IL Postcard

The Due Diligence Dilemma

Date: 05/23/2008

Saturday, May 24, 2008

Read more about investing in real estate overseas in International Living Postcards —Saturday Edition

A friend is investing in a pre-development real estate deal in Panama. It’s his first foray into international real estate, and he’s taking his due diligence seriously. He’s had his attorney in the U.S. look at the contract, but that attorney doesn’t do real estate law, so he passed it along to another attorney who does. However, this real estate attorney doesn’t know anything about Panama or the British Virgin Islands, where the holding company for the development resides, so he passed the contract on to an attorney who does deals in the British Virgin Islands.

Three U.S. attorneys later, it seems all the questions have been asked...at least about the companies involved in the deal.

Another colleague looking at a similar deal spent all his time asking about zoning issues and infrastructure costs. He wasn’t too concerned about the corporate holding structure, but rather wanted all the details on the planning process. Neither did he ask about the ultimate exit strategy—who, ultimately, would or could the property be sold on to?

Each of these guys carried out his due diligence on the international real estate investment in front of him the way he approaches his own business. One focused on structure, the other focused on infrastructure. Both these things are important, but they aren’t the only things and may not be the most important things to look at when considering a real estate investment in another country.

Wherever you’re looking to invest, you’ll find that the due diligence required will be different than if you were investing at home...as both friends figured out in the end.

Doing due diligence overseas requires extra work as it is completely different to the process back home.

In the case of a simple retail purchase overseas, you usually can rely on a good real estate attorney in the country to carry out the necessary due diligence. You will need him to check the title, review the purchase contract, and help walk you through the transaction. But before you even get to the looking stage, much less the stage of researching a particular buy, you should understand how the market works.

Make sure to ask: Who pays the real estate agent fees? What are the transfer taxes? Are there any restrictions on foreign ownership? What are the ongoing tax implications...property taxes, taxes on rental income, capital gains taxes?

And you need to understand the market cycles. At what point are you buying in? And, given that, what might your exit strategy be?

If you are looking to buy something to renovate or to build, then you have further issues to consider, such as zoning, permits, construction costs, timelines…

Invest in a wholesale-level deal like pre-construction, raw land, or an equity position in a development, and your list of due diligence questions expands further. With pre-construction, you should look into the developer and his track record, as well as the purchase contract. If you’re buying raw land with the intent to develop or to flip to a developer, you need to make sure you have proper access from the public road, electricity nearby, the ability to get water to the property (through the local municipality or from wells on the property)…

If you’re considering taking an equity position in a development, you should to carry out full due diligence for the real estate in question, as well as an additional round of due diligence on the corporate structure.

The extent of your due diligence must be weighed against how much you are investing and how much you’re expecting to return. If you’re looking to invest $10,000, you don’t want to spend $5,000 on due diligence (unless you have the reasonable expectation that your $10,000 could be returned to you 10-fold). On the other hand, spending $1,000 on due diligence for a $1 million investment is probably not enough.

Before investing in foreign real estate, you must educate yourself both on the location and on the local way of doing things. Don’t go in to a foreign market thinking there are safety nets to protect you (as there are back home), or that you know what you’re doing because you’ve done something similar somewhere else.

Go in recognizing that you must start at the beginning, for each market and for each kind of investment. Each new market will get easier with experience.

Lief Simon
For International Living

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