Look at the fine print in guaranteed rental returns

CALL them what you like leasebacks, buy-to-let, cash back, own-for-free developers have come up with creative plans to woo investors with guaranteed rental returns (GRRs) on yet-to-be-built properties.

Developers would agree to pay buyers rentals ranging from 8% to 12% per annum or a proportion of the purchase price for a certain length of time.

This kind of purchase, which has become increasingly common judging from the press advertisements, sounds enticing to investors who do not want the trouble of managing their own investments. You buy the property, and you get the rental returns thrown in.

While GRRs could be very attractive, investors need to know that the scheme is not as simple as it seems, much like ads that appeal to our desire to lose weight quickly, get rich fast or strike the lottery.

Realistic rentals

If a developer is offering GRRs, the buyer has no way of knowing whether that property is going to achieve the promise in the open market. The developer may not be able to get the guaranteed rent or the property may not be let out at all during the guaranteed period.

Pitfalls

Generally, GRRs are best for the laidback investor. Some people will value the “simplicity” of the deal. However there are issues that buyers have to be aware of and comfortable with before entering into such agreements.

A typical mortgage lasts 20 years. If you have a guaranteed rental for just three years, what will happen for the next 17 years? You are left to sink or swim on your own.

A typical table of returns will show potential buyers a surplus income. A potential investor has to take into account the cost of maintaining the property, the taxes that come with being a property owner, the cost of maintaining the mortgage and all other fees related to acquiring the property.

Under most GRR schemes, you will need to buy a furniture package with the apartment and commit yourself to the management charges and sinking fund of the building, on top of the regulatory quit rent and assessment tax.

These will often take a substantial bite out of any rental money left each month.

GRRs are specifically aimed at selling units to investors, so you may see a situation of 500 apartments all going to the rental market rather than owner-occupiers at the end of the scheme. You will need to consider how many people will be chasing tenants at the end of the guarantee period and most particularly how many prospective tenants there are.

In areas of high competition, landlords will have to reduce the rent to attract available tenants. Consequently, the market value of the properties will go down rather than up.

If you decide to sell, you will also be limited to buyers who will also be mainly investors. Sellers will also find themselves competing with developers who are offering higher rental returns with new developments.

Overpricing When supply is more than demand, developers always look for ways to avoid having to reduce prices. While GRRs may offer attractive secure returns, it will be a false economy in the long run if the buyer ends up overpaying for the property.

A guarantee is only as good as the company who underwrites it. Even if the GRRs seem reasonable and are offered with honourable intentions, investors need to be sure that the developer would be able to sustain the returns if the rental or sales market were to take a turn for the worse. If developers were to default on the payments due to buyers, these buyers will likely default on their respective loan repayments, thereby setting off a chain of events with dire consequences.

Terms and conditions in GRR agreements are not regulated by law. As such, the inexperienced investors may not understand that the fine prints are often written in the guarantors' favour. Example of such clauses:

“Provided always and it is hereby agreed between the contracting parties hereto that the Developer reserves its right to terminate the GRR agreement for any reason whatsoever by giving TWO (2) MONTHS written notice to the Purchaser wherein such a case the Developer's obligation to pay the guaranteed return to the Purchaser shall cease from the date of such termination. Such notice is deemed to have been received within three (3) days from the date of the letter”

Purchaser's nightmare

Quite sometime ago, we received an email from an observer who was at a developer's office. He narrated this incident where he witnessed an elderly Ah Pek who had just taken “vacant possession” of his investments, comprising four units of apartments with a GRR scheme. He was demanding that the developer “take back” the units and give him a full refund on the purchases.

The Ah Pek had discovered that the four units he purchased under the developer's GRR scheme had depreciated in value by 25%. To rub salt to the wound, the developer had terminated the GRR scheme as allowed in their agreement, leaving the Ah Pek frustrated with his “failed” investment. The elderly Ah Pek wept in full view of all present at the developer's office! Did the “generous” developer give the Ah Pek any refund? Your guess is as good as mine.

In another case reported in the local papers two years ago, a group of investors filed a legal suit to claim from the developer whom they alleged had breached their agreements. They were practically throwing good money after bad. Win or lose, lawyers collected their fees upfront.

Buyers beware

The rental market is volatile, depending on current competition and market conditions. People investing in these schemes are not just buying properties that they hope will increase in value in time, but also using “other people's” money (from rentals) to pay for the purchase. It is, however, a cyclical market, and one is subject to the laws of supply and demand as in any other sector of the economy.

GRRs offered to investors should be checked carefully against the local market and competition. A simple survey within the location will give an investor a fair idea of the state of the local market. If market prices are lower than the proposed rent, incentives and discounts being offered to woo the buyers, then this are issues to be considered. If guarantees of rentals are higher than the existing market rate, then a rent decline after the end of the guarantee is likely. It is a classic case of caveat emptor rental guarantees can sometimes guarantee investors nothing but heartache.

Anyone who has any real estate experience knows there is no such thing as a guaranteed rental. Real estate, as with any other type of investment, has its ups and downs. There are times when one cannot rent out. Any developer or any person (mind you) who says that he is able to predict the future is “bluffing.”

Our economic cycle goes through cyclical changes that response to economic and other happenings in, as well as, outside our country. Projected monetary returns that cannot be guaranteed (or self-guaranteed) are doubtful in nature.

Had it been so profitable, don't you think that the developer, their shareholders and related companies would have snapped them up before being available in the market? Why don't they keep it for themselves? Guaranteed returns should be accompanied by documentary proof of a trust account nothing more nothing less.

Chang Kim Loong is the honorary secretary-general of The National House Buyers Association, a non-profit, non-governmental, non-political organisation manned by volunteers. For more information, checkwww.hba.org.my or e-mail info@hba.org.my