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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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