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Swayed by guaranteed returns?
01/07/2005
Published in Malaysian Business - Housing & Property By National House Buyers
Association of Malaysia
CALL them what you like - leasebacks,
buy-to-let, cash back, own-for-free - developers have come up with creative
plans to woo investors withguaranteed 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 promised 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 investors. 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 GRRs scheme, 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 & 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 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"
One Purchaser's Nightmare
A fortnight 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 thedeveloper'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 in April 2005, a group of investors
filed a legal suit to claim from the developer whom they alleged had breached
their agreements.
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.
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