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Between Expected and Actual Performance in Cross Border Real Estate Investments

Between Expected and Actual Performance in Cross Border Real Estate Investments

Opinion Column by Elchanan Rosenheim (Translated from Hebrew)
Published in the Real Estate Section, Calcalist, July 17, 2018

 

An investment organization that publishes its record of yields on a selective basis – only when successful or only when local markets prosper – is engaging in an invalid and unacceptably bad practice. Investors must scrutinize the company in which they intend to place their trust and their money over the entire course of that company’s operations.

 

It is difficult to ignore the abundance of ads for overseas real estate investments; they appear in innumerable publications and even in official prospectuses. Competition in the field is focused on one overriding element: who offers the highest yield. The company that offers the highest yields is the one that raises the most funds from investors.

As a company that has been in operation for almost 50 years – 20 of those in the field of cross border real estate investing – the knowledge and experience we have amassed during good times and bad are our most valuable assets, on display in particular in the method by which we examine potential investments.

The macro-economic environment of the past few years has clearly led to phenomenal profits in real estate investments. However, the success of an experienced investing institution is not defined by its operations during periods of market prosperity. A professional investing institution must be competitive and perform at its best particularly during challenging situations, such as those that characterize the world of investing during ebbs and flows in economic activity.

Experience gained, especially during those bad times, enables companies to analyze, assess and hedge risks for each of its investments.

A business plan, as its name implies, is indeed just that, a plan. It is well-written when it is based on market data, investment statistics such as forecast assessments, existing and future contracts, market-based comparative rental prices, and similar other relevant facts. A business plan should also address various possible scenarios over the life of the investment. A comprehensive business plan examines supply and demand in the market, economic factors of the region and its markets, future trend forecasts including population growth, employment opportunities, demographic data including family income, regional alternatives, the cost of alternate housing, and the like.

A well-written business plan is designed to deal with the possibility that forecasts may not be fully realized and assets may decline in value, such as what happens during market crises. As a result, the terms and conditions for loans should be customized to meet the demands of a changing market. In the case of a loan that includes covenants, one must examine what conditions might cause a violation in addition to the feasibility of that violation. When there is a real risk of financial covenant violation, the heightened threat of seizure by the lending bank increases the inherent risk of the investment.

It is important to remember that reality goes far beyond imagination. That is, even well-thought-out business plans that addressed the many parameters that needed to be examined, failed to foresee the crisis of 2008. During those crisis years, the institutions that displayed resourcefulness, flexibility and, most importantly, uncompromising commitment to their investors, successfully adapted to the new, challenging, reality and did everything in their power to weather the storm and return to profitability or, at least, to keep losses to a minimum.

When investors decide to examine the company in which they intend to place their trust and money, they must scrutinize that company’s performance history throughout the years of its existence, looking in particular to see if the company survived years of challenging economic times and, if so, how the company weathered those years. Scrutiny must include an examination of the company’s planned forecast versus actual performance as well as the company’s actual performance relative to its markets during the same period.

The practice of publishing yields for selected years in which the publisher prospered, or only for successful investments, is unacceptable. As discussed above, it is important to present a full set of data, including the forecast published in the business plan as compared to actual IRR on realization.

It would appear that there is no investment institution that began operations after 2008 that does not present positive, and even unusually high, yields due to the perseverance of supportive tailwinds from world economic markets. This is not necessarily an indication of professional investment practices. Investors should be cautious of exaggerated yield forecasts designed to attract investors. Even if the investment is profitable, it may be significantly less profitable than originally presented. If a very high rate of return is forecast, such a forecast, if correct, reveals a high rate of risk. Even worse, it may be deceptive, and in any event, investors must be cautious.

Ultimately, in the world of investing, we are constantly balancing between returns and risks.  Opportunity-seeking investments – those that expose the investor to higher than usual levels of risk in return for higher than usual yields – are legitimate, but investors must be fully aware of the risks and take them into consideration when making investment decisions.

To summarize, my recommendation to anyone interested in investing via an investment institution is to examine that company’s full performance history, including forecast versus performance, and the company’s personal and professional background, including investment managers’ integrity and reputation.

Remember: If actual investment performance does not meet forecasted expectations, that does not necessarily indicate failure to perform; it sometimes indicates flexibility and adaptation to changing market conditions. However, it is important to understand and analyze what caused the difference, as well as the actions that were taken to make the business plan better conform to the changing environment and to maximize investment performance.

 

Opinion Column by Elchanan Rosenheim (Translated from Hebrew)
Published in the Real Estate Section, Calcalist, July 17, 2018