By Gerald Tay (guest contributor)
I want to highlight the risk to investors of the latest money making scheme to sweep the property industry. Overseas properties are being heavily promoted at various property networking events. These properties usually come with a “Rental Guarantee.”
So What Is Rental Guarantee?
A rental guarantee means the developer is giving a buyer the certainty of rental income for a predetermined period, usually two years. This saves the buyer from having to look for a tenant, particularly in the coming few years when economic uncertainty and a rising supply of homes may drive up vacancy rates.
Some developers are offering 6 to 7 percent guaranteed returns for two or three years to entice buyers.
There are two types of Rental Guarantee Property Schemes offered to unwitting buyers:
- Developer’s Guarantee
- Multiple-Let Guarantee
1. Developer’s Guarantee
Here’s how this scheme can lose a typical investor $100,000 in two years: A developer has 150 units and needs to sell them for $450,000 each. But the market is over-supplied and their true value is only $400,000. The market rental is only $400 a week. At a purchase price of $450,000, the investor’s gross return is only 4.6%. Investors won’t find those numbers attractive.
Here’s where the deception starts. The developer prices the units at $450,000 and guarantees a rent of $520 a week for two years. This provides a return of 6%. It now looks good to investors.
The developer will lease the apartments on the true market value of $400 and make up the $120 shortfall to the investor. It sounds like the developer is making a loss, but it’s not. The cost to the developer to finance the guarantee of $120 a week comes to a total of $12,480 over two years.
But the buyer has paid to the developer $450,000 for a unit that’s worth only $400,000. The Developer has profited $37,520 upfront from the buyer. In a 150 unit development, the developer will make an extra $5.63 million by selling apartments for more than they’re worth to ignorant buyers. All thanks to a dodgy rental guarantee.
The investor ends up with a financial nightmare. When the two-year rental agreement expires, the investor has to find tenants in the open market at only $400 a week.
Previously, with the developer’s guarantee, the investors can earn $27,040 a year in rental income. Without the guarantee, that income has dropped to $20,800 a year. The investor’s returns have fallen from 6% to 4.6% overnight.
And the problem magnifies at the time of exit. If the investor decides to sell, they find themselves competing with developers selling new units with new guaranteed 6% returns on top of the other existing supply in the market. At $400 a week rental income and a 6% return expected by the next buyer, the apartment is now worth only $347,000 in the open market.
The investor has lost $103,000 in two years on “Fool’s Gold.” Many developers inflate the price of the property to factor in the rental guarantee as a “cost” of selling the property.
Investors need to think very carefully about the investment as it stands on its own – without any guarantee in place. The only buyers for such properties are usually foreign investors who are seeking yield. Locals will typically not buy or rent these properties since most are located at or near prime areas.
I know of many Singaporean buyers who fail to understand a fundamental rule when investing in overseas property: “Only invest in overseas real estate where the locals can afford to buy or rent. If your market consists primarily of foreign buyers and renters, you’re asking for trouble.”
2. Multi-Let Guarantee
It’s a simple concept: Rent a house, then sub-let the rooms to sub-tenants and make as much profit as possible.
The scheme involves property entrepreneurs acting as middlemen between tenants and landlords to sublet rooms. These entrepreneurs contact landlords directly or through property management agencies and offer long term guaranteed rent to buyers. They also offer to carry out minor repairs to the property and to find and manage tenants on behalf of the landlord. This means that willing landlords can avoid the day-to-day hassles of managing a property and at the same time enjoy a guaranteed revenue stream.
The tenant agrees to look after the property, take care of maintenance issues and in some cases even carry out a refurbishment of the property. Then, the tenant sub-lets as many rooms as possible to willing sub-tenants who are happy to rent a converted lounge or dining room and live in a house shared with six other strangers. The “renter” then creams a profit on the difference between the rent he is paying the owner/landlord and the rent coming in from the sub-tenants as a result of the multi-let.
Many property “gurus” claim to make high profits on their property portfolios without having to buy properties or raise large cash sums for renovations or a deposit. They claim to earn tens of thousands a month on the hundreds of properties they own. What they don’t mention are the dirty behind-the-scenes secrets.
Sub-letting of rooms is illegal in many countries. As well as making money from illegal sub-letting, these high-profile ‘gurus’ are supplementing their income by providing workshops, seminars and ‘How-to’ publications.
In many countries like the UK, Sub-Letting must be licensed by local councils and are subject to strict regulation. It can be costly to conform to these regulations and there are heavy penalties for letting out rooms without a license. It may even lead to repossession for breaking the law. Even if the landlord is unaware that their property is being used for sub-letting illegally, they may still be liable.
Some middlemen may pose as tenants, but then convert the property and sub-let individual rooms without the landlord’s knowledge. The first time the landlord may know that there is a problem may be when neighbours complain about the number of people living in the property. Sometimes the landlord will receive the agreed upon rent, but in other situations the landlord may never see a penny.
One case in which a Singaporean buyer shared with me was, his tenant took leases on cheap USA single family homes and illegally subdivided them into rooms. Up to fifteen illegal tenants lived in each house and the tenant didn’t pass on the rent to the real landlord. The owner’s property manager called him months later to inform him that his property was harbouring illegal convicts on the local police “Wanted” list! What followed was expensive legal action that turned out to be a financial nightmare for him.
Another rental guarantee scheme that goes wrong is the recent case of Eco House who suspended their global operations (including Singapore) leaving more than 2000 of their investors in the lurch.
How safe is my money?
My co-partners and I have been very successful investing in overseas properties. 90% of investors lose money because they ask the WRONG question, “How do we make money?”
They completely ignore asking the most important question which is the key difference between successful and loser investors, “How NOT to lose money?”
Words of Wisdom for Overseas Property Buyers: –
- Avoid ALL rental guarantee property schemes available in the market
- Rental guarantee is a paper promise – nothing else! Going for any legal recourse is a foolish action. Why bother getting yourself into such a mess when you can avoid buying it in the first place?
- Find and partner with a credible experienced investors in the country you want to buy into. Someone who has deep underground knowledge of the unknown terrain and who has done it many times before. Make sure he has a vested interest in you and your property.
- If the above is hard to accomplish, avoid buying altogether. Cash is king when better opportunity comes along in your home market.
- Buy only properties which locals can afford to buy and rent.
When buying overseas properties, a lot of things can go wrong. It’s a classic case of buyer beware: rental guarantees often guarantee investors nothing but heartache.
By guest contributor Gerald Tay, who is the founder and coach at CREI Academy Group Pte Ltd, an organization dedicated to empowering retail property investors with smarter investing philosophy and strategies. He is a full-time investor with over 13 years of solid experience in building his wealth through Property Investment and is financially wealthy today.