Investors are always being reminded to be wary about “guaranteed rental return” (GRR) schemes in Malaysia property market. It will not be surprising to see more and more guaranteed rental return (GRR) schemes in the next few years.
As developers seek creative ways to increase the appeal of their property in a more challenging market to come, more hybrid variations will eventually surface. Over the past two years many GRR schemes were offered. The concern here is, however, whether the developer will be financially capable of honouring it.
What is GRR? Why is it popular?
GRR, also known as leaseback, buy-to-let or cash back, is resultant of developers’ creativity in wooing investors with a GRR scheme on yet-to-be-built properties like condominium, hotel, retail mall, shop house, vacation property, etc. According to the plan, developers agree to pay buyers guaranteed rentals in a percentage of the purchase price for a stipulated period of time.
A guaranteed rental scheme can provide buyers with peace of mind, safe in the knowledge that buyers will receive a fixed income for an agreed time period. Many buyers like to use the guaranteed rental income to pay associated mortgage and maintenance costs. Additionally, the management of the property is hassle-free as the property developer or management company is responsible for this aspect over the agreed time period.
Many investors like guaranteed rental schemes because they do not want to get involved with the management of the property. Generally, GRR are best for the laidback investors. It has proven to be extremely popular especially among overseas investors who like to know their property is looked after throughout the year while they receive a return on their investment straight away.
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.
What is behind the scene?
The “guaranteed return” is indeed included in the purchase price already. Developers are pricing the property higher than the market price with additional sum equivalent, if not higher, to the guaranteed return. For example, a condominium project with guaranteed 5% annual rental for 9 years may imply that the final price from developer is at least 45% (9 x 5%) higher than the market price.
A quick check to see if the final price is justified under such scheme, is to ask: after deducting this 45% from the price, is the property still looked attractive enough compared to a similar property in the same area at current market price? You may probably use the same amount of money to buy 2 similar units in the same area without the scheme!
In the above example, the total amount of “rental return” for the 9 years is in fact an amount of cash you pay upfront to the developer, borrowed by you from bank if you finance the investment. The developer then returns it piecemeal to you without any interest while you bear all the interest charged by bank.
Meanwhile they still “temporary own” your property to do whatever they want to do for the whole 9 years since you signed a leaseback agreement with them!!! Either they use your property to generate more money for their own pocket or just leave it vacant, they have nothing to lose because they have already got all this money from you, in the selling price…
Think twice and calculate thrice before you invest in such scheme because most projects marketed with such marketing arsenal are implying a weak financial situation (insufficient cash) of developers. Such developers are considered as high risk builders who might not even be able to complete and deliver their projects in the first place.
The Boss, one of Klang’s hottest development projects, has come to a halt victimising 300 confused investors who were promised with attractive return. Most of the buyers were attracted to the guaranteed high returns of 7.5 – 8% a year by the developer. Being launched in 2012, most of the buyers received information in February 2015 that the development has fallen to the hands of a liquidator.
Rental guarantee could be important for some investors who need reassurance. However, the guarantee is only as good as the strength of the company offering it.
What must be checked up front?
Six points to check before you buy property with rental guarantees.
1. If the GRR is not part of the deal, would you still buy this property?
2. Is the property selling price justified in comparison to other similar properties within the same vicinity?
3. Does the developer have the capacity to build and manage the property, and ensure the income is generated? Assessment of developer’s background, style and planning of asset management must be included in the due diligence.
4. Is the rental income figure realistic and achievable in the current market where the property is located? If not, the investor will see a dip in returns once the rental guarantee period ends, which indicates a potential drop in the value of the property. Many unscrupulous developers will inflate the rental guarantee figures to create a good impression.
5.What is actually underwriting the guarantee? Is there an actual contract in place where there is a legal recourse should the income not be generated? If not, then this should be a cause for concern.
6. Do you understand all the terms and conditions in the GRR agreement? 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 (2) 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”.
A wise investor should check the small prints for any hidden clause that allows the developer to avoid paying the guaranteed rent and it is always a must to seek expert advice.
There are some good deals out there and some good properties with potentially very good returns. But even in such cases, part of the essential due diligence is to research whether the investment property represents good value and ascertain what the rental market situation is.
The rental market is volatile, depending on current competition and market conditions. It is a cyclical market, and is subject to the laws of supply and demand as in any other sector of the economy.
There must be real rental demand to substantiate GRR scheme or it will not be able to last through the entire term, especially if the units remain vacant. The scheme could eventually become disastrous when developers face difficulty filling up the units to fulfil their promised rental returns.
This article is contributed by me and Dr. Ong Kian Leong, founders of the first ever online property investment course for Malaysians, called Property Method. Dr. Ong Kian Leong (commonly addressed as Dr. OngKL), is the creator of GoFinanceTM, a tool that allows investors to accurately evaluate if an investment is worth investing as well as worth financing for maximum return. Claimed by himself as a student in the life-long learning journey, he is also the master trainer of Property Method and the blogger behind Real Estate Investment Blog.