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Overseas Investors: Tricks To Financing Your Property Investment In Europe

Adopt a balanced attitude to your borrowing and never refinance

Overseas commercial property investments have taken off over the last year, but the striking thing is that, compared to before, my clients are choosing low yield high-quality property. When I say low yields, I mean in the range of 3-7% per annum. Often, new investors consider buying cheaper property with higher yields, but this is a risky choice. Actually, the best way to boost yields is to leverage your investment by taking out a loan. This increases returns, especially considering the favourable market conditions at the moment. For example, the Eurozone interest rate has been at an all-time low since 2014-2015.

Four reasons why financing is important

- leverage: getting a loan can increase yields

- options: more choice or larger properties become available

- taxes: loan interest is deducted from the revenue, reducing the tax base

- quality: subject to bank appraisal, loans only granted for good property

Now take a look at this real example. One of my clients bought a retirement home in Germany in 2015 on the following terms:

Lease term

25 years with no right of cancellation

Tenant

Major management company on the market since 1945

Type of rent

NN lease (tenant pays 80% of maintenance costs)

LTV (loan-to value ratio)

60%

Loan term

15 years

Interest rate

2% per annum

Repayment of the principal (balloon loan)

2% per annum

The yield (annual rental revenue divided by property value) was 6.3% and the project IRR (Internal Rate of Return including, but not limited to, the proceeds obtained from the loan) was approximately 8% excluding buying, tax and management expenses. This model is calculated according to the assumption that the property sells in 15 years with similar yields, minus maintenance and major repair costs.

Taking out a loan should increase yields

Last year, we also managed to obtain over 10% IRR for a client simply by leveraging the investment and structuring the deal correctly. Our client, a Russian investor, was looking to purchase commercial property with 70% LTV on a 2% fixed interest rate per annum. His aim was simple - earn stable revenue in a reliable foreign currency - which is exactly what we achieved and more. The property was nothing spectacular; in fact, it was a rather ordinary investment that came with a 15-year lease contract (unbreakable), an excellent tenant and a B+ location. How did we do it? It was the correct loan structure that enhanced the IRR, meaning that 10% p.a. in foreign currency is a realistic possibility. However, there are a few tricks to leveraging your investment, as we'll see below.

No loans on your first investments

To become a risk-free client of a European bank as a non-EU national, you will need to "prove your worth". Because even if you are equal in terms of taxation, banks prefer to endorse foreign citizens that show themselves to be reliable. This is mainly because financial institutions find it a lot more difficult to verify foreign assets and income. For instance, often just the documents provided (even translated) can be "unintelligible" for European banking institutions, but also, they won't accept any property assets in your home country if they can't appraise it.

How to get the bank's trust

- Buy your first couple of properties outright, with no loans.

- When they are making a profit, you will have verified income and saleable assets.

- When buying a third property, refinance the whole asset portfolio to increase the chance of getting 70 % LTV.

- Get an EU residence permit, this will make the situation almost ideal.

The volume of financing is also important: bigger loans are more attractive to banks and get better terms. As non-EU investors (particularly from the Middle East, Asia and Russia) are considered higher risk, banks only take them on if they can see substantial future gains. A 70% LTV loan is more likely to be granted if the credit line exceeds €10M. It's true that this is mostly useful to major investors but smaller budgets still have options. Banks look at your investment portfolio uniformity and you are more likely to get better lending terms if your properties are of the same type.

Invest in low-risk and easy-to-sell property

If you want a loan to finance your overseas property, make sure you are investing in reliable low-risk real estate, otherwise you could lose revenue and maybe even your property. For example, residential property is considered less risky and benefits from more demand so overseas investors, like my clients from Russia, can generally get a loan on an apartment for personal use, that they later rent out to tenants. The average interest rate is about 2.5% with LTV not higher than 60%.

The property type will determine your financing options, as banks have their own criteria pertaining to real estate projects they consider viable or not. For instance, nearly all banks will finance high street retail premises, but only some are willing to consider retirement homes. This is mainly because assisted-living facilities, like retirement homes, are a highly specialised market segment and not every bank has the tools to appraise the property value.

