A double-edged sword can conquer the world for you, but it can also end up cutting you. The wielder of such a sword must understand and respect the power of the sword, and use it responsibly.
…As tempting as it is, I refuse to insert an overused quote here about ‘power and responsibility’ that may or may not be from the movie “Spiderman”.
There is a double-edged sword that all UK real estate investors must wield whether they want to or not – forex.
All overseas UK property investors are also foreign currency investors by default, since if you are buying property in the UK, you must do so in British Pounds.
Having to purchase the foreign currency adds an additional level of complexity that purely domestic investors do not need to face directly (indirectly, forex is still a factor due to the cost of imported building materials etc). Depending on the various factors discussed below, this could either be a great advantage or disadvantage to the overseas investor.
Imagine that you are a Hong Kong investor who purchases a property in the UK for £100,000. The exchange rate is HKD 10 : GBP 1, so you’ve paid HKD 1,000,000 for the property.
In 2 years, the value of the property has gone up by 10%, at which point you decide to sell the property and bring your capital back to Hong Kong.
Let’s analyse 3 currency scenarios:
1. The exchange rate has not changed, i.e HKD 10 : GBP 1
The amount you bring home: HKD 1,100,000.
Net gain: HKD 100,000
2. The GBP has appreciated 20% against the HKD, i.e HKD 12 : GBP 1
The amount you bring home: HKD 1,320,000
Net gain: HKD 320,000
3. The GBP has depreciated 20% against the HKD, i.e HKD 8 : GBP 1
The amount you bring home: HKD 880,000
Net loss: HKD 120,000
This is obviously an oversimplified example, but it should serve to illustrate the power and importance of the currency variable in international property investing. As you can see, it can serve to massively amplify your returns or diminish them.
As with anything when it comes to property investing, you must find ways to maximise exposure to upside potential while minimising downside risk. Below are some ideas:
Control what you can, let go of what you can’t
The market is going to go where it’s going to go. You can try and forecast movements by looking at macroeconomic and international relations, but you will never be able to predict exactly what is going to happen. The earlier that you accept this and detach yourself emotionally, the better you will be as an investor.
So what can you control?
You can only control your own actions, such as the timing of your currency transactions. For example, in the scenario above, if after liquidating your property in the UK you find that the currency climate is not favorable, you can simply hold on to your Pound Sterling indefinitely until it appreciates against the Hong Kong Dollar. You could even reinvest it into another property in the UK in the meantime.
Once the Pound appreciates (assuming that it will at some point – but who knows?), you can bring your capital back to Hong Kong.
This is not a luxury that every investor can afford due to various reasons, but all of these factors should be taken into account in the initial due diligence stages.
You can hedge currency risk
It is not possible to completely eliminate exchange risk, but it is possible to mitigate some of it.
The most obvious way to do so is to invest in a country that has a currency that is pegged to yours, such as the USD and the HKD. You can always expect buy USD 1 for HKD 7.85, minus fees.
Another way to hedge against exchange risk is to purchase currency options and/or futures. However, these instruments are not readily used by smaller retail investors.
Find your better half
When you first begin investing in the UK, you will likely have to exchange substantial amounts of your own currency into the destination currency. However, as you start to establish yourself as an investor and build your portfolio and your relationships with the UK banks, you might find yourself needing to exchange less money outwards.
This is because the portfolio should begin to become more or less self-sustaining over time, allowing you to reinvest the profits, which is in GBP anyway.
You might also raise financing from UK based banks, which is of course denominated in Pound Sterling.
This means that over time, you will need to transfer less and less into the UK from the outside, substantially diminishing your forex risk exposure!