How guaranteed are guaranteed rental return schemes?

Some time ago, we received an email from an observer who was at a developer’s office. He narrated this incident where he witnessed an elderly investor who had just taken vacant possession of his investments, comprising four units of apartments with guaranteed rental return (GRR) schemes.

He demanded a full refund because the developer had terminated the GRR scheme, which, probably he was unaware of, was allowed in their agreement. To rub salt to the wound, the investor discovered the properties had depreciated in value by 25%!

Distressed over his failed investment, the elderly investor wept in full view of all present at the developer’s office. Did the “generous” developer give the investor any refund? Your guess is as good as mine.

In another case reported in the local papers, a group of investors have filed a legal suit against a developer whom they alleged had breached its GRR agreements. In our opinion, they were practically throwing good money after bad. Win or lose, the lawyers would collect their fees upfront.

Not as simple as it seems

While GRR schemes sound very attractive, investors need to know they are not as simple as they seem. In fact, they should be approached with as much caution as advertisements for fast weight loss pills, get-rich-quick ventures or striking the lottery.

Call them what you like – leasebacks, buy-to-let, cash back, own-for-free – they are all marketing names of the GRR scheme that developers have come up with to woo investors on yet-to-be-built properties.

Basically, developers would promise to pay buyers rentals ranging from 8% to 12% per annum, or a proportion of the purchase price for a certain period of time.

This kind of marketing, which has become increasingly common, sounds enticing to investors who do not want the trouble of managing their own investments. They buy the property, and they get the rental returns thrown in.

However, the buyer has no way of knowing whether the 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.

Moreover, terms and conditions in GRR agreements are not regulated by law. As such, inexperienced investors may not understand that the fine prints are often written in the guarantors’ favour. An example of such clauses is:

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.

Pitfalls

Generally, GRRs are best for laidback investors. Some people 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 had guaranteed rentals for just three years, what would happen in the next 17 years? You would probably be left to sink or swim on your own.

Developers will show a typical table of returns that show a surplus income, but potential buyers have to take into account the cost of maintaining the property, including taxes, mortgage payments and all other fees related to acquiring a property.

Under most GRR schemes, you will also be required to buy a furniture and fittings package 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.

GRR schemes specifically target investors rather than owner-occupiers, so when the term of the scheme ends, you may see 500 apartment units all going to the rental market at once. Imagine how many people would be chasing tenants then compared to how many prospective tenants there would be. Amidst the high competition, landlords would have to reduce rents to attract takers. Consequently, the market value of the properties would go down rather than up.

If you decided to sell, you would also be limited to mainly investor buyers, not to mention the competition you would face from developers offering higher rental returns with new developments.

Overpriced

When supply is more than demand, developers always look for ways to avoid reducing prices, and GRR is one of them. However, it will create a false economy in the long run if buyers end up overpaying for the properties based on the promise of attractive secure returns.

A guarantee is only as good as the company which underwrites it. Even if the GRR seems reasonable and is offered with honourable intentions, investors need to be sure that the developer would be able to sustain the returns if the rental or sale market were to take a turn for the worse.

If developers were to default on payments due to buyers, these buyers would likely default on their respective loan repayments, thereby setting off a cycle with dire consequences.

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 over time, but also using “other people’s” money (from rentals) to pay for the purchase. The reality, though, is the market is cyclical, and it is subject to the laws of supply and demand as in any other sector of the economy.

 Hence, before buying into a GRR scheme, investors should consider carefully the local market and competition, such as through doing a simple survey of the area. If market prices were lower than the proposed rent, incentives and discounts being offered by the developers, think twice, because then a rent decline after the end of the guarantee would be likely. You don’t want to end up with caveat emptor rental guarantees that guarantee nothing but heartaches.

No guarantee

Anyone who has any real estate experience knows there is no such thing as guaranteed rentals. Real estate, as with any other type of investments, has its ups and downs. There are times when you cannot find tenants. Any developer, investor club or any person who says that he or she is able to predict the future is bluffing.

Our economy goes through cyclical changes that respond 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 the developers, their shareholders and related companies would have snapped them up before making them available to the market? Why don’t they keep the units for themselves?

Should they be offered, guaranteed returns should be accompanied by documentary proof of a trust account – nothing more, nothing less. 

Datuk Chang Kim Loong is the Hon. Secretary-General of the National House Buyers Association (HBA). 
HBA can be contacted at: 
Email: [email protected]
Website: www.hba.org.my 
Tel: +6012 334 5676

This story first appeared in the EdgeProp.my E-weekly on May 14, 2021. You can access back issues here.

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