In my family, the greatest compliment you can give another person is this: "You are absolutely 100% right." I almost never hear that. So I have to say, "I told you so." How annoying. But I did:
Faltering real estate market presents opportunities
By Garland M. Baker
Special to A.M. Costa Rica
A personal trip to the Parrita-Quepos area to look at property and meet with real estate agents turned out to be an invaluable experience. The real estate slowdown is quite evident, but there is good news for well-informed investors. Today’s deep discounts are tomorrow’s profits.
For sale signs are everywhere. Property prices have dropped on some real estate 50 percent or more. Some people have walked away from the houses they were building before completion and assigned them to real estate agents with instructions to sell them for whatever they can get. Some condominium developers are selling their projects out using factional ownership so they can make some sales and bring in badly needed cash flow.
Early August, on CRL, there was an enthusiastic discussion about Costa Rica real estate, money and investments. This is of great concern to expats. Most of us are living here on pension money, retirement accounts or savings. Where that money is sitting these days is critical: pension/retirement accounts are going bust because so many were invested in "safe" subprime mortgage securities that are now worth, well, nothing. It is not pretty.
One member, Scott, put it beautifully about why not to buy and when to buy. He's buying and he makes some excellent points. This is long, but if you are at all interested in the topic, it's a good read. He's kind of a smart-ass. So, of course, I like him:
"There are three rules of thumb I have always been taught by successful real estate investors:
1) The monthly rental a property will fetch is generally about 1% of its true, uninflated market value.
2) If the "premium to own" in a real estate market is greater than about 25%, the market is overvalued and in a bubble. Meaning, that if the 1% rule holds, a property that rents for $1200 per month is worth about $120,000 in a flat, uninflated market. The premium-to-own rule would suggest that this property should not be purchased for more than $150,000, because its value is unsustainably high.
3) "This time, it's different" are the most famous last words of every failed investor, real estate or otherwise. Anyone who says that, is living in a pipe dream and is about to get burned. The laws of economics are immutable, and never get repealed, no matter how fast the bubble is rising, or how quickly a burst bubble is collapsing, or the cause of the bubble in the first place. The current real estate market is a classic example. We all heard "This time it's different, because…." and there were lots of reasons given: retiring baby-boomers, Costa Rica real estate has been undervalued for a long time, the country has made legal changes that make it a more attractive investment venue, etc., etc., etc. But now we see the bubble bursting, don't we? They ALWAYS burst. That NEVER changes, regardless of the excuses given for the bubble happening in the first place.
[If] the net income [of a] the property generates … $833.33 per month. The 1% rule therefore suggests that the true, uninflated market value of the property is about $83,333 (regardless of what it actually cost to build, which is irrelevant to its true value), and the 25% rule suggests that it should never be purchased at a price of more than $104,310. If the asking price is $310,000, then the price is approximately double its best reasonable value. So, no, I would not buy it. Maybe at half the asking price… Maybe… At $83k, yeah.
That is not the only issue you should consider, either. In the 1930's there were so many rentals on the market, and so few people with money to rent them, that rents declined by almost 90%. I am not saying that is likely to happen again (though there are some very troubling signs), but it is a possibility you should be prepared for. If you are depending on rental income to make the payments, you could lose everything if the economy goes south.
In a rising real estate market, everyone makes money, but hey, even a pig can fly in a hurricane. And this market has been rising for a long, long time. Too long.
I strongly urge you to get a good book on the basic principles of real estate investment and read it before you get too deep into this. As I said in my last post, the Costa Rican real estate waters are infested with sharks. A lot of them. They have sharp teeth. And the waters are soon to be stained red with the blood of a lot of failed gringo real estate investors. Just watch the fat sharks, as they swim away, boys and girls…
After writing the above, a few people wrote to Scott asking other questions. He responds:
"A CRL reader sent this to me off-list:
> You may also want to add, for Costa Rica, the lack of liquidity in the market, as well as the pitfalls of having renters here. Most of the retirees would do better renting. But good luck trying to convince them.<
He brings up some very good points. Many, if not most expatriates living overseas, including here, should rent if they can, rather than buy. Why? For a lot of good reasons:
1. What economists call "Country risk." This isn't the United States, folks. The U.S. is such a big a country, that, at a national level, things usually change slowly, when they change at all, and USAnians are used to that. Not so here. Besides issues with the rule of law, such as a court decision going against you (good luck with that denuncio, gringo), there is the fact that national policy can turn on a dime. An election, a political deal cut in the Assemblea Nacional, a Sala IV decision, decisions made by a newly-appointed minister, all these and many more can all affect the livability of the country to you. And you can wake up in the morning, only to discover that the paradise you were living in yesterday, no longer is paradise at all.
