Why do developers offer rental guarantees?

Feb 8, 2017 | Emerging Trends

Most of us are naturally sceptical when we see attractive offers. We always assume that there is a catch or that something is “too good to be true” but often this is not the case. There is often a mutual benefit to offering an attractive return and if this attractive return isn’t offered, then no one would take up the offer. In effect the whole deal falls through without offering a ‘carrot’.

An attractive offer that is available at the moment in a number of areas is rental guarantees on investment properties. Demand is high at for property rentals for a variety of reasons so therefore the number of properties needed is also on the increase. To increase the supply of rental properties you have two options, the first is buy existing properties and turn them into rental properties, the second is to build purpose built rental properties. Both options have their benefits but we will concentrate on the new properties.

Assuming that you build new properties, you must initially find a developer who is prepared to construct such units. There will obviously be a significant amount of risk involved in this from a developers’ point of view. They must buy the land, they must construct the building and of course they must sell enough units firstly to have sufficient cashflow and secondly to make the desired level of profit.

 

The developer could of course put all of the capital in themselves but this by no means guarantees that the units will be sold, just that they will be constructed – rather risky from their perspective. Therefore, to reduce the risk that they are exposed to the developer needs to encourage the early sale of units, thus freeing up cashflow. This could be done by reducing prices – something that is no doubt effective but reduces profit margins or alternatively you could offer a different incentive.

The rental guarantee is therefore an attractive option. The developer maintains their profit margins but raises the capital required to complete the project therefore reducing their risk and exposure. The problem then comes from an investors perspective. They will be required to pay a significant sum, leave it tied up for ‘x’ number of years with a certain lack of liquidity. Obviously, the investor needs to be compensated in some way.

The ball is then back in the developer’s court. As they have generated the profit margins that they initially aimed for with the sale of the property, they now need to offer something back and it obviously must be greater than that offered by other investment vehicles. The return must be over a ‘reasonable’ time period, twelve to eighteen months would not be attractive so 10% p.a. over five to twenty years suddenly becomes very attractive.

This is the deal that is being offered by the New Nordic Group who are located in Pattaya, Thailand. They have dozens of properties already completed and have been offering the same scheme for around a decade. They always use the rental guarantee incentive to generate capital for new projects and this has proved hugely successful for all parties with many existing investors continuing to buy more units.

The company has well-established links with domestic and international tour operators therefore guaranteeing bookings months and in some cases years in advance. They could quite easily fund the projects themselves but favour the rental guarantee approach to reduce risk and ensure that they have sufficient cashflow. It is therefore a win, win situation for both developer and investor as both parties gain the returns they are looking for whilst being exposed to minimal risk.

You can certainly understand why developers and investors find this sort of investment very attractive.

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