Sharks in Offshore Waters, Part Two
Offshore investing is one of those things that's easy to do but hard to do well. Whip out a reasonably hefty checkbook and you'll find lots of smooth operators ready to sell you a Latin American beachfront condo, Swiss bullion account or sure-thing Chinese stock, all wrapped up in an impressive-sounding trust or LLC. But of course these things aren't always what they seem, and separating the honest brokers from the predators is tough for beginners. So while we should all be moving some capital beyond the reach of our soon-to-be-desperately-crazy home governments, it's crucial to understand the risks going in.
Part one of this three-part series explored some potential problems with offshore bank accounts, trusts and insurance policies. Part two, drawn from a January 2010 article I wrote for CFA Magazine, covers gold storage and real estate:
GOLD STORAGE ACCOUNTS MAY NOT CONTAIN GOLD A traditional, simple way to move money offshore is to buy gold or silver bullion and have it stored in a foreign vault. Dozens of firms, ranging from Swiss banks to state mints to coin dealers offer such services. But they're not all what they claim to be.
"In 2001 I bought my first gold through a household-name Swiss bank. My Swiss banker promised me they would act exclusively as a private custodian bank, so the gold would be mine. But when I looked through the documentation - very carefully - it became clear that the gold was the bank's property and its liability to me. I was exactly where I'd asked not to be - on the bank's balance sheet [as an unsecured creditor]," says Paul Tustain, who subsequently founded Bullion Vault, a London-based gold storage firm.
Why do banks play such games? "Bank regulators accept physical, unallocated gold as a liquid reserve asset - i.e. as forming part of the pile of ultra-high quality assets which banks must prove to their regulator that they maintain at hand, to help them survive some future crisis," says Tustain. "The effect of gold being allocated to you - as your property, held in custody - is to exclude it from the bank's liquid reserve. So unallocated gold was (in my opinion) invented primarily to enable the bank to use 'your' gold as its reserve. When you sign the form which keeps your physical gold unallocated at the bank you are transferring your property and making an unsecured, interest-free, gold deposit to the bank. You are - believe it or not - allowing the bank to expand its balance sheet using your gold as the liquid asset which permits it! Banks love it, which is why they overcharge for allocated and make unallocated storage free."
REAL ESTATE MAY NOT BE REAL The ultimate offshore asset is a Brazilian beachfront condo or an Argentine ranch. It can't be forcibly repatriated, and it's there as a second home -- a nice second home -- if needed. But because it's the kind of purchase that most people make only once or twice in a lifetime, offshore real estate is a happy hunting ground for an array of predators.
"The single biggest mistake people do when they buy property overseas is that they don't follow the steps they'd take when buying property back home. They leave their common sense at the airport," says Margaret Summerfield, managing director of Pathfinder International, an Ireland-based real estate consultancy that specializes in Latin America.
"If they were buying property back home they would always have their own independent attorney. They would always check the title deed and the sale contract, and they would purchase title insurance. And then for whatever reason they go on vacation and see a property they love they think, 'great, let's buy that,' and they don't follow those steps."
One reason for extra due diligence is the fact that real estate rules and customs vary widely from one country to the next, says Summerfield. "In Panama to be a broker you have to be a citizen and take an exam. You have to be a member of the governing body." In Belize, on the other hand, there is no regulation whatsoever. "You can be a butcher today and set yourself up as a realtor tomorrow. You're not a member of a professional body, you've got no professional training, no insurance, no guarantee, nothing."
Conflicts of interest abound. "A lot of people when they're overseas will meet someone in a bar who says 'oh I know a great property down the road and I know the family and I can get you a good deal and I know an attorney who can help you out.' And they often end up using the developer's or seller's attorney. I know people who bought property in an area with title issues. They used the seller's attorney who turned out to best friends with the seller and it turned out that they didn't even own the land. It was just a scam."
The language barrier adds another layer of risk. "The legally binding sale contract is the one that's in the language of that country," says Summerfield. "You can purchase something in Panama or Costa Rica, and you'll be given a contract that's in English, but the binding one is in Spanish. So you should have an attorney look over the Spanish version and then get an independent translation."
Title insurance, while not automatically a part the deal in many places, is crucial in places with a history of political and economic upheaval. In 1980s Nicaragua, for instance, the Sandinista government confiscated property of its political rivals, in many cases without compensation. Some of those properties are on the market today, but their previous owners may still have viable claims. "So you have to be very careful when buying in Nicaragua to go back through the chain of title to make sure there's no confiscation, buy title insurance, and make sure you're covered if there is a claim," says Summerfield.
And then there are the squatters: "What people don't seem to think of is what happens when they're not there," says Summerfield. "Squatters [who gain property rights by occupying land or buildings] can move in, so you need to have a caretaker. But if you house them on your land you could be granting them rights to your property." One common Latin American real estate scam actually employs squatters to occupy recently-purchased properties. The apologetic developer then offers to buy back the now-worthless land at a discount. Once the foreign buyer has been fleeced, the developer chases off the squatters and puts the land back up for sale.
Latin America, of course, isn't unique. Every major offshore real estate market has its home-grown predators. Even before its meltdown Dubai, for instance, saw frequent reports of pre-construction apartments being sold multiple times, and developers collecting deposits and disappearing. In Cyprus, developers who sold properties with undisclosed mortgages are being jailed, leaving their victims are left to sort out the mess. One couple reportedly discovered that their property carries a delinquent mortgage totaling E164,000.
And in the U.S., the real estate bust has been a boon for scammers. To take one of dozens of possible examples, a New York con artist was recently convicted of fraudulently convincing 70 investors to loan more than $27 million towards the renovation of Manhattan apartment buildings.