Should you trust investing in a leaseback scheme in the real estate market?

Introduction

Everyone who intends to purchase real estate is covered by two main desires: the first can be described as the desire to return the investment, and the second is related to the desire to receive a regular income that will eliminate the need to engage in constant labor. In the context of the offers of various real estate agencies, the leaseback program seems to be one of the most tempting ways to invest, approaching the ideal investment. But is this really the case, or is there a clever trap lurking behind this “free opportunity”? The concept of leaseback and its benefits for private investors should be studied more thoroughly, based on the opinions of professionals from Russia working in a specific area of the international real estate market.

What is leaseback?

What is leaseback? The term can be translated as “leaseback”. This investment model has become popular in countries such as the United States and the United Kingdom, but in France it has been most common in residential real estate since the 1980s, and in recent years other countries such as Spain, Italy and Switzerland have begun to follow suit.

The essence of leaseback

The very concept of leaseback is a shortened form of the term “sale-and-leaseback”, which translates as “sale and leaseback”. The essence of this process is that the buyer of a real estate object after its purchase immediately leases it to the original owner for a long period of time. As a result, the new owner is actually unable to fully utilize his acquired real estate (in most cases), as he transfers it to the management of the selling company.

This management company, in turn, can rent the property to third parties on a short-term basis, and the property owner receives a pre-agreed and guaranteed rental income. In some situations, this income may even exceed the mortgage payments.

Advantages of the leaseback scheme

What makes this scheme attractive to all participants? In order to better understand how leaseback benefits the buyer, what inspires the seller and why government agencies support such programs, it is worth taking a closer look at the situation in France. The involvement of the state is particularly important here, because without the relevant legislation, the leaseback concept that we know would not be possible in France.

History of leaseback in France

Igor Indriksons, head of the investment department at IntermarkSavills, which was the first to introduce the French leaseback model in Russia, explains:

“The leaseback system was launched in France back in 1976. Today, the country is at the forefront in terms of the number of tourists: for 60 million local citizens there are 140 million foreign visitors per year. In the late 1970s, however, France was experiencing a crisis in the tourism industry. The potential was huge, but infrastructure was needed, particularly places to accommodate travelers.”

Conclusion

Thus, the leaseback scheme not only brings financial profit to the buyer, but also meets the interests of all participants, including the state authorities interested in supporting and developing tourism. Ultimately, this model contributes to the creation of new jobs and improvement of living conditions in the country, which makes it interesting for a wide range of investors. This system resembles a mutually beneficial relationship, where each participant receives certain benefits, opening up new opportunities for the development of the real estate market.

The essence of the leaseback method

The leaseback method assumes that the property must be rented at least 90% of the time. The management company takes full responsibility for all aspects of the process, allowing owners to receive a stable income, which is additionally protected by insurance.

State initiatives

In order to attract developers to this scheme, state authorities offer land plots practically free of charge. As Igor Indriksons emphasizes, these are the best plots for construction. As a result, the cost of square meters of housing is reduced, which attracts buyers.

VAT refund

Another positive point provided by the state is the possibility of VAT refunds. In the case of France, this tax amounts to a significant19.6%of the cost of the object, which significantly reduces the final purchase price. Thus, the state receives a flow of tourists who spend money in the country, which in turn increases tax revenues.

General principles of leaseback

Although this information gives a general idea of the principles of leaseback, it is not exhaustive to form a final opinion on the investment. Irina Dupor, head of Immoconcept's Paris office, explains some of the details of the process: “French leaseback has its own specific system of tax advantages, which has deteriorated over time, effectively undermining the interest of private investors in the hotel business, although it still remains relatively attractive compared to other types of leases.”

Objectives and risks

The most frequent leaseback objects are tourist residences, which contributes to the development of the tourism sector. The state uses such tax concessions in the interests of investors.

Expectations and fraud

• On the one hand, this policy has met the expectations of the authorities in the tourism sector.
• On the other hand, it has opened up such opportunities for fraud: some unscrupulous developers try to sell people leaseback properties that do not meet the necessary standards and market requirements.

In the pursuit of tax benefits, buyers often find themselves overpaying for their purchases. In most cases, owners can expect rental income at the level of4-5%annualized.

Introduction to tax incentives for investors

Tax incentives under certain conditions open up extraordinary opportunities for investors, especially in the field of residential real estate. It is important to keep in mind that this does not mean a complete exemption from value added tax (VAT), but rather the possibility of its reimbursement after a certain period of time after the start of operation of the object.

VAT refund: specifics

Specialists at Edison Ford Investment Property report that the value of VAT refunds varies depending on the type of property:

• When you purchase a new apartment, you can expect a full tax refund.
• In case the property has undergone renovation, the refund amount will be only 11-14% of the amount invested.

It is important to clarify that tax is only refundable on costs related to repairs, as indicated by theIrina Dupor.

