In the first part of our interview we explored how our real-estate expert Andrew Thompson finds opportunities in the market and what strategies he uses to minimize investment risk. In this continuation we focus on investment locations, the financial model for calculating returns, and concrete examples of risks that a careful approach to property selection can uncover.
How important is location when choosing an investment property, and which types do you prefer?
We focus mainly on seaside, mountain, or lakeside resorts, but if we find an interesting opportunity elsewhere, we don't necessarily limit ourselves to those. Generally, we want to stay away from cities, because people want to take their holidays by the sea, by a lake, or in the mountains. It makes sense, and we have the data to back it up.
We also stay away from cities because of licensing and regulatory risks. And for that reason we currently also avoid countries like Northern Cyprus or the United Arab Emirates, where we couldn't buy properties directly, only through an SPV, which is something we don't want at the moment.
Among European countries, do you have any favorites from an investment standpoint?
So far we've primarily looked at Portugal, Austria, Croatia, the Czech Republic, Slovakia, Spain, and Cape Verde. Some countries have seen regulatory changes recently, so lately I've also started looking at Italy.
In general, we don't avoid any opportunities, but of course we can't cover every market, so I have to be very selective about what's worth spending time on, in order to properly weigh the benefits and any risks.
Do you have a set of criteria you use to choose locations?
I like locations where new development is difficult, which is common in many mountain and coastal areas. When you can't build in a given place, the prices of existing properties and rental income rise faster, because you have a limited market. In the Austrian mountains, for example, it's very difficult for developers to start greenfield projects; most of them are renovations. Getting permits for new projects is very complicated.
By the way, it's the same in the Czech Republic. In the Czech mountains, most projects fall under renovations or reconstructions of existing properties; almost no new ones are being built, because here too it's hard to get permits. In Prague, the market says it needs 10,000 new units a year, but in reality only 4,000 get built, because the permitting system is very complicated. Which is good for investors, but of course worse for buyers.
It's also good to have amenities and services in the given location. Access to data on the local micromarket is naturally important too, as it lets you read off its investment performance. And we also prefer projects with an experienced operator, ideally with an established and well-known brand.
But the location is just one piece of the puzzle, and it has to make sense within the overall financial model. Different countries have different acquisition costs, different selling costs, transfer taxes, and so on.
What all do you include in the financial model? What do you compare, evaluate, and so on?
In some projects, the operator is the developer itself, who provides us with a set of data. These are various indicators of returns and yields and costs, essentially a profit and loss statement (P&L). That kind of situation is ideal.
Elsewhere, though, we have to find it out ourselves from third-party materials. Then we look at things like performance over the last three years, what the potential occupancy is, what the potential rental income is over the course of the year, what the estimated growth in capital value is, what role seasonal variability plays, how high the costs are, and what percentage of the income they eat up.
With this kind of research I have to be very careful about data quality. When something is, so to speak, off, thanks to my experience I can see it at a glance. For example when income or costs don't add up, when they seem too high or, conversely, too low. I simply have a feel for this now.
When I trust the data, I derive from it the potential return over 5 years, which is our standard holding period. Then I start calculating tax — for that we have our own expert who can calculate it for every country. In the end I come up with potential dates for buying, selling, and so on.
Some of the projects we've found recently also offer guaranteed income. That is, guaranteed net income before tax. These are very attractive in terms of risk and return; it's essentially a yield guarantee for some five, seven, or even ten years.
There's an enormous amount of detail in it, and every project is different, so it can't really be generalized.
What about the legal side of things? How do various regulations affect this whole process you were talking about?
Let's take a look at Lipno, which we recently added to our offering. At the start we had about fifteen projects, we visited ten of them, and in the end we negotiated on three. We eliminated projects based on regulations too; for two of them, for instance, we weren't certain they were approved for purely short-term tourist use.
A similar risk is common in Prague, for example, where there's a debate about which properties should be designated for short-term rentals and which only for long-term living. But it's already seeping into the regions as well. By the way, it's the same in Spain and Portugal, where there have recently been major changes regarding tourist licenses. There's generally a lot of uncertainty and risk in it, which we try to avoid.
But as I've said, every project is different. So our lawyers also look at the purchase contract or the reservation contract, conduct negotiations, and carry out legal due diligence (checking all the formal requirements). They're interested, for example, in whether the seller is really selling us a property they have access to, so that we don't later have to deal with some complications regarding access roads and the like.
Do you have a specific example from the recent past?
Take Lipno again. In one of those apartments we examined, during the technical due diligence we discovered that it was located directly above the boiler room and the electricity source. So there would be vibrations and noise there, which would reduce the attractiveness of such a holiday property. Nobody wants to spend their vacation above a power plant.
What was interesting was that during the viewing that room wasn't in operation, so we didn't notice it. But then we came across the information that someone had been accommodated there in the past and had a bad experience with it.
So sometimes it's purely about luck, good information, and experience. We already had that apartment picked out, but when we found this out plus about two or three more similar things, we ultimately withdrew from the deal. It actually might not have been that big a problem, but it was a risk. And as I said earlier, our main concern is the safety of the investment. We don't like surprises.
How does the selection process at Investbay differ from other players in the market?
Funds usually buy larger projects and focus on SPVs rather than smaller assets, so they also have to examine the legal entity that owns the properties. They often also buy up entire buildings, which we may get to one day at Investbay too, but we're not there yet. It's a slightly different process.
In a sense, we're looking for a new path and a new concept. Funds and agencies are used to selling properties to tenants or to people buying a second home. They're not used to selling them to investors who want to understand what the total acquisition costs are, the expected returns from management or operation, and so on.
In a sense, with our approach we're educating the market so that sellers provide more relevant information. At the same time, though, we approach it similarly. Like every other fund, we do very thorough research in terms of finances and so on, as I mentioned earlier. We're not trying to reinvent the wheel, just to improve it a bit and make it accessible to more people.
If a small investor were to make such a purchase on their own, they would almost certainly end up in a situation where they lacked relevant information. They'd be left with pretty pictures and brochures, but wouldn't be able to calculate whether the investment will bring them 8% or 12% a year. Precisely because funds and real-estate agencies are used to selling housing to owners who care more about those pretty pictures than about returns.
That's exactly why Investbay has no real competition with this approach on the Czech market.
Speaking of information, what is Investbay's approach to transparency? What does an investor need to know, and what is already an unnecessary detail?
That's a good question, because some people enjoy poring over dozens of pages of documents, while others get lost in it and no longer know what's essential for them and what isn't. Our approach is to give investors the information that's relevant to making the right financial decision. On the other hand, we don't overwhelm them with every technical detail. We do fine-tune the final form of the investment prospectus with every new property in the portfolio, though, so it may still change a bit in the future.
Not every investor, after all, makes decisions based on long analyses and Excel spreadsheets full of data. For some it's enough to trust whoever is selecting the properties. Or they may have experience with a given market, have acquaintances in that location who supply them with yet another type of information, and so on. We're all different.
In the third part of this interview we'll look at our sales strategy, which forms the largest and therefore key component of the overall return on our properties. At the same time, Andrew will share his view on what awaits the investment market in the future and what investors should be prepared for.
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