Can they work in South Africa?4th Sep 2020
Buying a property for rental is a big investment that is not without risk. So, can rental guarantees sweeten the deal?
What is a rental guarantee?
Rental income is key for investors, so developers offer rental guarantees as a way to entice investors to sign on the dotted line. A rental guarantee is usually a net return that a developer promises to pay an investor purchasing a buy-to-let property. The amount tends to be a percentage of the property price, and is paid on a monthly basis by the developer for a pre-agreed length of time.
Developers offer rental guarantees on off-plan properties before any tenants are in place. It’s a big thing in the UK, where buy-to-let investors typically snap up more than 60% of new residential units before they are even built.
There rental guarantees range between 6% and 10% for residential homes and flats, and between 7% and 9% for student accommodation over a one- to three-year period. Hotel rooms can fetch anything between 8% and 10% for rental guarantees spread over a 5–10-year period.
Even local councils in Britain, desperate to work with the private sector to provide much needed social housing, are getting in on the act. Milton Keynes City Council, for instance, offered a guaranteed monthly income of 10% above the Local Housing Allowance rate to landlords with a two-bedroom flat costing £722 a month.
What are the pros and cons for an investor?
Unless the developer goes bust (which seldom happens with more experienced developers), this rental guarantee is contractually arranged and thus guaranteed. It reduces the uncertainty of initial cash flow, as new builds typically take between three and six months to fill up. When the new development is eventually advertised to let, it often saturates the market, especially if it is a larger development. This gives tenants more choice, which in turn means they take longer to decide, actually move in, and start paying rent. A guaranteed rent period makes sure that the investor/home owner has an income regardless of this uncertainty and time factor.
Other advantages are that there are no unexpected costs for the investor, as the net payment does not include costs such as service charges, maintenance, and agent’s fees. These are all arranged and paid separately. In most cases the developer will start paying the guaranteed rent even if they run over with construction and completion deadlines, which is another huge win for the investor.
The only major catch is that nearly all rental guarantees tend to be cash purchases, regardless of whether they are residential or commercial property sales. This is because lenders generally do not like guaranteed properties.
So, does the developer make a loss in guaranteeing rent?
The answer to that is ‘no’, provided the developer is wise about its offering. In the past, some developers in the UK priced their units significantly higher than the market, sometimes up to as much as 20%, which enabled them to pay rental yields for a few years. However, this has become more difficult thanks to the internet and property price comparison sites, which make it easy for investors to see the true value of properties in the area.
Today, it is very unlikely for a developer to offer a rental guarantee payment unless they are making enough money to cover all associated costs, and then some! In up-and-coming areas, rent prices are likely to be on the rise, but a developer will still probably only offer a rental amount that is between 5% and 15% above what the investor would receive with normal prices and normal costs. As prices increase on average by at least 3% per year, the market rental income typically catches up with the guarantee by the time it ends.
Can it work in South Africa?
It definitely can, and there is certainly a market for it. However, because rental guarantees are cash purchases, they will only ever work for a very small number of investors. Rawson Developers, for example, are offering guaranteed rental income as part of their Newlands Peak development in Cape Town.
The developers claim that investors taking advantage of the special offer could break even as early as their second year, and start turning a profit the year after that, and those investors who take out a 25-year bond could break even from day one. The developers also hope that tenants could make use of the scheme to become owners, enjoying the incredible lifestyle and convenience of Newlands Peak for a fraction more than they are currently paying in rent.