As an example, take Panama. For a long time, it was more attractive than Costa Rica, but no more. Changes to the immigration law combined with a new, draconian defamation law which has effectively ended freedom of speech in that country, mean that the flood of gringo retirees moving from Costa Rica to Panama has recently reversed. A similar thing has happened in Nicaragua – a new immigration law there makes it a lot harder to get a residency visa than it used to be only six months ago – and it was done as a policy decision, not even a new law. Combined with right-wingers' nervousness over having a Sandinista revolutionary running the country, a lot of folks decided that the time had come to leave, and market values there are down by 40% from what I hear.
And even in this country, changes to the property tax laws that have been proposed, could make this country a whole lot less attractive to owners of ritzy properties, or changes in income tax law, to those making lots of money, whether that income is earned inside or outside Costa Rica.
2. Lack of liquidity. As my correspondent suggests, the real estate market is a LOT less liquid here than in the U.S. The house I bought some years back in Arenal had been on the market for over a year before I bought it. And when I sold it, it sat unsold for just about as long. The house I have just agreed to buy has been on the market for 9 months.
The MLS system here is in a rather primitive state, few realtors are members of it, and that means it is really hard to market a property for the ol' gringo double, and getting it sold takes time even at Tico prices. So if you gotta get gone (as in you're under a deportation order deadline), you're going to need to be dealing with the country for a long, long time. By remote control. Good luck, gringo.
3. Market risk. What goes up, comes down, and if it comes down because of something that has happened in the country (such as a tax law change, or an unfavorable political situation), it can come crashing down with a bang. So buying property here as an investment is a very risky thing to do. Best not to consider it to be primarily an investment because the risk is so high, and the high risk is one of the reasons why prices in Latin America generally, including here, are so volatile, and vary so widely from country to country.
4. Property management risk. If you have a high-end property (anything that rents for more than about $600 per month), your only market for renting it is going to be to other gringos. Ticos that can afford that kind of rent are usually owners already anyway, and don't need to rent, so high end properties are rented almost entirely to gringos. That's fine, but you need to recognize that the market for rentals to gringos varies tremendously from one season to the next, and it may sit empty during the off-season, or what got $800 a month last year may get only $500 per month this year.
Lower priced properties can be rented at the drop of a hat (there is a terrible shortage of low-cost rental properties in Costa Rica at the moment), but it is going to be to Ticos, and every Tico renter knows the law like the back of his hand and will not hesitate to use it against a hapless gringo landlord.
A renter who has a rent receipt, under the law has a rental contract, and the terms of that contract are the renter's laws, unless he has specifically signed a lease agreement with you. That means you run a lot of risk that you wouldn't necessarily expect – Costa Rican rental law very much favors the renter, and does not allow for a renter who is current on his rent, to be evicted for up to three years after occupying the property, except under limited circumstances.
Can't raise the rent, either – as I recall, dollar-based rents can only go up 9% per year, and colon-based rents, 15%. And when the renter finally moves out, it is not uncommon for him take everything with him and disappear into the cloud forest – toilets, electrical wiring and fixtures, plumbing, doors, windows and cabinets, etc. The light bulbs are a particular favorite and almost always disappear.
Since you're only allowed to charge a single month's rent as a security deposit under the default contract, you'll probably end up holding the (empty) bag. Renters are only responsible for the damage they themselves do, not damage done by someone else while they were renting your property – so if he annoys a neighbor, and that neighbor sets the house afire (not uncommon), you'll get stuck with the tab for rebuilding the place. Or, if he hires something done and doesn't pay, the merchant can file a mechanic's lien on the house you own, and he moves out and disappears, scot-free, leaving you to pay the bill for re-tiling the kitchen with that truly hideous purple tile.
5. Disclosure risk. Ain't no law in these parts that protect a buyer from a material fact that the seller did not happen to get around to disclosing. Attic rafters have termites in them? House built on fill? Property has a title defect? It's up to you to figure all that out. Hopefully before you plunk your money down. This is an "assumed risk" country – as in, buyer beware.
If you're renting, rather than owning, and paraiso suddenly becomes infierno, you can call the mover and be outta here in a week.
So, given all that, why buy?
Well, not ordinarily as an investment, that's for sure. But having said that, there are some valid reasons to buy here.
1. You want to do things with the property that no landlord would ever allow. In my case, I am a ham radio operator, and want to set a tower in the back yard, with an enormous set of antennas mounted on it. No landlord, not even my present one, who happens to also be a ham's ham, would allow that. So if I want to get on the radio in the style to which I would like to become accustomed, I need to pour about a cubic meter of cement in a big hole in the back yard. If I own the place, I can do that. Put up all the antennas I like. Blow a big-ass hole in the wall to bring the antenna cables inside. Really turn the place into a landmark, visible far and wide, that would truly horrify a landlord.
2. You can't find the sort of rental property you really, really need. This is probably the most common *valid* reason. The buyer of my house in Arenal, for example, who is a professional fishing guide, wants to build some cabinas on the property he bought from me, for use by his fishing clients. There is a dandy fishing pond on the property already. Great idea. Good reason to buy.
3. You want a place you can hold as a family property, either for use by various family members now, coming and going as they like, or as a legacy you can leave to your children when you push off (just see a good abogado about your will).
