Cross-Border Investments and Currency Risks

Motivation for Cross-Border Investments

Investors invest in foreign real estate for several reasons:

1. Diversification — distributing risks among markets and currencies
2. Yield — seeking higher yields in other jurisdictions
3. Tax optimization — utilizing differences in tax regimes
4. Lifestyle — purchase for leisure or future emigration
5. Residency — golden visa programs
6. Capital safety — moving funds out of unstable jurisdictions

Structuring Cross-Border Investments

Direct purchase (Personal Name)

• The simplest option
• Suitable for a single property
• Taxes: in the country where the property is located + possibly in the country of residence
• Risk: Inheritance Tax (UK — 40%)

Through a company (SPV — Special Purpose Vehicle)

• Asset on the balance sheet of the company (LLC, Ltd, etc.)
• Advantages: protection from IHT, simplified sale (share deal vs asset deal), tax optimization
• Disadvantages: ATED (UK — from £3,800/year), administrative burden
• Popular: for commercial properties and portfolios

Through a fund/trust

• For large portfolios (>€5 million)
• Professional management
• Tax efficiency (depends on the jurisdiction of the fund)
• Example: Luxembourg SICAV-RAIF, Jersey Property Unit Trust

Currency Risks

Exposure to Currency Risk

When investing cross-border, the investor is subject to:

• Transaction exposure — the exchange rate at the time of purchase/sale
• Economic exposure — the effect of the exchange rate on asset value in the “home” currency
• Translation exposure — recalculation of the portfolio's value

Examples of Impact

An investor from the Eurozone bought an apartment in London for £500,000 in January 2016 (rate 1.30 → €650,000). By January 2020 (rate 1.17): value in EUR = £500,000 × 1.17 = €585,000. Loss: €65,000 (10%) solely due to the weakening of the pound (even if the price in GBP remained the same).

An investor bought an apartment in Dubai for AED 1,000,000 in 2020 (rate AED/EUR 0.25 → €250,000). In 2024 AED/EUR = 0.25 → €250,000. The rate is stable (AED is pegged to USD, USD/EUR changed).

Hedging Instruments

Natural Hedging via Mortgage

The best way to reduce currency risk is to take out a mortgage in the currency of the property’s country:

Example: purchase of an apartment in London for £400,000. Own capital: €100,000. Mortgage: £300,000 (in GBP). Currency risk: only on own capital (€100,000) and not on the entire value (€520,000). If GBP falls: the asset value decreases, but the debt in EUR also “becomes cheaper”.*

Tax Implications

Double Taxation

• DTAA (Double Tax Avoidance Agreements) — agreements between countries
• Usually: real estate income is taxed in the country where the property is located
• Tax credit in the country of residence (tax credit method) or exemption (exemption method)

Examples of DTAA

Currency Risks in Cross-Border Investing

International investments in real estate are unavoidably accompanied by currency risk, which can offset a significant part of the returns. Let’s consider a concrete example: an investor from Germany purchased an apartment in Dubai in 2021 for AED 1,000,000 (~€230,000 at that time’s rate of €1 = AED 4.35). In 2024, he sells the property for AED 1,300,000 (+30% in dirhams). But since AED is pegged to USD, and the euro has weakened relative to the dollar over this period, the proceeds in euro amount to €260,000 — an increase of only €30,000, or +13% in euros over 3 years. This is still a good result, but it is significantly less than the +30% in dirhams. Currency risk hedging instruments for private investors: forward contracts (FX forward) — fixing the rate for a future date for large payments (e.g., at sale), available through banks or specialized FX brokers (OFX, Wise, Currencies Direct). For the long-term investor (5–10 years), currency risk is often acceptable, but it must be consciously factored into the investment analysis.

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Practical Assignments

Assignment 1. An investor from Germany (tax resident) buys an apartment in Dubai for AED 2,000,000 (~€500,000). Currency of income: EUR. Calculate scenarios in the event of a 10% strengthening and weakening of USD/EUR over 5 years.

<details> <summary>Solution</summary>

Current rate: 1 EUR = 4 AED. Scenario 1 (EUR strengthens by 10%): 1 EUR = 4.4 AED. Value in EUR: 2,000,000 / 4.4 = €454,545. Currency loss: €45,455 (–9.1%). Scenario 2 (EUR weakens by 10%): 1 EUR = 3.6 AED. Value in EUR: 2,000,000 / 3.6 = €555,556. Currency gain: €55,556 (+11.1%). Rental income (AED 140,000/year) is also affected: if EUR strengthens — €31,818/year vs €38,889/year if it weakens. Difference: €7,071/year. Recommendation: hedge the rental stream with forward contracts or spend the AED income in the UAE.

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Assignment 2. Draw up a structure for a Russian investor wishing to buy 3 properties: an apartment in Dubai (AED 3M), a house in Spain (€800K), an office in London (£1M). Goal: minimizing taxes and asset protection.

<details> <summary>Solution</summary>

1. Dubai (AED 3M): purchase in personal name. 0% taxes. Golden Visa. Draw up DIFC Will for inheritance protection.
2. Spain (€800K): via Spanish SL (Sociedad Limitada). Avoidance of Impuesto sobre Sucesiones (inheritance). Corporate tax 25% on rental, but expenses and depreciation deducted.
3. London (£1M): via offshore SPV. But note ATED (£3,800+/year) and IHT still applies to UK property. Alternative: residence in UAE + UK life insurance in a trust to cover IHT. Overall structure: UAE tax residency (183+ days) → 0% on global income in UAE. Spain and UK — taxes only in these countries + DTAA.

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