Risks, Rewards and Ratings Systems

Admittedly, Matthew (my employer) and I often have intellectual debates regarding the many aspects of the Global Property Guide. One of the most recent discussions was regarding the Investment Rating System. Each country is given a "star rating" based on the desirability of a country for a buy-to-let investment.

There were several issues involved. One of the most difficult issues to resolve is the primary basis of the rating system itself.

Matthew asks for a rating system primarily based on yields. According to him:   

 

We are interested in focusing attention on high yielding places. If people want safe, no-risk, conservative investments with moderate to low yields, they will stay in their own countries.

At a glance, I can see that though not all 5-star countries are high yielding and not all low-star countries are low yielding, there are obvious reasons for it, where countries are exceptions to the "high-yielding = more desirable" rule.

I have several problems with this type of rating system. There are several risks and rewards in an investment. For me, an investment rating should show the balance between risks and rewards. In this case, the rewards are the rental yields. The risks are multiple. This includes political and economic risks and ownership risks.

An investment rating must show the balance between risks and rewards. A rating system based mainly on yields is a ranking based on yields and not an investment rating. 

Matthew argues that if investors wanted low risks with moderate rewards they would not leave their own country. What if you live in a low rental yields country? Then you must go out and look for investments the can give you the return that you want. But should you invest immediately based on the rewards? No. You must check what are the risks attached to that high returns.

High returns attract the attention of investors. For instance, if rental yields in a particular city are high, then a lot of investors will come in. The increase in rental supply brought by the increase in investments will eventually push down rents. This will lead to lower rental yields. However, this increase in investment can only happen if the market is perfectly competitive.

In reality, markets are not perfectly competitive. In several countries, there are restrictions on the entry of foreign investors. While there maybe loopholes and shortcuts to go through the limitations this is extremely risky from the point of view of investors.

Political and economic risks are also significant hindrances for investors. Investors generally avoid countries that are on a brink of a civil war or economic collapse. In undemocratic regime changes, foreign investments are frequently the first victims of expropriation.

The results of a yields-based rating system are equally disturbing. Included in the best cities for buy-to-let investments is Thailand (currently ruled by a military junta which clamping down on foreign investments), China (currently flip-flopping on whether they actually want foreign investments in property or not) and the Philippines (whose president is constantly in political trouble).      

For me, a country worthy to be considered among the bests is the one without any restrictions on ownership of buy-to-let properties. Rents are high because of high demand and not because of lack of supply due to barriers to entry. A country with a constant supply of renters because it continually attracts people due to economic and political stability.

(to be concluded... or not...)