City & Country: The flip side of guaranteed rental returns

In 2000, Amy (not her real name) and her relatives invested their hard-earned savings to acquire nine serviced condominium units in Nilai, Negri Sembilan, for RM130,000 each. They were enticed by the developer’s offer of a guaranteed rental return (GRR) scheme of between 8% and 10% for 15 years.

The developer told her and the other buyers that the units would be rented to students studying in higher learning institutes nearby. The scheme would be managed by another property management company.

Six years later, in May 2006, Amy received a letter from the property management company which stated that the GRR scheme would be terminated two months from then. She found out that the students had been provided with hostels and that renting out the units was an uphill task. The value of the apartments has since plummeted by almost half.

TA Properties believes a GRR scheme gives homebuyers a chance to make money. It is offering a 7% GRR for two years on its 15 unsold units in Idaman Residences in the KLCC areaOver the years, there have been instances of unscrupulous developers failing to honour their GRR schemes, leading to a hefty depreciation in the value of the affected properties. This issue has come to the attention of the National House Buyers’ Association (HBA) but the association admits that homebuyers will be left holding the baby whenever a GRR scheme fails.

HBA’s secretary-general Chang Kim Loong views such GRR schemes as a gimmick and says they sometimes guarantee nothing but “trouble and nightmares”. “If the GRR is so good, why don’t the developers keep it for themselves? Why should they market a product when the GRR is better than [getting] bank interest?” he questions.

Too good to be true?
GRR schemes sound attractive, with guaranteed returns and capital appreciation envisaged later down the road. Developers may describe these schemes as “buy-to-let”, “cash back” or “own-for-free” to enhance their appeal and boost sales.

In essence, a GRR scheme is one where developers promise a guaranteed sum for a specific period to investors, who have to pass the units back to the developer or the appointed property management company to be managed.

Some property consultants describe the scheme as a “laidback” property investment option — developers sell the real estate as “hardware” and offer a guaranteed package as “software” to entice investors to buy.
Research and consultancy director of JS Valuers Property Consultants Sdn Bhd, Chan Wai Seen, says GRRs currently being offered range from 5% to 8% gross or net returns of the purchase price.

“Compared with the prevailing borrowing cost of about 3.5% [based on BLR-2%], GRRs are deemed attractive. To a certain extent, they are able to improve sales,” he adds.

Many projects have worked well with such schemes, executive director of Regroup Associates Sdn Bhd Paul Khong tells City & Country. These are usually projects in good locations in cities or resorts, undertaken by big players with a reputation to maintain.

However, he adds, many have also gone bad, with developers unable to honour their obligations because of poor take-up or rent for their products. In a few isolated cases, developers even closed down the companies and absconded.

Is it legal?
Are GRR schemes even legal? That would depend on the terms and conditions of the agreement, says lawyer Richard Kok.

“Generally, the concept of guaranteed rental return, which essentially means a developer agrees to pay a purchaser for the use of his premises after its completion for a certain period of time, is not illegal.

“Like any other contract, the aggrieved party can initiate legal action against the party in breach for specific performance and/or for damages,” he says.

If affected homebuyers think the government will come in and save them from their predicament, they are in for a disappointment. Property consultants say a GRR scheme is essentially a contractual arrangement between investors and developers and does not come under the purview of existing regulations governing property developers.

HBA’s Chang says there are hidden escape clauses in GRR agreements — such as “provided always” and “subjects to” — that allow developers or property management companies to terminate the agreement at any time.

The buyers discover later that the guarantee comes from a different company, perhaps a subsidiary of the developer.

“When you check, the paid-up capital of this company might be only RM2 and it means nothing. You can’t sue the developer because it is only selling the product to you. In the event a GRR scheme fails, you sue the other company and you have no case against the developer.

“And when you sue, you waste your legal fees because it is just a shell company. The worst is if it goes bankrupt and buyers can’t get anything, having wasted legal fees on suing a shell company. It is not worthwhile to sue. On the bright side, you still have a property, [even though] the GRR is worth nothing,” Chang says.

Similar to a deed of covenant, documents signed under a GRR scheme are side contracts and are not regulated by the housing ministry.

