13.7.2015 Tommi Kemppainen

Home in homeland – Real estate investments globally

Stretched Valuations and Zero Cash
How much is a lot of debt?

Nearly everyone has an opinion on housing and real estate investments. I see my own house primarily as my family’s home and not as an investment. Nonetheless, every now and then each one of us feel very pleased when house prices go up. In recent years, inflation has been rather moderate or merely non-existent, and this together with rising house prices brings the feeling of getting rich. Still, the experience of everything constantly increasing in price bothers this illusion. I wonder, is one getting rich or does the increase in house prices reflect more a decrease in the currency’s purchasing power? Did something happen to our currency – or to currencies in general?

Oatmeal is still cheap as well as potatoes and other root vegetables. By eating those, using a bike for transportation, and by camping, one could perhaps feel rich. Yet if you want a roof overhead, drive a car, and sometimes eat out and perhaps travel by plane to spend a holiday abroad, the feeling of being rich disappears. The situation is similar to when comparing the nominal house price development to the price development that takes into account the fact that currencies loose their purchasing power over the decades. In the really long term the real housing returns have been very small! One could not talk about getting rich (In the US 1890-2004 yearly 0.4% on average, including the 52% increase after the year 1997. Source: wikipedia).

Figure: Inflation and house prices in the US

Did Something Happen to Our Currency – Or to Currencies in General?

This is not just my own daydreaming of reaching the state of economic freedom. This positive feature of real estate, that it at least seems to preserve value in the long run as it is a real asset, is one of the particular features why in my HCP Black fund one significant investment segment is real estate. The really small real returns in the very long term is a poor feature, which is why I invest in this asset class with a active strategy. If you own merely passively real estate it is not probable to gain that high returns.

Real estate is a real asset with value, regardless of the prevailing state of a currency. I do not claim that currency crisis is a risk that has materialized at this moment. I claim that it is improbable but if occurred, it is a risk with great impact and like any other risk it has to be taken into account when investing. It is always possible with currencies, that people lose their faith in the currencies ability to maintain their purchasing power.

Writing this, the media reports daily on Greece, loans, and financial support packages. At the same time plenty of European quantitative easing is being done to speed up economic recovery. The whole chain of events is unforeseen and that is why one should not say anything  certain about what will happen next. In my opinion it is healthy to humbly note, that things that are happening right now, can cause disbelief in the currency’s ability to retain its purchasing power. Or who is willing to estimate what the impact would be, if we would start issuing as the European Union group together some new bonds to the market to raise money with one trillion euros worth at a time.

When considering Russia, a region far deeper in crisis than Europe, the currency crisis can already be seen materialized. Numerous articles on how Russians have bee buying expensive real estate abroad has been written in recent years. The big question has been, why did they pay excessive price buying the most expensive buildings with low rental yields. After the materialized currency-crisis of ruble one do not need to wonder anymore. Every international real estate investment the Russians did are now safe from the ruble crisis.

When the currency is in crisis real estate has a better capability of retaining value than many other asset classes. Bonds, for instance, typically do not perform well during currency-crisis. If you have borrowed money to a country (in their local currency) entering a currency-crisis  to receive a fixed annual coupon, you will not have much protection in a currency-crisis.

Specific Risks in Real Estate Investing

Investing wouldn’t be so fascinating if real estate investing was this simple.  When real estate perform better than some other asset classes during some specific crisis, they also include specific risks of their own, ones that other asset classes do not have. As far as Finland is concerned, the following risks are to be considered:

House prices in Finland have been rising almost non-stop since 1992 – soon for a quarter of a century! Every financial price tends to reflect our human behavior  in the way that we move preferably in groups. Not even real estate investments are immune to this phenomenon. Like any other financial prices on average, real estate prices typically head towards the same direction for longer periods of time than they would under a random processes. (Economic bubbles Source: wikipedia)  The result of this kind of process is that prices usually exaggerate when decreasing as well as when increasing. Constant flow of income from rents is not crating such a smooth increase in wealth, when taking into account the fluctuations in the price of real estate.

