Most of the real estate units that are sold to individual investors in UK, are coming with a rental guarantee. Who offers this guarantee, why do they include it in the package and how secure is it?
In most European countries the “normal rental yields” are quite disappointing. You would be lucky to have 2-3% rental yield, and you may have to deal with seeking tenants and changing light bulbs. On top of this, the tax man takes easily 10-15% as soon as you start investing. No wonder the market for buy-to-lets is under developed. Funds would have a similar or better return without the hassle. As a result, most people are buying to live, not to rent out and developers have little incentive to offer rental information. Let alone rental guarantees.
This is different in UK. Buy-to-let investors typically snap up more then 60% of new residential units. Rental income is key for them. Developers tap into this market by offering (and advertising) a rental guarantee.
The rental guarantee reduces the uncertainty of initial cash flow, as new buildings typically take 3-6 months to “fill up”.
Rental guarantee: gross or net?
Most advertised rental guarantees would range between 6% and 10%. Except in the real hot spots of course. In London the demand is high, the price levels even higher and net rental yields below 2%. A guarantee makes little sense. For residential units (typically 6-8%) and student flats (typically 7-9%) developers would typically give a 1-3 year rental guarantee. For care homes and hotel rooms, the operator would typically give a 5 or 10-year commitment of 8-10% and a buy-back guarantee.
Unless the developer goes bust (which seldom happens with the more experienced developers), this rental guarantee is contractually arranged and thus guaranteed. In most cases, you will need to pay ground rights (typically 400-500£/year) and sometimes other costs. It is good to check in the commercial documentation to make sure what is included.
Is this rental guarantee at market level?
The million dollar question is of course: is this guarantee at market level? Developers have been known to price their units significantly higher then the market, so they can afford to subsidize rental yields for a few years. It happens, but with today’s transparency in both sales prices and rental prices, it has become quite difficult to get away with. People can check on the internet in a few minutes what rental prices and sales prices are for comparable units. Selling 20% higher then market, in order to subsidize rental income has become all but impossible.
Typically, a developer will give a rental guarantee that is 5-15% above what the investor would receive with normal prices and normal costs. He has some leverage on the management companies, who will reduce their management fees in the first years, in exchange for the large management contract he provides. As prices increase on the average by at least 3%/year, the market rental income typically catches up with the guarantee by the time it ends.
We are checking for you
Obviously, we are checking for you whether the offer on the table is conform with the market and whether the guarantee provided is anywhere near the expected net market income. And of course we only work with experienced developers, who have a clear track record in building (and paying the guaranteed rental).
This does reduce the risk and avoids sleepless nights.