FX Risks in Overseas Property Investments

It is important for property investors to understand the risks associated with acquiring offshore assets.

As the value of the Australian dollar frequently changes, the currency has become a very topical issue, with everyone from the taxi driver to the barista having an opinion as to where the currency is headed.

Due to the Australian dollar reaching record highs in the past, more Australians headed overseas in record numbers to countries such as the United States on shopping expeditions, Australians were not only buying more from overseas but were investing in record numbers in overseas markets.

This is clearly seen in the number of companies that have recently been set up to facilitate the purchase of property in the United States for the Australian investor. The rationale is simple: the Australian dollar is at record highs and the US property market is suffering from an unprecedented downturn. Further, many self- managed super funds are looking for higher returns in overseas markets for similar reasons. The value proposition is undeniable. However, many investors may not be aware of the risks involved in this investment strategy.

The risks that investors who intend to acquire overseas assets face are the same as those that can effect importers and exporters. Investors, importers and exporters alike are concerned largely with “where is the Australian dollar headed?”. However, the forecasting of exchange rates is notoriously difficult and even the most experienced economists are often wrong.

The fact is no one can accurately predict currency movements and the value of our currency is subject to a number of factors such as the economic growth rate in China, the ongoing European debt crisis, the price of commodities and the state of the US economy, amongst many others. The most experienced economist has to make a complex analysis of the various factors that affect exchange rates and how these factors interact under an almost infinite number of scenarios to predict currency rates. Even after all the factors are analysed and the numbers have been crunched by complex mathematical models, the predictions are, at best, educated guesses. So if it is such a difficult task to predict currency movements, what chance does an individual who is a first time international investor have of accurately determining the trajectory of the one factor that may have the biggest influence on the value of their investment?

Therefore, the question shouldn’t be “where is the Australian dollar headed?” but rather, “what is the impact on my investment of currency fluctuations and what can I do to protect my investment from adverse currency movements?”

For most importers and exporters, the level at which the Australian dollar trades directly affects the viability of their business. It is a rare company that has an exposure to currency risk that can afford to ignore that risk. The same applies to the international investor who is looking to invest in overseas property. In the past, investors had longer investment time frames and markets were less reactive to information flows. Today, markets are increasingly volatile and the advent of the information age has meant that the markets can and do react quickly and significantly to information flows. Doing nothing is no longer an option when it comes to managing foreign currency exposures.

The markets can move so swiftly and savagely that asset values can be decimated in relatively short time frames. Let’s take the example of an investor who decided to buy US property in July of 2012 when the Australian dollar was trading at $0.90. Assuming no change to the value of the asset itself, the Australian dollar’s move from $0.90 to levels of $1.07 would have resulted in an effective investment loss of 16 per cent. Taking steps to hedge and manage foreign currency exposures is no longer an optional extra for overseas investors.
Please Note: Examples are for illustrative purposes only and do not necessarily reflect current or future market or price movements.

Let’s now take a step back to examine the most common mistake investors make when choosing to invest overseas:

  • They often ignore the importance of sourcing a competitive exchange rate when initially making their investment;
  • When transacting ongoing foreign currency transactions over the life of the investment;
  • When disposing of the asset to repatriate funds.

Like consumers who have become more savvy and price conscious, investors need to become more effective at identifying a foreign currency payment provider who has the best combination of service and price to meet their demands.

However, like consumers who are happy to pay margins of more than 4 per cent to currency exchange bureaus, investors have for years simply accepted the foreign exchange rates given to them by their service provider, most likely a major bank. Whilst margins in most areas of the operations of banks have been squeezed due to increasing price transparency, consumer knowledge and competition, the margins in the foreign exchange departments of the major banks have actually increased.

It is important for investors to understand the risks associated with acquiring offshore assets. Investors should treat their foreign exchange service providers like any other supplier of goods to ensure they source a competitive price. When purchasing overseas property, the initial settlement of the investment, with a poor exchange rate can result in an unnecessary loss of up to 5% of the investment due to excessive margins and profit taking by their foreign exchange payment provider.

Foreign exchange doesn’t have to remain a mystery to the average consumer or investor. Compass Global Markets is one of a number of financial services organisations that have been established to bring increasing price transparency and consumer knowledge to the foreign exchange related services industry. The changes we are looking to promote in the industry will be similar to how pioneers like John Symonds changed the face of the home loan industry. In the process, we will seek to give consumers access to much more competitive exchange rates, increase consumer knowledge of foreign exchange products and benefit individuals, businesses and investors alike by demystifying a subject that is often placed in the “too hard” basket

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