No recourse
So what recourse do affected homebuyers have? “It would be ideal if buyers lodge reports with the housing [and local government] minister in cases like this. Give the ministry a wake-up call and let’s do something about that,” Chang says.

He adds that property values will surely slump if a GRR scheme fails as the scheme would already have been factored into the initial selling price.

“Buyers should carefully check local market conditions and competitiveness [of the product] as well as whether the offer is realistic. As an example, a condo in a certain area may be priced at RM150,000, but developers may sell it at RM190,000 with a GRR scheme. The scheme has been factored into the selling price,” he says.

Property consultants generally advise home buyers to be aware of what they are buying into. They must understand clearly how the GRR agreement and its mechanism really work and how the parties are bound legally, as there is no standard template.

The credibility and reputation of the developer must definitely be the first thing that investors must consider. Property consultants add that genuine GRR schemes will be backed by insurance policies, financial institutions, big corporations or trust funds. For example, some developers in Australia offer GRR schemes backed by insurance.

Besides the selling price, buyers should also check if the returns are really offered at “reasonable market rates”. Regroup’s Khong says guaranteed returns should be offered at reasonable market rental rates that are comparable to those in the vicinity and not figures that cannot be justified. This is crucial for the guarantee to survive the agreed period.

“The worst-case scenario is when the developer does not pay at all and the company that extends the guarantee goes bust. Then there is virtually no recourse,” he adds.

Tang Chee Meng, the COO of Henry Butcher Malaysia Sdn Bhd, tells City & Country that investors should check whether developers are financially sound and capable of meeting their obligations under a GRR scheme.

“Make sure that the company operating the rental management scheme is experienced and capable of undertaking such operations profitably. The investor should also check whether the guaranteed return is calculated on a gross or net basis, that is, after deducting all operating costs, and what are the expenses he has to bear on his own.

“He should also find out when the payments will be made to him, whether it will be on a monthly, quarterly or annual basis. The investor should also not ignore fundamental issues like whether the project is situated in a good location and is priced fairly,” he says.

Sustainable schemes
GRR schemes can be a plus point if they work well. JS Valuers’ Chan says the properties must be investment-grade and be able to generate attractive rental returns as GRR schemes based on non-investment-grade real estate are frequently not sustainable.

He adds that the properties must be in strategic locations, be attractive and boast competitive building designs and layouts.

“Before buying a property with a GRR scheme, it is imperative for the purchasers to plan for the future use of the properties in the event the scheme is discontinued. Purchasers must then be prepared to take over and manage it. Failing which, the property’s condition or the project as a whole will deteriorate, contributing to depreciation in its value,” he says.

Henry Butcher’s Tang says it is normally compulsory for the investor to take up the standard furnishing package offered by the developer on signing up for the GRR scheme if the unit is not already furnished.
In most cases, homebuyers must buy furniture of a certain amount from a particular company. An industry observer says a standard furnishing package is necessary so as to offer the same package to the tenants.

Opportunity for buyers
Not all developers fail to honour their GRR agreements. TA Properties Sdn Bhd is among the developers that offer GRR schemes for their properties. Its senior manager of marketing and customer care, Roshan Menon, says the GRR scheme is a marketing strategy that gives homebuyers an opportunity to make money.

“The property market is a bit sluggish and bank interest is low. We created this opportunity [offering GRR schemes] to bring in investments from foreign prospects as well as Malaysians. Property is always a good hedge against inflation.

“Some people are against GRR schemes because some small developers have been taking advantage of it and cannot pay the homebuyers when things go wrong. On the other hand, some developers with financial muscle have executed the scheme well. For TA Properties, we allow buyers to use the first-year income to offset part of the 10% downpayment. If we are not sincere, we wouldn’t do that,” he adds.
Early this year, in an effort to boost sales, TA Properties offered a 7% GRR for two years on its 15 unsold units in Idaman Residences in the KLCC area. As at May, there were nine units left.

Homebuyers are reminded not to rush headlong into GRR schemes without doing their homework. Citing those who have been in the predicament before, HBA’s Chang says: “Learn from their mistake and remind others not to repeat it.”

This article appeared in City & Country, the property pullout of The Edge Malaysia, Issue 765, July 27-Aug 2, 2009


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