An Englishman's second home in the sun may have long been his casa, but in the 21st century it is more likely to be his dom or kuc´a. This is the prediction of overseas property experts, who are seeing a gradual switch in demand for second homes from the traditional sunspots of southern Spain and France to the emerging markets of central Europe, including Croatia, Bulgaria and the Czech Republic.
Affordability is largely driving the change in demand, for both investment and retirement property. In January, France and Spain, which account for nearly two thirds of English households owning second homes abroad pushed the UK off its perch for house price inflation growth. This was good news for the estimated 200,000 Britons who own properties overseas, but disheartening for the thousands more wanting to get a foothold in southern Europe.
What has been driving the boom in parts of Europe has been a combination of low interest rates in the euro zone and the flight to bricks and mortar as investors shy away from the stockmarket.
In the UK, many first time buyers also have turned to Europe as an investment option, having been squeezed out of the market in the UK. A recent YouGov poll found that some young Britons were turning to buy-to-lets overseas having been priced out of their own backyards. In a recent report, international property agents Knight Frank provided evidence of the shifting appeal of the European market and new opportunities for investors. It found a typical €250,000 (£170,000) apartment in south west France did not go up in value over a 12 month period from 2003 to 2004, bucking the national trend, although it had 4 per cent rise in rental yields over the period. This compared with a €300,000 apartment in Croatia which grew 20 per cent in value over the same 12 months and produced a 20 per cent rise in rental yields.
“The attraction of the emerging markets is the low capital entry costs and considerably higher yields,” says James Price, associate with the International Residential Department at Frank Knight. “As the more mature markets have become increasingly popular and expensive, buyers have sought new locations offering greater value for money and which are less developed.” Recent figures released by the Royal Institute of Chartered Surveyors made sober reading for those still dreaming of getting a foothold in high demand areas such as southern France or Spain. The report said a three-speed Europe was emerging with France, Spain, Ireland and the UK all occupying the fast lane with double-digit house price inflation. Countries in the middle had growth of 5 per cent, while those at the bottom, including the Netherlands, Germany and Greece had 0-2 per cent growth.
“Some countries have clearly unsustainable house price growth rates while others are still weak,” says Michael Ball, professor of urban and property economics at the University of Reading. “What is interesting is that there is no sign that the markets are converging.” Financial advisers say those hoping to take advantage of bargains in emerging areas, or even further a field such as South Africa or Thailand, should be aware of the risks of becoming overweight in property. The lessons of taking on too much could be coming home to roost for those who extended their mortgages in the UK at the top of the market to buy homes outright overseas. “People could potentially find themselves in negative equity if they are mortgaged to the hilt,” says Justin Modray, investment adviser with IFA Bestinvest. “Our general advice to people is to consider property as part of a balanced portfolio.” Modray also extends caution to those eagerly waiting to take advantage of changes to pension laws which take effect in April 2006, which will allow investment in residential property through a Self Invested Personal Pension or Sipp (see below).
Property experts are predicting an explosion in demand for buy-to-lets in places like France on the back of the law changes. “It is very important to appreciate the risks if you are investing the bulk of your retirement income [in property],” says Modray. Another key, but little publicised area, which could influence purchase decisions in the short term is the outcome of Inland Revenue deliberations on the tax status of those who have bought second homes through corporate entities. Using a corporate structure was a popular way for UK tax residents owning holiday homes abroad to legally by-pass local inheritance laws, specifically in France, which would dictate who the property would be passed on to, when the owner died.
But the Revenue has previously viewed these companies in UK tax terms and is deciding whether to tax the individuals as employees. “At present, taxpayers who have fully funded the purchase of their properties, but who happen to have used a corporate structure, are looking at substantial potential tax bills,” says Simon Rees, senior manager, private clients at PwC. “This is not, I believe, a remotely academic issue and people should be seriously concerned.”
This tax issue exposes the potential heartache for those wishing to buy property in areas where legal and tax interactions are complex. This will be a greater issue to those thinking of picking up a bargain in Croatia or Warsaw where local authorities may be unaccustomed to dealing with foreign investors.
Those not wishing to take the plunge directly and buy overseas but still wanting to ride a property boom in emerging markets are having more options opened to them. Development Capital Management, a Jersey incorporated investment company listed on Aim, the junior market, is seeking funds for a Black Sea Property Fund which will invest in properties to be built in prime coastal areas of Bulgaria's coast and ski resorts.
The fund managers have bought options on 1,300 properties and are offering a choice between property shares and capital protected units. DCM is estimating its property shares will have an internal rate of return of 41.2 per cent a year and its CPUs, 12.2 per cent a year. The property shares offer significant potential for growth, but significant gearing on the fund means losses could be high if the Bulgarian property market enters a downturn.
Financial advisers say the arrival of the fund shows that investing in overseas property is starting to move towards the mainstream. “This is a specialist area of the market,” says Modray. “But I can see them playing an increasing role in the future.”