Due diligence on target countries

[Brandon Goldsmith]

I have been constantly trying to do research on prospective countries and to see what type of real estate is hot in certain markets/counties and possibly not in others. I have been looking into Latin America mostly but have also done some research on other markets as well. I would like to get started in waterfront Airbnb focused assets eventually.

When doing your due diligence and extensive research on a country, what is the best way to go about this? I am curious on how to most efficiently make connections internationally, find the benefits to different tax laws, and ultimately wonder how people start off building global portfolios while minimizing their risk.

Any insight into the matter helps!

[Mike Lambert]

@Colin G Murphy

I totally agree with all that you mention that makes the US real estate market such a great market to invest in real estate, for now. However, if you take a 30-year mortgage, you might want to look further out. And then, I have to agree with @Israel Sternbuch that the US is necessarily the best place to invest in real estate and especially not the US middle class heartland. I agree with his comments and there are actually many other reasons that many of us ignore and which I outline below.

Let's not make the classical mistake of looking in the rearview mirror (in the past) to make a decision regarding the future. Let's also beware of the recency bias, according to which we assume that what is true today will hold true forever.

I'll explain further why the US middle class heartland might actually be one of the worst places to invest in real estate today if your horizon is the next 30 years (the duration of the typical US mortgage). However, let's assume for a moment that you're 100% right and that the US is the best country in the world to invest in real estate over the long term as well.

If the Covid-19 crisis has taught us anything, it is that, even in countries like the US or my home country of Canada, civil liberties can be taken away from us on a whim. Yet, most Americans, and especially the less fortunate, have only one passport, have their income originating 100% in the US, have their 401k invested exclusively in US assets, all their bank accounts in the US, all their stocks are US stocks and all their real estate is in the US. As every crisis has shown us (and especially the real estate meltdown of the last decade) having all our eggs in the same basket is never a good idea. Real estate can be especially problematic in that it is easy to confiscate. Therefore, having your real estate spread over several countries make sense, irrespective of any other factors.

Now these are some of the reasons why US real estate (and especially in the middle class heartland) mightn't be the best investment you can make today, when compared to international real estate:

1. US real estate prices are artificially popped up by a huge debt bubble as a result of decades of questionable FED policies. Let's not forget that the last real estate crisis was a debt-induced crisis and the only way it was solved is by bringing interest rates to zero, which exponentially increasing the already high and problematic amount of debt in the system. It's akin to giving more heroin to a heroin addict to "cure" him. Does that work long term? I don't think so. The current interest rate down cycle started well before the COVID crisis as the FED couldn't raise interest rate past 2.5%. Mind you it's even worse in Europe (and Japan), where interest rates never went above 0 and remained negative all along. The US economy was supposed to be firing on all cylinders before Covid-19. The reality is that, when an economy is really booming, interest rates have to be raised to cool it down. Not being able to withstand 2.5% interest rates because you have so much debt is not the sign of a very healthy economy.

2. In spite of what I just mentioned, the US, even with a sub-par economic growth over the last decade, has arguably been the best house in a bad neighborhood. The problem with the US economy pre-Covid wasn't its GDP growth or low unemployment rate, which gave the impression that the economy was healthy. You had to look behind the scenes. It's the obscene amount of debt (government + individuals) and the growing income and wealth inequality that are hugely problematic for the future.

3. These FED policies (that artificially prop up the real estate market) can't continue forever, as that would lead to the ultimate demise of the financial system. Moreover, every time they're implemented, they lose in effectiveness. And they only work without thrashing the US dollar because the US dollar is the reserve currency of the world. As the US loses its status as the superpower of the world this century, it's likely that the US dollar will lose its status as the world's reserve currency (and the Chinese, Russians and others are hellbent to have that happen sooner rather than later). As this happens, the US will be forced to raise interest rates to defend the currency, which might sink the real estate market and economy way more than during the last crisis.

4. As a result of the FED policies mentioned above, the wealthy keep getting wealthier while the poor and the middle classes keep losing ground. This has been going on for decades and is now widely acknowledged. Basically, all the GDP growth of the poor and middle class is stagnating to going down but the GDP growth of the wealthy is so high that the GDP of the country becomes (artificially?) positive. While the poor and middle classes haven't seen their income rising much over the last decades, they're surviving thanks the deflation resulting from technological progress and ever cheaper goods being produced in countries like China or Vietnam (although that has been destroying many of their jobs). Still, the rising income and wealth inequality has caused political and societal divisions and help the rise of left-leaning or even socialist political figures, which would have been unthinkable a few years ago. While socialism doesn't work well for the economy as a whole, at least economically speaking, it might make the poor and lower middle class better off. Yet, socialism is generally rejected in the US by pretty much everyone because it's against the American dream. The problem is that, when the poor and the lower middle classes start realizing the the American dream is getting ever more out of reach for them, they might think that socialism isn't such a bad idea after all. Some people have suggested that this might end up with street riots, class warfare and maybe even a civil war. I hope it doesn't get there. Sadly, it could be a logical result of what's been going on for decades.

