Guaranteed rental return schemes: Too good to be true?

 

Time and again, we have cautioned house buyers to be wary of the so-called ‘Guaranteed rental returns ‘GRR’). In the current weak market sentiments, developers will be ‘hanging the carrot’ to entice those naïve house buyers and laidback investors.

Property investors who are considering guaranteed (GRR) schemes, which promise a fixed rental income for house buyers for a certain period of time, should proceed with caution as such ‘schemes’ are not governed by the Housing Development (Control & Licensing) Act.

“The sale and purchase agreement (SPA) is covered by the Act and its Regulations but the GRR scheme is not. Thus, if there is a case it will be brought to the Civil Court as the Housing Tribunal has no jurisdiction.

We have posted the following simple questions with our easy to understand rationale and we hope readers will be able to comprehend them.

1. What is a GRR scheme?

CALL them what you like leasebacks, buy-to-let, cash back, or own-for-free: Property developers have come up with creative plans to woo investors with (GRRs) on yet-to-be-built properties.

Developers would agree to pay buyers rentals ranging from 8% to 12% per annum or a proportion of the purchase price for a certain length of time.

This kind of purchase, which has become increasingly common judging from the press advertisements, sounds enticing to investors who do not want the trouble of managing their own investments. You buy the property, and you get the rental returns thrown in.

While GRRs could be very attractive, investors need to know that the scheme is not as simple as it seems, much like ads that appeal to our desire to lose weight quickly, get rich fast or strike the lottery, it is more like sales and marketing gimmicks.

2. Pros and cons of entering into one, risks v. rewards?

Realistic rentals

If a developer is offering GRRs, the buyer has no way of knowing whether that property is going to achieve the promise in the open market. The developer may not be able to get the guaranteed rent or the property may not be let out at all during the guaranteed period.

Pitfalls

Generally, GRRs are best for the laidback investor. Some people will value the “simplicity” of the deal. However there are issues that buyers have to be aware of and comfortable with before entering into such agreements. A typical mortgage lasts 20 years. If you have a guaranteed rental for just three years, what will happen for the next 17 years? You are left to sink or swim on your own.

A typical table of returns will show potential buyers a surplus income. A potential investor has to take into account the cost of maintaining the property, the taxes that come with being a property owner, the cost of maintaining the mortgage and all other fees related to acquiring the property.

Under most GRR schemes, you will need to buy a furniture package with the apartment and commit yourself to the management charges and sinking fund of the building, on top of the regulatory quit rent and assessment tax.

These will often take a substantial bite out of any rental money left each month. GRRs are specifically aimed at selling units to investors, so you may see a situation of 500 apartments all going to the rental market rather than owner-occupiers at the end of the scheme. You will need to consider how many people will be chasing tenants at the end of the guarantee period and most particularly how many prospective tenants there are.

In areas of high competition, landlords will have to reduce the rent to attract available tenants. Consequently, the market value of the properties will go down rather than up.

If you decide to sell, you will also be limited to buyers who will also be mainly investors. Sellers will also find themselves competing with developers who are offering higher rental returns
with new developments.

Overpricing

When supply is more than demand, developers always look for ways to avoid having to reduce prices. While GRRs may offer attractive secure returns, it will be a false economy in the long run if the buyer ends up overpaying for the property.

A guarantee is only as good as the company who underwrites it. Even if the GRRs seem reasonable and are offered with honourable intentions, investors need to be sure that the developer would be able to sustain the returns if the rental or sales market were to take a turn for the worse. If developers were to default on the payments due to buyers, these buyers will likely default on their
respective loan repayments, thereby setting off a chain of events with dire consequences.

Terms and conditions in GRR agreements are not regulated by law. As such, the inexperienced investors may not understand that the fine prints are often written in the guarantors’ favour. Example of such clauses:

“Provided always and it is hereby agreed between the contracting parties hereto that the Developer reserves its right to terminate the GRR agreement for any reason whatsoever by giving two months written notice to the Purchaser wherein such a case the Developer’s obligation to pay the guaranteed return to the Purchaser shall cease from the date of such termination. Such notice is deemed to have been received within three (3) days from the date of the letter”

3. Has HBA received complaints about them?

Yes, HBA has received numerous complaints from naïve and unwary house buyers pertaining to GRR.

