Holiday home finance

01 March 2006

More than a quarter of a million people now own a second home abroad, according to the latest official figures. The most popular destinations are still Spain and France , although we are venturing further afield to parts of eastern Europe and the Caribbean .

The big attraction is often the weather. A burgeoning expat community is another draw, as are the typically cheaper prices for property abroad.

So it's no surprise that a growing number of companies specialises in foreign property transactions. And many offer some tempting deals. Assetz, for example, recently promoted a scheme that would get you a “French holiday home for free”.

So how does the scheme work? You put down a deposit of between 20% and 30% to buy a property in a new development that qualifies under the government-approved leaseback scheme, known as the “Residence de Tourisme”. The properties are mostly in coastal locations, ski resorts, and around Disneyland Paris. We are not talking up-market. You can get a property for less than 100,000 euros and most are below 250,000 euros.

You take out a euro mortgage to fund the rest of the purchase - and to take advantage of the low interest rates of about 3.5% in the eurozone.

You then lease the property back to a management company (such as the giant Pierre & Vacances) which guarantees to pay you about 4% of the purchase price in rental income each year for a minimum of nine or 11 years.

So, the property does not cost anything to run because the rent is more than the mortgage. The French government also gives you a VAT rebate of 19.6%, which does not quite cover the deposit, but it's not far off.

You are even allowed to use the property for free, usually three to six weeks a year. Of course, your rental yield will suffer accordingly.

Mike Boles, director of Savills Private Finance, is a fan of the schemes: He says: “You don't have to find much money upfront – and you get the VAT rebate. It should cost you nothing to run because the investment washes its face, as we say. And you don't have the hassle of dealing with tenants and maintaining the property. You should also make some sort of capital gain over 10 years or so, so it's hard to see what can go wrong.”

In fact, Boles is so smitten with the schemes that he tried to invest in a ski lodge recently but the properties sold out within two weeks, even though the building work will not be completed until 2008.

However, even Boles concedes that the schemes are not for everyone - and there are risks. The biggest risk is that the guarantee is only as good as the company behind it. If it goes bust, or cannot find enough tenants at the right price, it could all go horribly wrong.

Remember also that the company guarantees only the rent. It does not guarantee that house prices will rise or that interest rates will stay the same.

The investment might finance itself while mortgage rates are below the rental yield, but what if they go up? Is it such a good deal if your rent is guaranteed at 4% but interest rates are at 5%?

Experts usually recommend that you take out a euro mortgage so that your loan is in the same currency as your asset and your income. But it's not always easy to get a French mortgage. The banks often insist that the repayments on your British and French mortgages be no more than 35% of your income after tax - and they won't take the rental income into account.

If you take out an interest-only loan, you pay back only the interest to the lender. So, after 20 years or so, you are still stuck with the original debt. If you want to sell the property and prices have crashed, you could be in trouble. Stephen Smith, a lawyer specialising in French property, says: “A scheme that looks good now may not necessarily be the same in 10 or 20 years. In some cases, a property that has not been looked after, in an area that has been highly developed, may decrease in value.”

There are also more costs involved than simply the cost of the property. Legal expenses such as notary fees, bank charges and arrangement fees can add another 3% to 4% to the purchase price. You should check too whether you are liable for local taxes.

When the contract expires, you can either renew the lease or sell the property. But experts advise you to think of the deal as long term – with good reason. You remember that generous VAT rebate? Well, you only get to keep the full 19.6% if you hold the property for 20 years. If you sell after 10 years, say, you have to give back half the money. I wonder if there really is such a thing as a free holiday home.

You can find more information on sale and leaseback properties in France at www.francophiles.co.uk or www.propertyabroad.com

Savills Private Finance can give advice on finance for international property deals and will charge up to 1% of the mortgage amount. Contact international@spf.co.uk