We often see developers, sellers, or even estate agents promoting projects with guaranteed rental income. In reality, the rental guarantee is provided in exchange of charging buyers higher prices.
There are two prominent promotional faces for this:
• They promote very high percentage returns as rental guarantee just to hook clients and to generate interest from investors, such as “25% guaranteed rent”. Once potential clients call them, they say it is 25 per cent over four years or so, which is still a myth.
Because when they advertise 25 per cent rental guarantee, they do it in a way that gives the impression of providing investors with 25 per cent per year. Maybe you and I can understand that it is impossible and it will never trigger us to make an enquiry.
But you would be surprised by the number of inexperienced investors that fall for this.
• They promote a high percentage per year as guaranteed rent, let’s say 8 per cent. In reality, they know it is impossible to achieve 8 per cent not just when it comes to the actual rent, but when you factor the occupancy rate it becomes even more difficult to achieve. So how do they still offer it?
Go with what’s already there
Developers are often guaranteeing a rent return without even having a ready property and without having a tenant on board. When the property is ready, tenants will not pay more than the market price, despite the developer’s agreement with the investor for a higher rental guarantee.
Which means the investor’s best strategy is to buy a ready property that is rented or easy to rent. If you don’t have the time to manage it, you can easily choose a professional property manager to do it on your behalf.
A false premise
Most developers tend to create a third-party limited lability shell company to guarantee the rent. So, the developer or seller as a legal entity is not the actual guarantor - it is a third-party that has no assets and no solvency power.
If for any reason they decide not to pay you, there is not much you can do, even if you take them to court. It is a limited lability shell company that can announce bankruptcy tomorrow and the actual entity that sold you the rental guarantee will remain untouched.
In most cases, rental guarantees are based on side agreements and are not part of the actual sale and purchase agreement (SPA). Which is, for the lack of better words, an act of fraud.
Multiple risks
On offplan projects, developers base the guaranteed rent on the completion date of the property. Which means, if the completion is delayed, which is the case for almost every project, rental income will be delayed and all the capital invested will be frozen without generating any income.
Any real estate sold on guaranteed rental income is for sure an overly priced unit. Because the extra amount they pay per year as guaranteed rent is surely added to the price of the property. Which means, forget about any potential capital appreciation, because in effect, you are buying a property at a much higher value than what it is actually worth.
So, even if the entire real estate market goes up by 10 per cent, the price of your property will remain the same.
Not recession-proof
What is the point of a rental guarantee if they pay only during good times? If that is the case, then you do not need the guarantee. Just buy a well-priced property and rent it.
Never buy expensive apartments on the promise of guaranteed rental income. If they can rent it, then so can you. Most guarantors defaults on rental payments during down markets.
In most cases, rental guarantees apply to select units that did not sell well. In other words, the least attractive units in a project. Which is another risk for investors, which will backfire on them when they are trying to re-sell.
Have a lawyer look it up
Get a real estate lawyer to read the sales and purchase agreement and most importantly to qualify the legal and commercial legitimacy and solvency of the actual guarantor of the annual rental amount.
Make sure the actual guaranteed rental amount per year is in line with the actual rental market price for such property.
Conduct thorough research on the seller.
Finally, ensure that the price of the property is not inflated. It has to be more or less in line with the market price.
The only legit rental guarantee:
• Is mainly on ready properties.
• The guarantor must have credibility, legitimacy and solvency power.
• Properties are rented to blue-chip companies on long-term contracts are often the best rental guarantee investment you can find.
• The annual guaranteed rental amount is reasonable and in line with market price.
Sooner or later, all playmakers in this fraudulent game will stink. The good news is that it does not take much research for new potential investors to learn about them.
I strongly believe that advertising any off-plan projects based on guaranteed rental amount needs to have the stamp of approval of the regulating authorities in any market to prevent possible frauds from happening. No developer, seller or agent should be promoting guaranteed rental income without obtaining the prior approval from the authority.
- Firas Al Msaddi is CEO of fam Properties.
