- New Mountain Investments
- Posts
- Is Investing in Costa Rica Risky?
Obviously, I believe the risk profile is good. That’s why I’m betting my next decade and capital on Costa Rica.
Since deciding to invest in Costa Rica, I hear daily, ‘You’re taking a HUGE risk.’
People often suffer from the “mere exposure effect.”
“The mere exposure effect describes our tendency to develop preferences for things simply because we are familiar with them….
Financial professions may be particularly impacted by the mere exposure effect. A 2015 study done by economist Gur Huberman found that financial traders were more likely to invest in domestic companies they were familiar with, even though this is not the most profitable or risk-averse strategy.”
I believe that most investors do not correctly calculate the risk profile of Costa Rica.
We mitigate our risk at New Mountain by considering these 3 different factors.
Macro Forces - I want to invest where macro forces have momentum.
Deal Fundamentals - I want the X’s and O’s on the investment to be in my favor.
Competent & honest management - I want to ensure the people running the investment are trustworthy.
1. Macro Forces
I’m not going to go into every reason why I believe the macro risk profile of Costa Rica looks great in this email, but it’s important to note we have decided to invest in Costa Rica largely for several macro forces that we firmly believe are in the works that will influence investments over the next 10 years.
I will often touch on one or more of these macro themes as I discuss our investments.
One of those themes is that we are seeing rising conflict worldwide and will likely see more sustained conflict throughout the next decade.
Historically, economies have often faced challenges when engaged in conflicts. World-leading countries tend to bear the primary financial burden when conflicts arise, as they often enter into the conflict earlier and are required to allocate the most significant resources.
If you’re interested in learning more about how wars affect economies, click on this link to see a study that was created in light of the Ukraine war.
2. Deal Fundamentals
When we were considering building out our last subdivision in Utah, we were going to build starter homes around 2500 sq ft. The deal originally looked like this:
It wasn’t a slam dunk, but a decent deal, and we liked the product.
Once we finished the improvements, we didn’t like the risk profile, even though we knew the fundamental supply/demand side was heavily in our favor and the margins were the same.
Although the margin hadn’t changed, the risk profile had gone up significantly since the cost to the consumer had gone up, and it was 100% dependent on rock bottom rates.
Local builders viewed the profile risk differently than we did, so we unloaded our lots at record-high prices for that location.
Let’s compare that situation to our project ‘Black Coast Estates’ in Playa Negra.
As you can see the projected margins are slightly below 40%. These homes will attract three separate buyer pools.
The first consists of wealthier Costa Rican buyers who have access to a mortgage. Historically, Costa Rican mortgage rates have been within an interest rate range much more aligned with current inflation rates, mitigating the potential rate shock factor experienced in the U.S.
The second & third group of buyers consists of foreigners primarily using cash or private loans at rates around 50% LTV. There is a continuous stream of new borrowing options for foreigners interested in buying homes.
The second group comprises wealthier retirees seeking a vacation home in warmer climates for the winter. This has been a growing trend among Guanacaste's traditional home buyers over the last 20 years.
The third type of buyer is foreigners seeking a different lifestyle for their families. There's a rapidly growing trend of people seeking new locations to raise their families—places free from political conflict, offering recreational opportunities, and featuring more affordable living standards.
In the next week's discussion, I'll delve deeper into my concerns regarding development in the secondary home markets. I'll review my strategy to mitigate these concerns.
3. Competent Management
Risk in development can also be mitigated by adopting specific business approaches throughout the entire process.
For instance, you can do multiple things while finding and purchasing a property:
Buy a property below market rate.
Implement fundamental changes to the property before closing, such as zoning alterations.
Entitle a property before closing.
We've already incorporated elements of these strategies into our Black Coast Estates project and intend to apply them to any future projects we undertake.
Currently, we're extensively researching various locations to determine our next purchase. We're evaluating different cities, property types, and deal structures. We will know the opportunity when we see it.