From time to time we receive advertising material promoting new developments with the deal “sugar coated” by the offer of a rental guarantee.
On the face of it these offers look like a good deal with a guaranteed rental income for a fixed period of time…… but do you ever stop to think about who is paying for it?
If a rental guarantee is being offered you can be reasonably sure the developer believes the stock may take time to sell.
They believe a rental guarantee will give a potential investor some belief that the price they are asking can be justified and a level of peace of mind knowing that the rent will come in regardless of whether they can find a tenant or not.
Let’s have a look at an example to explain how a budding investor could be “sucked in” by this marketing strategy:-
A developer is marketing their latest offering of a purpose built townhouse development which is in a poor location and at a time when property is “off the boil”.
They realise the townhouses are not going to be easy to sell quickly in the current market.
Currently investors are looking for a 5% rental yield. The developer is hoping to sell each townhouse for $400,000 which means each townhouse at 5% rental yield would require a rent of $385 per week. However in this area the market for rent on equivalent townhouses is $325 per week at best, which is a rental yield of only 4.25%. There is little chance that a tenant can be found that is willing to pay rent of $385.
Here’s what the developer does……
They offer buyers a rental guarantee of $410 per week over say a two year period and price the townhouses for sale at $420,000. This price is $20,000 above true market level, but the deal now appears to be very attractive to an investor who hasn’t done their research.
The rental yield is now artificially bumped up to 5.07% return based on the higher $410 per week rental guarantee.
When the deal is settled, the developer pays the townhouse buyer the guaranteed $410 per week and rents the townhouse out at the going market rental rate of $325. This means there is an $85 per week shortfall costing the developer $8,840 over two years – but remember the townhouse was sold for $20,000 more than its true market value, so the developer is more than $11,000 in front.
Plus the developer has made a sale he wouldn’t have made otherwise.
At the end of the rental guarantee period of two years, the buyer of the property will have to lease the property on the open market. They have no hope of getting $410 because $325 is the true market level for rents in that area.
Having paid $420,000 they are now achieving a return of only 4.02% at $325 per week assuming it is let 52 weeks of the year – and, on that basis, they would never achieve a price of $420,000 if they tried to sell.
Because investors expect a return of 5% on residential property, the townhouse would fetch only $338,000 on the open market.
The investor has made a quick capital loss of $82,000 plus there are the purchasing costs like legals and stamp duty, etc. If the buyer borrowed the full purchase price of $420,000 at 8% interest, the investment would be costing them $33,600 in interest alone each year, whereas the rental return is now only $16,900…..this results in a loss of $16,700 per year.
This deception shows how critical it is to do your own research and know your market well….. ……remember, no business person will give a rental guarantee out of kindness.
It will most likely already be in the price tag of the investment. Please make sure you do not get tricked into buying an investment property just because a rental guarantee is bring offered.
At Property Friends we are continuously keeping up to date with the latest research and what is happening at “ground level” in the areas we select for our team. We also always strongly encourage you to do your own research as well. We take immense pride in our selection of property and our fantastic results are confirmation that we must be doing something right….in fact, A LOT RIGHT!!!!!
For daily property investment updates follow our Facebook page here.
Property Friends is a specialist Property Investment Strategist that provides solutions for people aspiring to financial independence, choices in retirement, or leaving a legacy. www.propertyfriends.com.au (03) 9758 5331