Buyer expenses

(approx. 10% of total value)

Property transfer tax

5.0%

Real estate agent commission

3.0%

Notarial fees

1.5%

Due diligence, lawyer and tax advisor fees

0.5%

Paperwork and fees for opening an account

€10,000

When investing in buy-to-let property, these expenses can be deducted from the tax base. However, they will not be covered by the loan, so it's important to calculate them, because they will cost you up to an additional 10% of the property value.

Loans and lending terms: payment structures and interest rates

There are different kinds of loans. A balloon loan is when the interest is paid as a lump sum at the end of the term. An amortizing loan sets a schedule for principal and interest repayments during the life of the loan. Interest rates are commonly fixed (the same throughout the term) or variable(depending on inflation, bond yields, Euribor, Libor).

The cheapest loans have variable interest and no early repayment clause

Some loans can be paid off before the end of the term, while others forbid this. The most expensive loans come with fixed rates and an early repayment clause. In the case of short-term loans (i.e., five years and less), fixed rates can work out cheaper than variable interest. This depends on the property type and the entity requesting the loan: commercial property loans given to legal entities are more expensive than loans for residential property given to individuals.

Adopt a balanced financial strategy

Much like yields on commercial property, the more you leverage your investment, the more risk you take on. Here are the two worst situations you should avoid at all costs:

- negative but not critical: you use a loan to buy property and when the agreement expires, your interest rates go up. You have to refinance the property on a higher rate and yields decline.

- worst-case scenario: the loan agreement expires as the market undergoes a "correction" and prices drop by 20%. If this happens before you pay off the major part of your principal, the bank can consider your investment is risk and demand you to recapitalise.

The solution is simple: adopt a balanced approach to borrowing and never delay paying out the principal: aim to reimburse at least 40-50% of the principal before the agreement expires.

Extending the loan can be more beneficial than early repayment

If the market situation is good, in 5-7 years after getting approval, try extend your loan for another 5-10 years before the agreement expires. This can lower the risk of renewing it in a bad market phase so I strongly recommend negotiating this clause into your agreement with the bank before you sign.

Early repayment is not profitable for banks because they borrow from a Central Bank and lend to you. So if everybody paid off their loans early, the banks would still be indebted to this financial institution, meaning that if you try repay your loan early, they will probably fine you.

The maximum loan term shouldn't exceed 20 years, but if you can manage it, 10-15 years is even better. The reason is simple: longer terms are more expensive and more exposed to market downturns.

Clauses to check before getting a loan

  • variable or fixed loan interest rate
  • early repayment and penalties
  • cancellation terms if selling property before expiry
  • refinancing option prior to expiry date
  • terms and conditions regarding recapitalisation obligations

Covenant risks

Loans always include covenants (terms and conditions) imposed by the bank on certain actions that are either authorised or prohibited during the loan term. Excluding the standard obligations, the contract can include the following provisions for commercial property investments:

  1. - the bank can request you to pay off the debt before the loan has reached the end of its term. If you can't pay, the bank will repossess the property and put it up for auction.
  2. - the bank can ask you to recapitalise if there is a sudden loss of value (e.g., the market falls by 20%). If you can't, it can be foreclosed or they can offer another credit line.
  3. -the bank gets the legal rights to the property if you are late with payment.

Loans on commercial property with long-term tenants and an unbreakable lease do not usually have such covenants, because even if the market "falls", rental revenue remains stable. However, it is always crucial to investigate market risks that could affect the standard terms and conditions.

These are my top recommendations for clients who want to get a loan on good terms and minimise risk:

  • buy one or two properties without a loan to boost confidence with banks
  • choose good property with quality tenants and long-term lease contracts
  • balance your borrowing strategy and don't bite off more than you can chew
  • take a 10-15 year loan to maximise leverage and keep costs down
  • don't pay back early, but get the option to extend it before expiry
  • pay off the interest first and the principal closer to the end of term
  • review your covenant clauses carefully and evaluate your risks

George Kachmazov, managing partner at Tranio.com.