Length of lease agreement

The leaseback agreement can be concluded for a period of 9 to 25 years, with an option to extend it at the owner's request. It is noteworthy that the owner has the right to sell the property at any time; however, if this happens during the leaseback period, part of the VAT will have to be refunded to the budget.

However, in 2006 a law was passed which allows the property to be sold together with the existing lease without having to pay back VAT, opening up new horizons for owners.

Critical importance of site selection

Irina Dupornotes that such a tax scheme is like a cherry on the pie; many people, in pursuit of this cherry, forget the importance of the main product. When choosing a property to invest in under such a scheme, it is crucial to realize its real value and market conditions, as well as the demand for rent or sale.

You should also keep in mind that leaseback is focused on long-term investments and is not suitable for short-term risk-taking in an investment portfolio.

Financial settlement practice

In practice, financial calculations can yield very illustrative results. Let's consider a concrete example:

• If the value of the apartment is €100,000, including 19.6% VAT, the total amount the buyer must pay is €119,600.
• Of this, 19,600 euros can be refunded after filing a tax return.
• If the rental rate is 4.5% per year, this equates to €375 per month.
• With a 25-year mortgage at 3.5% per annum, the monthly payments will be around €500, which means that the owner will have to pay an additional €125 per month.
• In order for the rent to fully cover the loan, the down payment should be approximately €25,000, in which case the monthly payment will remain at €375.

Conclusions

Thus, it can be argued that the dwelling will generate income for its owner and will be able to cover its own expenses. A remarkable aspect that emphasizesIrina Dupor, is the ability to index rents; while mortgage payments may decrease over time due to inflation, the difference in income will increase over time in the investor's favor.

Introduction to the lisbeck system

Tourist residences are just one of the real estate options that are available under the lisbeck system. Student apartments and apartment complexes specifically designed for the elderly can also be found in this area. Although such properties are not intended for the direct use of their owners, they can be an excellent opportunity for a long-term investment.

Rental income stream

So how can real estate owners ensure a reliable and constant stream of rental income? According to expert Igor Indriksons, companies operating in this niche apply effective price management strategies. For example, IntermarkSavills has entered into a partnership with Pierre & Vacances, a major operator in the European lisbeck market.

“Their methodology is to provide customers with attractive accommodations, assuming that tourists will spend money on various extras and recreational activities.”- notes Indriksons.

When renting accommodation in a ski resort for ten days, the whole family can pay as little as 300 euros, but you should realize that there is plenty of room for extra spending. This model is similar to the cheap accommodation system in Las Vegas, where low accommodation prices are offset by a variety of activities.

Questions about profitability

Why are companies willing to give up a stable source of income that brings such profit? Why not keep a part of the income, for example, 4-5%?

“That's a really reasonable question.”- Irina Dupor says.“But for a management company, rental income depends on the scale of its operations, and financial institutions stop funding if debt levels exceed acceptable limits.The organization is faced with two-sided decisions:

• slow development for five to six years and expect,
• or bring in outside investors.

Investments can be used to build new facilities, which will allow the company to focus on its core business while continuing to pay rent. It is also worth noting that such investments are accounted for in the statements as equity, which has a positive impact on the financial indicators and contributes to capital increase due to the growth of shareholder value.

Risks and protections of the lisbeck system

Although the lisbeck system has its risks, they are rather minimized. In particular, in France, the guaranteed income must be insured. Even if the management company encounters financial difficulties, payments to the owner will continue at the expense of insurance until another organization takes over the management of the facility. State authorities protect this market from unfair practices, which contributes to its stability.

Thus, investors can be confident in the reliability of their investments and receive the expected profits despite fluctuations in the economic environment. The lisbeck system, on the one hand, provides excellent conditions for those who wish to invest and, on the other hand, provides protection and certainty for real estate owners.

Conclusion

In conclusion, I would like to emphasize that investing in real estate through schemes like leaseback carries both significant benefits and potential risks.

We see that such a model was successfully implemented in France, which was able not only to attract tourists, but also to create conditions conducive to the development of the real estate market. However, despite the attractiveness of the promised income, it is important to realize that achieving long-term success requires careful analysis and understanding of all the nuances.

Risks and Cautions

Many analysts emphasize that with the growing popularity of leaseback, there is a threat of unscrupulous developers who may offer less favorable terms than originally stated. This makes it necessary to turn to professionals who will be able to protect the interests of the investor, providing them with market knowledge and legal subtleties.

Key points to look out for:

• The need for careful analysisall the terms of the deal.
• Risks of unscrupulous developersand the possibility of getting unfavorable terms.
• The role of professionalsin protecting the investor's interests.

Result

In the end, leaseback can be an effective tool for creating passive income, but it requires a balanced approach, serious research and awareness of all possible risks. You should always remember that real “free cheese” exists only in a mousetrap.

To make the right choice, investors must act prudently and with an understanding of the built environment. I hope this article has provided readers with useful information and will help in making informed investment decisions in the future.