Like any form of investments, buying a property abroad is not without risks – the biggest being foreign currency movement.
A slight fluctuation in foreign exchange (FX) rate could make a world of difference between losing or profiting from an offshore real estate investment.
In fact, the currency risks that an investor face – not unlike those confronting exporters and importers - should be recognized in the investment decision and managed adequately.
While economists can analyse a range of factors, including economic indicators to make forecasts on currency values, the truth is, no one can predict currency movements accurately all the time. However, there are ways to monitor FX trends, which will enable investors to take necessary actions in mitigating their impact.
Currency rates fluctuate for a variety of reasons, including the inflation rate, a central bank’s monetary policy, as well as economic outlook and political stability. For instance, Britain’s decision to exit the European Union – termed Brexit – in June 2016 roiled financial markets and sent the British pound to its lowest level in over 30 years against the US dollar. For many overseas investors, that represented a major buying opportunity as properties in the UK became cheaper due to the change in currency exchange rate.
Why FX risk is an important consideration?
Exchange rate will affect the purchase price in local currency terms
For example, a GBP1 million property in the UK which cost SGD2.1 million when the exchange rate was GBP1 to SGD2.1, would be significantly cheaper today at SGD1.86 million based on the prevailing rate.
In addition, investors should bear in mind that a property transaction could take up to three months to complete. During this time, the FX rates may have moved and will affect the capital outlay for the property.
Impact on property financing: Margin call
A margin call occurs when the market value of the property drops substantially – a possible scenario in the event of a big shift in currency exchange rates. For instance, the value of a property purchased in British pound but financed with a loan denominated in Singapore dollars will fall significantly when the pound devalues. In such cases, the investor may be asked by the bank to top up the difference between the outstanding loan and the property valuation; or top up the difference to bring the Loan-to-Value ratio back to the prescribed level.
Movements in currency exchange rates can also erode your rental income. Assuming an investor rents the property in British pound; a weakening pound against the Singapore dollar means he/she will see a drop in rental income in SGD terms. This is especially important for investors who are borrowing in Singapore dollar as it could directly impact their ability to financing the mortgage.
How to manage FX exposure?
An experienced broker would be able to recommend ways to mitigate or hedge foreign exchange risks. Broadly, investors who are keen to buy real estate abroad should do their homework which will put them in a better position to make informed decisions.
- Wherever possible, it is advisable to borrow in the currency that the asset is purchased with
- Consider the long-term outlook of currency
- Evaluate the potential savings in interest rate and whether they justify taking out a loan in a currency that is different from the purchase currency
- Assess the impact of currency devaluation on your ability to finance the investment
- Monitor major global economic developments
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