| Real Estate Financing - Foreign Currency It involves the use of foreign currency denominated loans to finance the purchase of local property. It is however only applicable to foreign investors; under certain circumstances a local may be able to obtain a foreign currency loan if he has income coming from abroad or is involved in international business. There are three component to such financing; interest rate, exchange rate and rental income. Interest rate differential The benefits of such an arrangement is that some foreign currency denominated loans attract lower interest charge. Take a simple example; a yen currency loan has an interest of 2-3% as compare to an Australian dollar loan at 6-7%, a differential of 3-4% point. Exchange rate difference Most mortgage loans are long term in nature the investor is able to switch loans to another currency or the home currency where the property is bought. Foreign currency gains can be realised. It is similar to having a foreign currency option with long expiry dates equivalent to the tenure of the loan. It can be exercised anytime the movement in exchange rate is favorable to the investor. E.G. A Singapore dollar loan (80%) taken for the purchase of an Australian property (A$500,000). Loan to be taken in Australian dollars: A$400,000 Prevailing exchange rate, Australian/Singapore: A$1 : S$1.2 Converted to a Singapore dollar loan (A$400,000X1.2): S$480,000 The Australian dollar appreciates against the Singapore dollar (to A$1 : S$1.3) and the investor switches back to an Australian loan. The outcome, principal sum outstanding (S$480,000/1.3): A$369,230 The realised gains by switching loans (A$400,000-A$369,230): A$30,770 Foreign currency loan is a more sophisticated form of financing. To benefit from exchange rate movement we always buy into the currency that we anticipate will depreciate. Predicting exchange rate movement takes experience and knowledge. Rental income The third component concerns rental, this is affected by the currency loan taken and the interest rate prevailing for that currency. As in the above example the rental income from the property will be in Australian dollars and it has to be converted into Singapore dollars to service the mortgage payments. E.G. Singapore interest rate at 5% on an interest only loan, i.e.only interest is paid and no principal payments. Net rental income is 5% of the property purchased ( A$500,000). Assume that the exchange rate is A$1 : S$1.3. Total interest charged for the year (5% X S$480,000) S$24,000 Net rental received for the year (5% X A$500,000) A$25,000 We need to convert the Australian dollar rental income to Singapore dollars to pay for the outstanding interest. Total interest charged for the year (S$24,000) Net Australian rent convert to S$ (A$25,000 X 1.3) S$32,500 Net positive cash flow in Singapore dollars S$8,500 As with any benefits there are also risk involved, the reverse could happen with a fundamental move in exchange rate and not just temporary fluctuation. For those less incline to such exposure, the best option to take is to match the source of income derive from the investment with the funds borrowed. i.e. Australian dollar loan with Australian rental income. We can use hybrid currency loans to mitigate the downside of such financing but at the same time, the gains will be capped. Hybrid currency loan It involves multiple currency loans; e.g. Singapore and Australian dollar loan or a combination of other currencies. E.G. We will use the above example except that a 50/50 mix in Australian and Singapore dollar loan is taken. 50% loan in Australian Dollars: A$200,000 50% loan in Singapore Dollars (A$200,000x1.2) S$240,000 The Australian dollar appreciates against the Singapore dollar (to A$1 : S$1.3) and the investor switches it back to an Australian loan. 50% loan in Australian Dollars: A$200,000 50% loan in Singapore Dollars (S$240,000/1.3) A$184,616 Principal sum outstanding A$384,616 The realised gains is reduced by half (A$15,384) compared with the above example where the foreign currency loan was in Singapore dollars only. Using this method the benefits derived from any favorable foreign currency movement is reduced; the same goes for any unfavorable movements. |
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