We have written and published many articles and appeared in interviews to forewarned buyers of the ‘gimmick’ of GRR. Buyers should be matured enough to seek knowledge to empower themselves to make an informed decision.

Purchaser’s nightmare

Quite sometime ago, we received an email from an observer who was at a developer’s office. He narrated this incident where he witnessed an elderly man who had just taken “vacant possession” of his investments, comprising four units of apartments with a GRR scheme. He was demanding that the developer “take back” the units and refund him in full on the purchases.

The man had discovered that the four units he purchased under the developer’s GRR scheme had depreciated in value by 25%. To rub salt to the wound, the developer had terminated the GRR scheme as allowed in their agreement, leaving him frustrated with his “failed” investment. Did the “generous” developer give him any refund? Your guess is as good as mine.

In another case reported in the local papers couple of years ago, a group of investors filed a legal suit to claim from the developer whom they alleged had breached their agreements. They were
practically throwing good money after bad. Win or lose, lawyers collected their fees upfront. The said housing developer has since been wound up by the Court of Law on the petition of Lembaga Hasil Dalam Negeri (LHDN) for failure to pay taxes.

They are not regulated by the governing Housing Ministry who issues license to housing developers. As far as the Ministry is concerned these GRR Contracts are between the buyers with the developers/ their subsidiaries/ hotel operators/ service provider and the Ministry has no role here to regulate them. The aggrieved victim could not even file their case with the Housing Tribunal as their type of cases is not within the scope and jurisdiction of the Tribunal for Home Buyers Claim.

5. Completely legal?

Yes, it is signed between two consenting parties and their terms and conditions are within the four corners of the Contract.

Buyers are advised to seek independent legal advice from their own lawyers and not to save on it the developer’s facilitated scheme of “Free Legal Fees”.

6. What recourse does someone have if they fall victim to a bad scheme?

If the amount of indebtedness is substantial and that it warrants a civil case against the party (offering the GRR); and that it is worthwhile to sue after conducting sufficient financial checks on the said party, then, go ahead to sue after negotiating a reasonable fees with your lawyers.

Consider whether it is worthwhile to ‘throw good money after bad’. Will you succeed to reap in the fruits of your successful litigation or just a mere ‘paper judgement’. Mind you the ‘paper
judgment’ is not even tax deductable. One could also try to file their case with the Consumer Tribunal whose jurisdiction is only RM25,000.

Buyers Beware

The rental market is volatile, depending on current competition and market conditions. People investing in these schemes are not just buying properties that they hope will increase in value in time, but also using “other people’s” money (from rentals) to pay for the purchase. It is, however, a cyclical market, and one is subject to the laws of supply and demand as in any other sector of the economy.

GRRs offered to investors should be checked carefully against the local market and competition. A simple survey within the location will give an investor a fair idea of the state of the local market. If market prices are lower than the proposed rent, incentives and discounts being offered to woo the buyers, then this are issues to be considered. If guarantees of rentals are higher than the existing market rate, then a rent decline after the end of the guarantee is likely. It is a classic case of caveat emptor rental guarantees can sometimes guarantee investors nothing but heartache.

Anyone who has any real estate experience knows there is no such thing as a guaranteed rental. Real estate, as with any other type of investment, has its ups and downs.

There are times when one cannot rent out. Anyone who says that he is able to predict the future is “bluffing.” Our economic cycle goes through cyclical changes that responds to economic and other happenings in, as well as, outside our country. Projected monetary returns that cannot be guaranteed (or self-guaranteed) are doubtful in nature.

Had it been so profitable, don’t you think that the developer, their shareholders and related companies would have snapped them up before being available in the market? Guaranteed returns should be accompanied by documentary proof of a trust account nothing more nothing less.

While it may seem very impressive for said property to increase in value by RM330,000 (or 16.5 times), we must remember that this appreciation occurred over a span of almost 40 years. We have worked out that the compounded annual increase for this property from 1977 to 2017 is 7.42%. However, a large factor for this increase is due to inflation and when we talk about inflation, there is always the official inflation rate and the ‘real’ Inflation rate borned by the rakyat.

DISCLAIMER: The opinion stated in the article is solely of and is not in any form an endorsement or recommendation by iProperty.com. Readers are encouraged to seek independent advice prior to making any investments.

 

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