the market soberly when projecting occupancy rates. Think through what you can expect depending on the seasonality of the location… then assume you’ll capture 90% of that… and have zero occupancy the rest of the year.
“In the Algarve, for example, the guaranteed rental season is July and August. You’ll be full for those two months no matter what. However, with turnover days, etc., you’ll still have days without a renter.
“You can assume maybe 60% in the shoulder season months of June and September.
“You should make your calculations based on income from those periods only. Even though you’ll get some renters in April, May and maybe October, assume zero income for those months and the rest of the year. Any rent you earn beyond the summer season is gravy.
“Any rental property requires ongoing repairs and maintenance, and that bonus income will help to cover those expenses.
“Regarding leverage,” Lief continued, “one saving grace for most investors is that banks won’t typically lend you more than 60% or 70% LTV for the purchase of an investment property. More common is 50% LTV.
“If you’re buying a place to live (as opposed to an investment property), leverage is more about what you can afford.
“Most people buy as much house as they can qualify to borrow to buy. A bank makes the determination of how much to lend based on an analysis of the would-be borrower’s debt-to-income ratios. However, you shouldn’t count on this alone to protect you. In some markets during some climates, banks overlend.
“I’d suggest that, if you’re buying a place to live, you should first compare the cost of owning versus the cost of renting in that market. If you can rent the same house for less than what you would have to pay in mortgage payments, you’re probably better off renting.
“You’ll save money, but, more important, you’ll be safeguarding yourself from a market that is very likely askew… and not a buy.”