07/06/2018 by Paul Winder
Rental Guarantees - The Good, The Bad and The Ugly....answered
To a lot of people the idea of a rental assurance is a very reassuring thought, and they are exactly that when they are in place, in fact more and more local estate agents are offering rental assurances on normal AST rental properties when they are in desired locations – everyone wins really, the agent potentially makes more money and the owner has security, but with just a small hit on the return – so for example, if you have a property that would normally rent for £700 pcm and the potential of voids (and the rule is you allow for 2 months void when working out your returns) and you are assured £650 pcm but without the risk of voids then that is a good thing (12 x £650 = £7,800 and 10 x £700 = £7,000) but obviously it is a risk reward thing and you may well not have any voids at all should you want the full amount, but it’s nice to have that comfort blanket in my opinion and then it is somebody else taking on the risk of getting a tenant.
So when properties are sold to investors that offer a rental guarantee, then it is an attractive feature, although understanding why they are offered is important, how they are managed and the “what happens if” questions are answered.
The majority of rental guarantee options are cash investments and revolve around student options but there are also plenty of residential developments that offer this option as well, it is worth noting on the residential side that lenders do not tend to like rental guarantees which might seem bizarre but they feel that the guarantee is somehow hidden into the price paid, it’s a flawed logic but in honesty it is the case on some developments (and how to see if it is pre-loaded into the price will be mentioned later).
What does a rental guarantee mean?
Under a guaranteed rent scheme, a landlord signs over their property to a company or letting agent for a specified period of time, in return for a guaranteed monthly/quarterly income. The agent then "lets" / "sublets" the property to tenants and manages the tenancy. Most schemes also promise to cover any void periods and maintenance costs.
This means that the owner is assured their agreed rent, and will be protected from void periods, they will also have all their management and letting costs covered, maintenance and any service charges – the management and service charges are still paid, but they are deducted from the gross rent to allow you your guaranteed rent – in some cases ground rent is also covered but in most it is not, this is a separate cost.
So why are rent guarantees offered and who manages it?
Simply because a management company feel they can fill the development, but they will only take it on if they manage the entire block, then because of economies of scale, and the fact they already have the man
power and systems in place, they can manage it for a fraction of what an individual could, or A.N Other management company could do - so again from a business point of view they can make more and can protect the investor from voids and then agree a % return that is attractive to the owner, pretty straightforward when you think about it. They will only aim to make a small profit from each unit over the allocated time of the rental guarantee but when you take a small amount and multiply it by 100 or 150 units then you can see why it works for them, and it is worth noting that you would not be able to make the extra they take by having another management company or by yourself because if those economies of scale.
Why do they issue them for 3 to 5 years generally, or more importantly why do we feel these are the best options?
This is always a question that is asked, and the answer is because they know that during that period they can sustain that level of income and then they will get reviewed – like any property you own, you would hope that rents increase after 5 years so why wouldn’t this be the same, this is why we do not advocate or promote 10 year rental guarantees, because you are losing out – it is a rental market right now and this is not going to change as they estimate that 2/3rds of millennials will rent for the vast majority of their working life and in particular student numbers are increasing year by year, particularly from overseas, so this means that rents are going to increase as demand increases and there is a lack of supply of suitable accommodation. So once your initial rental period is over you would be quite right to assume your rental returns will increase and any new assurance will be for more. So if you have a rent of £150 per week and this gives you a 9% return after deductions now on a £70,000 property and rents have increased by 3% per year (the most touted figure) then that £150 per week unit would now be around £200 per week in year 10 which would entitle you to something like a 14% net return – why would you want to be only achieving 9% from years 5-10 when you could get 12% and securing your returns and protecting yourself from voids.
How do I know my rental guarantee is fair?
That is quite easy to work out, but this is by far the most important factor when it comes to rental guarantees – you need comparable evidence, and that is it – so you need to know that if you were not offered a
rental guarantee, or it wasn’t in place that you would be achieving the same sort of return – for example if you know a functioning self contained studio operating in the same location and used for the same market place is achieving £150 per week then this gives you a annual return of £7,800 – your management, service charges and ground rent come to £1,500 then this leave you Net returns of £6,300. The property is costing you £70,000 and you are being offered 9% Net returns for 5 years – 9% of £70,000 is £6,300 per annum which means you know that your rental guarantee is not only achievable (and the management company, and the economies of scale, as mentioned before, can run the block for less that an independent, hence they can offer the protection) but it also a “real” return, meaning it has not been factored into the price.
But this can go the other way...
A client of mine asked me to give an opinion on a residential investment in one of the large cities – the potential buyer was looking to purchase a 2 bed apartment for £180,000 (and hoping to get a 75% mortgage) and it offered a 7% Net rental guarantee – now that sounds like a VERY appealing return, but once you broke it down it becomes a horror show. Based on the cost of the apartment, the net return per annum would be £12,600 – as the return was net then you have to take into account the management, service charges and ground rent which worked out to be £2,200 per annum. This means that the guarantee would have to be making sure that the income for the property would be £12,600 + £2,200 = £14,800 per annum to be a “real return” or to break it down, £1,233 per month. I did what any lender would do, googled the postcode, found like for like developments and found an equivalent apartment and looked at what it was renting for and it was £700 pcm – so take into account the additional expenses of £2,200 per year that the owner has to pay, this would be £700 x 12 months = £8,400, deduct the service charges of £2,200 and this would leave the investor with £6,200 per annum which equates to a 3.44% net return – under HALF the guaranteed amount.
So the question is obvious – how can they offer 7% for 2 years – the answer is unfortunate, because the rental guarantee has been added into the price, you have paid for your own returns, so in numbers you have probably paid an extra £12k for an apartment. What is worse, these are the same checks a lender would do – so it means they cant justify or approve the rental returns you are saying you have guaranteed and because you have effectively paid for your own returns you have an overpriced property and the valuation is declined, this means no mortgage and you either have to have the cash or you risk losing your exchange deposit – you may have the option of selling on before completion but you will only be able to sell it on at a real price so you would lose money.
To sum up
So yes, rental guarantees, when demand and the figure can be proved are a wonderful thing, they offer you security and zero hassle, but when they are merely used as an incentive and pre loaded into the price then you have a whole heap of trouble, and wherever you buy, if it has a rental guarantee then these are the first things you have to ask to be proved and provided to you.
If you would like any information on current options with rental guarantees that DO stack up then let me know, we have offerings up to 10% NET return on your investment and starting from a price of £49,995, or if you would simply like to have a chat about property investments in general then please feel free to contact Residential Estates by clicking HERE or phone 01244 343 355 option 4.