4. You want a place to live where you'll never, ever have to move, ever again, no matter what. Or you're planning to be there for a very long, long time. Remember the one-percent rule? The flip side of that is that only if you are going to live here for longer than roughly a hundred months, you're better off buying the place (if you're not planning to over-pay for it, anyway). But a hundred months is a bit over eight years, so if you're an old geezer retiree who's about to kick off anyway, rent while you're here, and leave your kids some money for beer and chips.
But on the other hand, if you're a retiree who is seriously annoyed with your kids, and want to complicate their lives well and truly, then go ahead and buy, and when you finally push off, they can come down here from the States and try, with the help of an abogado who understands just how vulnerable they are, to figure out the ins and outs of dealing with Costa Rican probate (that's a whole other story) and then try to figure out how to sell your place, if and when they can finally manage to get a clear title.
¡Buena suerte, gringito y gringita!
very very good article, now if people used their heads instead of the “insert nasty body part” ….to think …and make a smart decision…
but no…..the idiot who suddenly woke up one day and said “I am retiring to Costa Rica, here I go……” (first time ever out of the US, no Spanish, believing all the bs that he read on a real estate site/travel agent/lawyers office…..on top of that …..set on his/her own ways etc) will always exist
I read this and wonder if we will ever go back to the time that most people bought a house for a home and really didn’t think much about it as an investment. Seems like everything anymore is sold as an investment. I guess that is the part of being on a Runaway Train going nowhere fast. That is what most people have to worry about anymore. Is Tomorrow going to be less of a hassle than today. Unbelievable. Life being as uncertain and short as it is needs to be enjoyed with every minute without constantly having to think about if your savings or salary is going to be enough in the near future let alone the further out future. Bob Marley said it best “The Rat Race” of course leaving out the cia part because it is still a rat race going around and around in circles. Not knowing what the great global economy will be like even next year. I say rent if you can and buy if you have to but do it in such a way that means something more than just an investment and wondering if you are making the right and clever move.
You know, the whole wild-party bubble only went from 2002… before that, people bought smart. I’d love to own my own home so I could do what I want with it, know it will be mine till it falls down. It doesn’t make sense yet. We are so far removed from the rat race, but still to make a living… it’s a compromise, but we love it. Don’t ever want to go back!
I love Scott’s stuff! I have read a number of his essays on his website – all very interesting and insightful stuff. And definitely *not* all finance :D.
What’s funny is (according to the article), as early as 2006, the real estate agents were already noticing a decrease in the sales, but if you read posts from real estate agents (even up to now) you’d think its still party all the time. But truly, what is the point of arguing with these people, if some dumb schmuck wants to pay $300k for a property that rents for $1200, then that’s his problem.
By the way, the real estate bubble did not just happen in 2002, its also boomed and busted back in the early 90’s, also in the early 80’s and so on. Its a cycle, just like any other mania. Its going to come back again, I can guarantee that 100%. Probably not in the next 5 years, maybe not even in 10, but soon enough we’ll see those commercials again on how to make millions through real estate. I’m actually actively looking for possible investment in the US, NOT HERE, because of exactly what Scott has pointed at. I can see so much more value in the US now than here. So when I find a property with the right price, then I’d be buying.
All markets always cycle. The relevant discussion for profit purposes is all about when these cyclic movements happen. Profits are just the movement of wealth from one party to another in a zero sum game of timing markets. My point is that just because YOU decide to opt out of the game doesn’t really exempt you from participation.
Whether you are renting because you believe the market is over priced or buying because you want to own and are less interested in the investment aspect, you are still in the game.
Your rent will shadow the real estate values and your purchase will, regardless of your subjective intrinsic valuation, also follow the ups and downs of the market. The one hundred month rule sounds like nothing more than a standard averaged waiting time for a market turn around. Timing.
My point is that you will play the markets no matter what you do. Eventually, if you want to win at this eternal game, you will have to jump in and buy. Renting is the same as putting your stock portfolio in cash and waiting for a market bottom.
Hi Anon, I was only talking about the recent bubble. For us in Key West, 2002 was the first year we saw prices take the first leaps. A house we had considered buying in Sept 2002 for $185K was selling for $400K the following Sept. With a paint job…
I am a real estate broker, I know what they were saying. Hal and I were saying the party’s over. But that just lost me customers and friends: nobody wanted to hear it. A few customers listened and got out in time or managed to stay out. No friends did except one. Not that we’re so smart, but if you know markets and cycles at all, the writings on the wall. You have to be out of denial to see it.
Yeah, the U.S. is actually getting less expensive in many ways than Costa Rica. Rents are falling, gas is slightly less there, the roads are better so your car lasts longer. You just have more food choices… ack. Stop me now.
James, I don’t mind playing the market. I just don’t want it to play me!!!!
This isn’t Akron, Ohio people. It’s like saying Hawaii is over priced. Just continue to go to the zoo and your man made lakes with a smug look on your face, and brag to your kids what a great investor you think you are.