Property investors buying second homes overseas are being forced to factor in exchange rate risk when deciding how to finance a purchase, as the sovereign debt crisis continues to cause volatility in currency markets.
Figures from World First, the currency broker, show Britons have not been put off buying property in the popular destinations of France, Spain and Italy in recent months, in spite of the unstable euro exchange rate.
It found property-related transfers in Spain by Britons were up 68 per cent in July from a year earlier, and up 20 per cent and 34 per cent in France and Italy, respectively, over the past three months. However, the number of Britons buying abroad remains significantly down compared to the peak in 2007.
Since then, sterling has undergone a significant depreciation against the currencies in a number of traditional second-home destinations. In 2007, Britons could get €1.5 to the pound and 2.4 Swiss francs. This has now fallen to 1.14 and 1.37, making the purchase of an overseas property in these locations much more expensive.
So, with the cost of buying a holiday home in Europe now considerably more expensive than before the downturn, many cash-rich buyers are opting to take out a euro-denominated mortgage, to reduce the sterling cost of purchasing a property abroad.
In the past, it was common for UK-based buyers of overseas property to raise money against their UK property and use the sterling funds to purchase abroad, but experts say this has become increasingly unattractive due to the exchange rate.
A growing number of wealthy buyers are therefore deciding to take out an euro mortgage until the exchange rate improves, at which point they can make additional payments in sterling and ultimately reduce the price they paid.
Using debt denominated in the same currency that the property is valued in provides sterling buyers with natural protection against exchange rate moves, argues Simon Smallwood of International Private Finance, the overseas mortgage broker – although a strengthening of these currencies against sterling would increase the sterling cost of the mortgage repayments.
Michael Hampden-Turner, a credit strategist at Citi Bank, recently bought a large penthouse in Zell am See in the Austrian Alps from Mark Warner Property. Although he could afford to pay in cash, he took out a euro mortgage – believing the euro will begin a slow decline and revert to its long-term average rate of 1.5 to the pound in a few years.
He believes that because of sterling weakness, it is to a UK buyer’s advantage to borrow as much as possible and reduce this leverage as exchange rates become more favourable. As a result, he has taken out a 20-year repayment variable rate mortgage with the option to overpay as much as he likes.
Hampden-Turner notes that while sterling remains weak – with the Bank of England base rate at 0.5 per cent compared with a eurozone interest rate of 1.5 per cent – recent hints from the European Central Bank suggest this differential is likely to change. Futures markets are predicting that eurozone interest rates will be down to 1 per cent by March 2012. “Therefore, the liability of a large euro mortgage is likely to decline over the next year or two,” explains Hampden-Turner.
A similar strategy could be employed by taking out a franc mortgage on a Swiss property. Last week’s decision by the Swiss National Bank to peg the franc to a ceiling of CHF1.20 to the euro has seen the cost of buying in Switzerland fall – although it remains expensive compared with a few years ago.
Buyers who believe the franc will depreciate further against sterling could therefore make big savings on a Swiss property purchase, particularly with the low interest rates on offer. Three-month Swiss Libor is currently at 0.005 per cent.
However, experts warn that majority of buyers – unless they are sophisticated investors with a strong understanding of the currency markets – should avoid trying to speculate on exchange rate movements, as markets are impossible to predict with any certainty.
Currency brokers say they have seen an increase in the number of Britons seeking to protect themselves from exchange rate volatility by using forward contracts to set their rate in advance.
According to HiFX, the number of clients booking forward contracts has increased by more than 30 per cent in the last three months. These contracts enable buyers to protect themselves from falls in exchange rates, although they also mean there can be no upside from any improvements in rates.
A compromise is to use a currency option. “Utilising currency options is one good way to protect your purchase from negative exchange rate moves in the market, by locking in a worst-case rate,” explains Nick Jones of World First. “But it also allows you to see the benefit if the rates move favourably in the lead-up to the time of the transfer.” (FINANCIAL TIMES)
