Paul Winder, our Senior Investment Consultant and Short Term Lets Manager examines rental guarantees, the figures and the need to know information before purchasing an investment.
I use my experience in the market to try to help out investors in areas where there are lots of offers and lots of figures that look very attractive and can be confusing, but sometimes the things that glitter are not always gold and sometimes they are exactly what they seem. This blog is going to explain what to look out for and what questions to ask, and the due diligence you can do yourself.
Rental guarantees are, fundamentally, a good thing, but they are there as security and ease really and the important thing to note and ask yourself is, what IF that rental guarantee was not in place then where would I be, there have been numerous stories of guarantees not being honoured, but there are also lots of stories where they have and you have very happy investors.
What is a rental guarantee?
A rental guarantee can take many forms, but in investment property they come in two forms, the first one will be a % return linked to the price of a unit which will be backed up by the developer, so the idea is that they commit to giving you £X per annum and if there is a shortfall off the natural return they make it up and any profit they keep, but ultimately the investor knows what return they are getting and do not have to worry about it.
There are other forms of rental guarantee that come direct from the managing agent and these will be their commitment to the landlord. For example, on the short term let accommodation and standard rental lets we run, we will offer the landlord a guaranteed rent in most cases which will be slightly below AST level but will also cover most of the running costs. Or they can choose natural returns where voids could come into play, so security versus potentially higher gains – the difference with this type of guarantee is that it is based on a case by case basis, whereas the developers return is sold with the investment at the start.
What properties come with a rental guarantee? The 3 main ones in the investment and hands-off sector are:
1) Asset backed properties such as Purpose-Built Student
2) Non asset backed investments such as bonds, car parking, Hotel rooms etc
3) Some Residential properties sold off plan
Are rental guarantee projects generally cash only investments?
Yes, regardless of whether it is residential or it states that mortgages are available – generally lenders do not like guaranteed properties UNLESS it can be proven the rental guarantee is based on AST figures and then it will be seen as secure because that is what lending is based on – security.
The reason why some will not get mortgages is explained below and hopefully that helps you see the logic. So if you see a project offering 8% NET returns on a £200,000 property and you think that looks amazing, be very careful because you need to know the facts and if you put your 25% down to secure the property and you can’t then get a mortgage then you are in some serious trouble.
Let’s look at the figures of the alternatives above:
Firstly, when you look at options 1 and 3 you have to look at them very differently to option 2 – with options 1 and 3 you still, and will always have a property to let regardless of the rental guarantee. You have an asset that is yours that can be rented out, so all is far from lost if the worst happens – whereas on option 2 you are actually investing in the success of a business.
For example, if you take the Hotel room scenario it is probably very achievable for a hotel room to generate 10% of the investment you made, but what happens if the other variables in that hotel fail. Guests stop coming and rooms are free, then that Hotel closes, you have literally no comeback – you may as well buy shares because that is the like for like – you don’t own a tangible asset, you own a share in a business.
Some facts and figures to back up the above:
One that works:
Using one of our projects: One London Rd – offer promoted and currently for sale.
Purchase price £69,999
Returns 10% guaranteed for 3 years = £6,999
Outgoings £350 per annum
Net return per annum to client = £6,649 per annum
WITHOUT rental guarantee based on current figures:
Same size unit in same developer unit completed this year – rent achieved £160 per week over a 51-week period
Income = £8,160 per annum
Service and management charges = £1200
Ground rent £350
Net returns per annum = £6,610 per annum
An Example of one that does not work: (worst case scenario but it is one I have seen on the market and in fact was offered to sell, but obviously refused)
Residential development on offer of £199,995 for a 2 bedroom apartment with a 8% NET rental guarantee for 2 years including service charges and management costs.
Net rental return per annum = £16,000 per annum or £1,333 pcm
If you include the service charges and management fees onto the actual amount the property has to raise to pay your rental guarantee that commitment is more like £18,000 per annum
Rent needed by the developer to pay you your rental guarantee would be £1,500 pcm
Postcode search for similar property and maximum rent £1,100 pcm
That is a £400 pcm shortfall or over 2 years that is almost £10,000
Problems attached to this.
In the best-case scenario, you get your rental return for 2 years (you are a cash buyer) then after year 2 your returns dip from 8% NET to approx 5% when they become based on real returns.
The more likely scenario:
A lender does the same calculations, realises the returns do not reflect the price and that makes the price over market price, with unrealistic returns based on ASTs against the apartment price, which would mean a refusal for lending because the instant assumption is that you have actually paid for your own rental guarantee.
Worst case scenario, your rental guarantee isn’t paid because the developer (based on a full occupancy (is having to make up 100 apartments x £10,000 over 2 years which is £1 million) does not have that money to cover the commitment.
So, the due diligence you need to do when buying a rental guarantee project is this:
- Work out the return based on the purchase price to a per annum figure
- Add the service charges and letting and management charges to this rental figure to have a total figure.
- Divide by 12 for the monthly figure
- If student find out the weekly rent figure for like for like unit.
- If residential find out the postcode and look for comparable rents.
- If they add up then great, if not then worry.
Do rental guarantee properties appreciate?
Yes, only recently one of our sub agents sold a resale unit after the 3rd year of a 9% Net rental guarantee had run out this September. Property bought off plan around 2015
Details – the client purchased for £60k with a 9% Net rental guarantee
After the 3rd year of receiving the returns he wanted to sell so now it is sold on the actual returns.
The rental per week was £155 per week at the time of selling on a 51 week agreement.
Gross returns per annum £7,905
Outgoings £1,450 per annum
Net returns = £6,455 per annum which in real terms would be a NET return of 10.76% per annum.
Sold offering a 9% NET return for £72,000 (of which £3,000 was a selling fee) so came out with £9,000 or a 15% profit
If you combine the 3 years of 9% which is £16,200 and then the £9k profit that is a profit of £25,200 over 3 years which is 42% ROI on investment in 3 years.
The above goes to show that a proven guarantee in a good market does show that cash investments are worth the investment as there is no debt on the cash invested and if you think 42% returns over 3 years is decent then it makes sense.
Paul Winder, Senior Investment Consultant and Short Term Let Manager
If you would like further information on any guaranteed projects or if you’d like help in identifying a property that meets your own personal investment needs, please get in touch with one of our advisory team today. Contact us on 01244 343 355 or get in touch via our contact form.
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