Figure: House Price development in Finland 1988-2015. Real price index (2000=100)

Even if we would not take into account the fluctuations in house prices and would just focus on the flow of income from rents, taxation is still a uncontrollable part of the net yield. As for Finland you do not need to be a fortuneteller to foresee that taxation on real estate will tighten during the next 15 years. Physical property is harder to take out of the country, which makes it easier to tax than other securities which are immaterial. With this risk of taxation it doesn’t help even if you close your eyes from the fluctuations of house prices, since increased tax will cut the net income one gets from rent. When unfunded liabilities like social security is realized in Finland during the next 15 years, tightening the taxation on real estate is potentially going to be one of the favorite targets for tax increase over and over again.

Figure: Unfunded liabilities like social security – Who could calculate the Finnish numbers?

Because of above-mentioned reasons I have not invested from the HCP Black -fund to domestic real estate. Studying Finnish housing real price index, one can note the fact that the asset class in question wouldn’t have offered much of annual return if the purchase was done with the previous top price in 1989. In my investments in this asset class I aim at finding countries that resemble more of the situation of real estate pricing in Finland in the year 1992. When the timing succeeds at least partly, good returns with moderate risks are to be expected in the long run.

The Best Real Estate Investments in the Current Market Situation

Taking all these risks into account I have invested 20% of the HCP Black fund into real estate. Most of these real estate investments are in the US. The initial purchase was done 2009 and I’ve steadily increased that weight since. As this asset class typically falls fast and then rises slowly, it is often better to be half a year too late when buying than half a year too early. The US interested not only because of the substantial discount, but also since taxation on real estate is already at a relatively high level in the country. Risk of taxation has already realized and it is included in the prices. And it is not expected that during the next 15 years taxation would get that much tighter and decrease the net yield of the investment.

Figure: The price development of house prices in the US and in Spain



The second biggest real estate holding of HCP Black is in Spain. I acquired it in the fall of 2014 since also in Spain’s real estate market offered a discount after the crash. In addition, there is growth that counterbalances the mass unemployment in Spain. This rapid growth of Spain is in its grey economy. Taking this grey money into account, the Spanish housing affordability ratio is already sound. This increases the potential of Spanish real estate as an investment. (Spain’s underground economy employs a million people and is worth 20% of its GDP Source: Quartz).

Figure: Unemployment in the US and in Spain



The third real estate investment theme in HCP Black is “global luxury real estates”. This investment is included for two reasons. First of all, in countries where the local currency start showing large risk of becoming a crisis, the need arises to buy something that will preserve value. Often for this purpose one thing that is bought is property from abroad. Globally the money for luxury real estates flows from countries where currencies and national economies are  getting into crisis. Nowadays you can see writings considering luxury real estates as a “new global currency”. It is not a currency, but for many, luxury real estate is still a way to preserve purchasing power and in this respect it carries out one classic function of a  currency. In addition, global luxury real estates benefits from positive network effects: when a person moves to any megacity in the world, by his/her presence and actions he/she takes, he/she makes the city in question more interesting for other agents already there. This process is a macro tailwind for the theme global luxury real estates, as the most expensive real estate is typically found in these megacities (or cities to become megacities). A terrifying opposite of the phenomenon is the marketplaces of cities with migration loss: The life vanishes shopkeeper by shopkeeper and soon the formerly lively marketplace ultimately changes into a idle parking lot. We can unfortunately see a lot of this negative network effect in work in Finland in cities that slowly becomes small towns again.

Figure: The Concentration of Housing 1950-2030

When making real estate investments, risk and reward must be evaluated as critically as always when investing. Through that it is possible to benefit from the specific positive features of real estate investing. If one is not interested in selling ones Finnish home, traveling by bicycle, eating oatmeal, potatoes, and root vegetables while having a tent as accommodation, maybe the right choice is to buy a summerhouse from Spain. As Spain is that much warmer than Finland, the expensive holiday hotel costs are saved and the root vegetables can be replaced with paella for a change! Even more convenient if one can sell an real estate investment in Finland and buy some real estate from Spain. Or you can join us in these real estate investments as well by subscribing to HCP Black.

Stretched Valuations and Zero Cash
How much is a lot of debt?
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