Puerto Vallarta Real Estate Articles

When we purchase a property that we want to enjoy for our permanent or holiday home, we don’t always consider the re-sale aspect. It can be good idea to determine upon sale, the amount of return on the asset or investment. When we are planning to receive rental income on our vacation home, we can also measure the investment performance.

There are two types of return or yield on income:

1. Return OF capital, which is the initial amount invested.
2. Return ON capital, which is the profit generated on the investment.

Almost all measures of investment yield use a formula to establish the relationship between income, rate of return and value. Only about nine countries in the world use a capitalization rate to evaluate the value of an investment. If the net operating income (income after operating expenses) is compared against the total cost of the investment as a percentage, this percentage is a capitalization rate. NOI (net operating income) divided by value gives a percentage.

A seller wants to receive a low capitalization rate when he sells his property, and a buyer wants a higher cap rate for the property he wants to purchase. The higher the cap rate, the less time it takes to pay the investment back, because the purchase price is less. For example, if the net operating income of an apartment building is $100,000 pesos a year and the seller wants to receive an 8% return on his income, the sales price is $1,250,000 pesos.

On the other hand, a buyer may want to purchase a property with a 12% capitalization rate, or want a 12% return as a minimum on the money he invests. If he wants to buy this same apartment building, which nets 100,000 pesos in income before taxes for a 12% return, he will want to pay $833,334 pesos for the purchase.

A more sophisticated method of measuring investment return is the Internal Rate of Return or IRR. This rate measures the income and expenses of money over a period of time. It takes into account uneven cash flows that occur in investments.

The value of the tool of IRR is that it gives the investor the ability to reduce a variety of investments into a common return rate. He can compare and see which investment looks more appealing. He can compare the IRR between an office building, a warehouse, and an apartment building.

An investment is considered attractive if the IRR (expressed as a percentage) is greater than the cost of the capital or money used to buy the investment. If the IRR is 10% and the cost of the money (mortgage) is 9%, the IRR is favorable.

The appreciation of a property gives you a rate of return. If you have a mortgage to pay off, the amount of money you get in access of the mortgage and selling expenses, gives you a profit before taxes. This net profit is divided by the number of years you have the money invested. This will give you a yield or annual return. If you bought a home for $75,000US 5 years ago, paid cash and have sold it this year for $100,000US with closing costs of $7,000US, your net profit before taxes is 18,000US for 5 years or $3,600US a year. This is a yield or appreciation before taxes of 4.5% a year.

You will want achieve a rate of return, greater than the rate of inflation in the country where the investment exists. Otherwise, you are losing money. Inflation is the increase in the amount of money and credit in relation to the supply of goods and services. If your rate of return is 4.5% a year for the home you owned for 5 years, and the rate of inflation is 5% a year, your return is less than the increase in what it is costing you to own the property. This is a negative return on your investment.

Yield is the rate of return, such as the ratio of the annual cash dividend or earnings per share of a stock to its market price.

Leverage is the use of credit or borrowed money to purchase an asset with the expectation of earning substantial profits.

Non-leverage is paying all cash for the property or asset.

Break-even is when your profit equals your expense: you don’t make money nor do you lose money.

Matching the investor to the market: Stability can be a primary consideration to investment, more important than rate of return. Keeping your nest egg, or the amount you paid for the home, can be more important than earning a percentage of return on the money.

In many countries in the world, not losing money on the real estate is more important than making a high return. Safety is the key issue.

If the investment in real estate is in a country whose currency is different from yours and you are converting your money into that currency, you will want to have an additional yardstick for performance evaluation. The conversion of currency from the local money back into dollars or whatever currency you used to purchase the property is a critical timing issue. It is important to closely monitor the currency exchange. If you take the money out of the country, there can be a big difference in your proceeds, depending on when you do the conversion. Be aware of timing and the conversion rate of the money.

Net operating income is the amount of money that is left after you deduct expenses from gross income, before you owe taxes.

Upon sale, you may find that you are subject to tax laws of more than one nation. Real estate laws and procedures vary from country to country. Cultural differences may influence the transaction. Prices, costs returns, income and cash flows are all affected by foreign exchange transactions and currency fluctuations. An international transaction has more aspects to it than a domestic one.

Currency exchange rates provide a general insight into a country’s economic and financial performance as compared to another country. If a country’s GDP (Gross Domestic Product) and positive trade out pace another country’s, that country’s unit of currency will be worth more than the others. When a currency improves or gains against another, its exchange rate falls. The stronger currency is worth more, so it takes fewer units to purchase the weaker ones.

If the Canadian dollar “strengthens” against the Mexican peso, it will take fewer Canadian dollars to buy pesos. Someone holding Canadian dollars can buy more Mexican goods with the same amount of money.

In many cases, investors buy real estate, not because of the features of the property itself, but because the trend of the investor’s local currency against a foreign currency is favorable.

This article is based upon legal opinions, current practices and my personal experiences in the PuertoVallarta-Bahia de Banderas areas. I recommend that each potential buyer conduct his own due diligence and review.