5. All this isn't happening in a vacuum. The 19th century was the century of Britain (the UK), which is only a shadow of its former self today. The 20th was the century of the US. And, as we've known for long, the 21st century will be the century of Asia. While the wealthy from the West will probably be fine and make even more money by taking advantage and investing in the rise of Asia, there's going to be a massive and historic transfer of wealth from the Western middle classes to the middle classes in Asia and other emerging countries. When you think about it, if you create a global market, high salaries will have to go down why low salaries will go up. That's what the free market inevitably does.

6. The rise of the emerging markets and of Asia as the next superpower should be obvious given the differential in economic growth and population numbers. Yet, most people don't give a second though about it, it is happening in front of our very own eyes. Take the trade war with China. Previoulsy, China was only competing on manufacturing. Now, they're competing in high tech and even surpassing us. Think 5G and Huawei for example. The US tried to stop the Chinese from allegedly stealing intellectual property but it failed. All China had to do to avoid further tariffs on its exports to the US was to agree to buy agricultural goods that they need to buy anyway (talk about making fake concessions). And nobody talks about the phase 2 deal anymore, the one which was supposed to tackle the intellectual property issue. For all intents and purposes, China won again. Most people in the West are up in arms about the effects of Hong Kong's new security law on the democratic rights of Hong-Kongers. Yet, they miss the importance of the situation on their own lives. What is more significant here is that, in spite of all the threats from Western countries, China went ahead. They know they've got the upper hand and the international community is powerless to do anything. Then, you have the virus. While China was the epicentre, they've recovered much quicker than the rest of the world. I could go on and on.

7. It's a well-known fact that the US middle class doesn't have much money set aside for retirement, investment or even just emergencies, as the actual crisis has shown. These are all the people in the middle class heartland who have lost their jobs to China or elsewhere and have seen their income stagnating for decades. They can barely afford increasing rents or home prices thanks to the ever artificially lower interest rates and lower prices of the goods imported from China and other places. There is a limit to how down interest rates can go though. Once the music stops, the (artificial) support behind real estate values could disappear.

8. Contrast all this with what's happening in places like Asia or Latin America. To start with, in the absence of a huge mortgage market, real estate prices there are much closer to their true value, as they are not propped up by cheap debt. Moreover, while the US middle class is challenged, the middle class in Asia and Latin America is growing by leaps and bounds, which underpins a healthy support for real estate demand and prices, that isn't supported by artificially low interest rates. Mortgage markets are still embryonic there but, as they develop, it will add a huge fuel under real estate values, already propped up by rapid economic growth and emerging middle classes.

9. What I wrote above is pretty much valid for the whole US, for my home country of Canada and other countries as well for that matter. However, they're even more potentially damaging to the middle class heartland. Things are changing at an accelerating pace and a city flourishing today might become an economic wasteland under the new world order tomorrow. So you can't take for granted that you'll be cash flow positive for the 30 years of your mortgage anymore. Long term, it might be wiser to invest in places where the wealthy live and in the international gateway cities that draw investments from the emerging middle classes from Asia and Latin America like New York, Los Angeles, Chicago, Boston, San Francisco or Washington D.C. Properties in those cities might hold their value better.

Finally, my conclusion might surprise you. First of all, let me start by mentioning that as a Canadian, I love the US, which is my favorite foreign destination. I admire all that the US brought to the world and I hope it's going to continue forever. I hope that the future will prove me wrong but I'm not holding my breath for it. Let's make no mistake. Both Canada and the US (and other countries) are in the same boat as far as this is concerned.

I invest in stocks too and the US is my favorite market for that. And it has been the best performing one. I could possibly even see myself investing in real estate in the US middle class heartland to take advantage of the current advantages described so well in your post above. Why would I do that in light of what I mentioned above? Because it works today and will still work for a while. The difference with many investors though is that I know this won't last for too much longer so I'll make sure I don't overstay my welcome and get out before the music stops. Most importantly, I invest internationally too so I'm diversified and covered.

So you might want to keep investing in the US to take advantage of the system as long as it works but maybe be aware of what's going on behind the scenes and I hope that this long post will help with that. And you might want to invest overseas as well to balance your portfolio, whether it is to take advantage of the economic growth and emerging middle classes there or simply to diversify.