Cost of hedging currency risk for US real estate investments

[TangoWhiskey]

There are factors worth investigating in the US in the right markets and hedging against the inflation risk of getting repaid in devalued dollars then just becomes a cost of doing business to add to the margins. How much do we need to add?



What's the realistic long-term cost of adding hedging to ensure that you get repaid in full value dollars? I'm guessing 3% annually to carry insurance against a long term devaluation of the US dollar. What do you guys think? What would be the most effective way to hedge say a 3 million down payment into a B class 80 unit apt complex in the US? Expected hold being 7+ years.

 

[Thomas Beyer]

One needs to ask: are you in the hedging business or the real estate business ? In my humble opinion, no hedging is required. Value of asset will go up correspondingly. Issue is huge taxes on gain on sale, then repatriation of $s. One option is to invest in US$s and do not worry about the exchange rate, and use $s in US for re-investment tax free on 1031 rollover or on ultimate exit for vacation home, trips, boats, etc.

 

[TangoWhiskey]

Clearly we're in the RE business and yes, we do plan to use 1031's for tax free compounding etc. However, whether its sooner or later the money still needs to be repatriated as you point out. It could be 20 years down the road, and whenever its done you also have a risk of the currency fluctuation being out of sync with a local real estate market and its degree of correlation to what the US dollar is doing; there are asymmetries (ie, threat and opportunity) everywhere in real estate. Its just one more risk to look at to make an informed decision on - is it a real risk, and if it is, what are mitigation strategies?



Are there ways to hedge long-term currency risk?

 

[bizaro86]

[quote user=TangoWhiskey]Are there ways to hedge long-term currency risk?



Borrow a bunch of money in the currency you want to hedge (USD) and convert it to Canadian dollars now.

 

[Thomas Beyer]

Life is full of risk, as is investing. The only way to hedge risk fully is to not invest, or to buy a very expensive hedge ( forward $s), timed exactly to your exit point, possibly canceling all likely gains. But, you do not know the exit point. Hence, do not hedge, and enjoy the ride. If US $ tanks, asset value will likely automagically inflate. The asset is the hedge.

 

[TangoWhiskey]

I totally agree with the thinking that the asset is indeed the hedge however more accurately it is the debt that is the hedge rather than the asset.



Thomas you mentioned that while you can get 30 yr debt at sub 5 % rates that will serve as the ultimate insurance, you observed that this long term fixed debt also means a loss of flexibility should you wish to sell. To me it seems a crap shoot - sometimes rates will be lower than your long term debt and then your long term 30 yr mortgage is a negative but when rates are moving up from your long term debt rate you have a real asset in both the building and the mortgage. To re-read financial press from the 70's it is striking to read how it was common knowledge to buy long term mortgage debt as a great inflation hedge.



I guess risk mgmt with very long term mortgages would be to be selective about who the lender is and avoid any who have sold the mortgages into a long term debt pool to insurance companies etc that would trigger every cent of foregone mortgage interest being clawed back where a sale paid out mortgages, similar to the penalties applied to CMBS debt thrown off by First National.



Michael and Thomas, anybody else, any thoughts?

 

[TangoWhiskey]

What would be the best way to do that? If i'm moving Cdn $$$ to the US to buy, and hedging it by somehow borrowing US $$$$ to ship to Cda to buy assets in Cdn $$$, then it seems like that would work so long as transactional costs are reasonable. I guess the easy solution (at least easy to say) would be to raise Cdn $$$$ from Cdn investors to invest there, and US $$$ from US investors to invest here in Alberta for example. Great case for it for either side actually. Logistically and organizationally challenging, but with the right partnerships very possible.



Any thoughts on it from experienced capital raisers? I've spoken twice with a guy from Vancouver who raises from Cdns' to buy Phoenix apt bldgs, and of course we have Thomas. I wonder how hard it would be to contact US hedge funds and push the idea with them as a fast but expensive way to skip the capital raising.



Thoughts?

 

[Thomas Beyer]

We had that same debate 5 years ago before we bought a large Texas based asset. We decided to not hedge due to cost, and guaranteed loss on the hedging cost vs. unknown future US $/ Can $ exchange rate. Type into google US Canada hedge and lots pops up. Buying in another country adds various layers of cost and risk, and the perceived higher return may not be there. CAP rates in the US for apartment buildings a very similar to Canada. The only difference is that you can find more distressed assets, but they are distressed for a reason. Plenty of US mortgage debt available, at rates slightly higher than Canada. Proceed with your eyes and wallet wide open, as both will be heavily used !

 

[TangoWhiskey]

"We had that same debate 5 years ago before we bought a large Texas based asset."



- BTW, having visited that Texan asset of yours in Denton, I thought the choice of sub-market was really excellent. If I had to pick one spot in Texas Denton would be for sure in the top 5 and maybe the top 1 in the DFW metroplex.