Guaranteed heartbreak?

CAVEAT EMPTOR: More and more properties are sold under a guaranteed rental scheme. NST RED examines what investors should look out for

Goh Ring Rong (not his real name) bought a medium-cost apartment several years ago hoping to cash in on the developer’s offer of a guaranteed rental return (GRR) of 8 per cent per annum for the next 15 years. He was sceptical at first but after the sales talk by the developer’s very persuasive salespersons, he was sold on the deal.

The sweetener that clinched the deal for him was the agreement that the developer had with the college next to the site of the still un-built apartments. The agreement stipulated that the college had agreed to rent the apartments, totalling about 300, from the developer for an agreed rental amount of up to 15 years, renewable at each five-year interval.

Two years went by, and Goh was getting anxious. He had not received his rental for the past six months, yet he was constantly called to pay up his maintenance fees, and other miscellaneous charges. When he finally went to view his apartment, which was at the outskirts of the city, about 40km away, he was shocked to see that there were 10 foreign workers staying there, not the three students that he was led to believe.

When he went to the developer’s office to demand an explanation, he was told that it was not the developer who was responsible. It was the management company that signed the contract to guarantee the rental that was responsible.

When he tried to contact the management company (which eventually turned out to belong to the same group of companies as the developer), he was told that it was never specifically mentioned in  the contract that the tenants must be students of the college, or any student for that matter. They even rubbed salt in to the wound and said that for all they know, some of the workers could be part-time students too.

In any case, they revealed that the college had closed down, thus they were trying to mitigate the situation by renting to anyone that they could find. As rental payment by the foreign workers were not regular, they could not pay him the ‘guaranteed’ rental. As the other 299 units were also looking for tenants, it was an oversupply situation and he was lucky that they could still find tenants even though they were not regular in paying their rental.

If the situation persisted any longer, they might have to terminate the agreement which they insisted they had a right to under the Guaranteed Rental Return Agreement which he had signed with them.

To make matters worse, as Goh had depended on the ‘guaranteed’ rental payments to pay off his loan instalments to finance the purchase of the apartment, the bank had wanted to foreclose on his unit for non-payment.

The above is a hypothetical situation of a worst-case scenario that could happen to the unwary (and unlucky) investor of a GRR-linked property in Malaysia.

In fact, some similar scenarios have actually ended up in court, and for the most part have been thrown out for, as the developer in this hypothetical story pointed out, it’s provided for under the GRR agreement. (Read: fine print).

In one case, it was decided by the court that the banks should not be made responsible for the ‘bad’ investment decision made by the buyers even though the Sale and Purchase Agreement was alleged to be illegal due to the alleged misrepresentation by the developer that a university town would be built at the location of the units.

There is also anecdotal evidence that when the guarantee period is over, the purchasers discovered to their shock that both the market price and the rental amount that they could get from their investment were way below the projection of the developer.

‘Eyes wide open’: Needless to say, one has to go into a GRR scheme with eyes wide open. The perils are many but for the investors that have done their homework well, the payoff is handsome and for such a minimal amount of work too.

“A guarantee does not mean that it is risk free! Even an AIG insured scheme does not provide total protection in a worst-case scenario. Conditions can change rapidly especially for private
institutions,” Brian Koh, executive director of DTZ Nawawi Tie Leung Property Consultants Sdn Bhd, said when commenting on GRR tied with educational institutions.

“You have to check and compare what the pricing difference is if there is an option for a non-GRR unit. As a smart buyer, you have to be aware that there are no free lunches,” he adds.

Chris Yong, principal of Rochester Properties agrees.“Many times, it could be just a sales gimmick or a pricing strategy and the price has already been factored into the purchase price.”

Chang Kim Loong, Honourary Secretary General of the National House Buyers Association (HBA) says they could be called by many names such as ‘leasebacks’, ‘buy-to-let’, ‘cash back’, or ‘own-for-free’. Chang has listed a number
of pitfalls that unwary buyers could fall into, among them:

• What happens after the expiry of the guaranteed rental period in cases where the period is a short two or three years while your mortgage lasts 20 years? Five hundred other apartments may be vying for tenants at the end of the guarantee period. When there is a surplus, the market value and rental will fall.

• A typical table of returns in a developer’s brochure or website will show potential buyers a surplus income. However, there are other costs that a potential investor has to take into account such as the cost of maintaining the property, the property taxes, quit rent, the cost of maintaining the mortgage including interests and all other fees related to acquiring the property including legal fees and stamp duty.

• Under most GRR schemes, you will need to buy a furniture package and pay to maintain it.

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

• Terms and conditions in GRR agreements are not regulated by law. Often they are drafted in the guarantors’ favour, for example it provides for the developer to terminate the agreement
for whatever reason at any time by giving notice.

Trustee or insurance: Chang advised that guaranteed returns should be accompanied by documentary proof of a trust account or insurance guarantee.

He adds that any additional cost and expense including that of insurance premium will always be factored into the sales price of the developer’s product. “Developers are profit oriented and will surely not reduce their profits. Similar to bank guarantees issued by financial institutions, developers will only issue such guarantees when they have collaterals pledged against such guarantees. Such form of guarantees has an expiry date whereupon it will lapse, if not extended or ‘cashed-in’ within a time frame. Insurance guarantees too are in such form,” explained Chang.

The HBA secretary-general adds that there are cases where some reputable universities have pulled out after discovering the breaches of the developers and their subsidiaries which have offered GRR.

This is why the reputation and financial strength of the developer should be a paramount factor when considering buying a GRR-linked property, advises Koh of DTZ. ‘You should also examine how the guarantee is structured and see whether there is any buyer protection as in trustees.’

Ho Hon Sang, managing director, Property Development, Sunway City Bhd, concurs, saying that purchasers must ensure that the developer is reputable, financially stable, a long term player and has a good track record in property investment. ‘Most importantly, the asset must be well-located, and is easily accessible by public transportation particularly the MRT (Mass Rapid Transit).’

 

Chang …“Guaranteed returns should be accompanied by a trust account or insurance guarantee.”

Ho … “Purchasers must ensure that the developer is reputable, financially stable, a long term player and has a good track record.”

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