3 problems with rental guarantees you can’t ignore

Developers are getting creative when it comes to marketing properties to investors.

They’re coming up with incentives to get you to buy from them. Things like rental guarantees, cashbacks and furniture packs.

Right now the property market is slow, particularly for New Builds. So, developers are looking to drum up sales without reducing the price.

Rental guarantees can be comforting, especially for first time property investors. But are they all they’re cracked up to be?

In this article, you’ll learn the pros and cons of rental guarantees. Importantly, you’ll also learn the 3 problems with them (that you can’t ignore).

If you have any questions or thoughts, please leave them in the comments section below.

What is a rental guarantee?

A rental guarantee is when a developer says, “If you buy my property you will get at least $X of rent per week, for X amount of years. And if you don’t, I’ll pay you the difference.”

So, if you struggle to get a tenant, the developer will pay you rent anyway.

Let’s say your rental guarantee promises $850 a week in rent for the first 2 years of owning the property.

If you can only find a tenant to pay $750 in rent, the developer will top that up by $100 a week. That way you get the $850 promised.

It’s the same case if you can’t find a tenant. You get paid anyway.

These are increasingly common.

Wolfbrook offers a 2-year rental guarantee for investors who use their property management.

Here at Opes Partners some of the developers we’ve worked with have offered rental guarantees in the past.

Pros of rental guarantees

Many investors like rental guarantees:

#1 – It decreases the risk of not having a tenant.

If you can’t find a tenant, you get paid anyway.

That is especially a benefit if you are buying a New Build around Christmas … it can be harder to get a tenant around that time of year.

So, even if the rental market is cooler you still get money in your bank account.

#2 – It gives you more confidence.

Rental guarantees take away a certain amount of risk. They are designed to give property investors confidence.

You’ll know the amount you get every single week, for (usually) 2 years.

Many first time investors get anxious about not having a tenant, so rental guarantees can give some investors confidence to take the plunge.

After all, what’s the point in buying a $1m investment if no-one will live in it.

This rental guarantee can help take the anxiety away.

But there are cons too. Crucially, there are 3 problems with rental guarantees investors must not ignore.

Problems with rental guarantees (you can’t ignore)

There are cons with rental guarantees. Here is what first time property investors need to know.

#1 – You may pay more for a property with a rental guarantee

Rental guarantees cost money. The developer has to pay you money. To make up for this some developers will bake that cost into the price of your property.

A rental guarantee might cost the developer $10k to deliver, so the property’s price might be $10k higher.

So properties with a rental guarantee may be sold at an inflated price.

This isn’t always the case. But the risk is that investors think they’re getting something “free”. But the guarantee can come at a cost.

#2 – You may get lumped with a bad tenant

Developers tend to have conditions with their guarantees. For instance, you might have to use a property management company they own.

This is the case with a company like Wolfbrook. If you want their rental guarantee you have to use their property management company.

So you don’t get to choose your property manager.

But the real con is that it can set the wrong incentives. Your property manager might rent to the first tenant who comes along. That way the rental guarantee doesn’t kick in, so the developer doe sn’t have to pay any money.

There is a risk the person renting your property takes the first tenant, not the best tenant.

They might take someone with bad credit history and roll the dice.

But then what happens if you have issues trying to get rid of them? Residential Tenancies Act changes makes it almost impossible to evict unruly tenants.

#3 – You might get sold a “dud” investment property

Some investors think that a rental guarantee is the market rent for a property.

In other words, they think it’s the amount of rent they’d get if there was no guarantee.

That’s not the case. Some developers use this “sleight of hand” to make you think a property is a better investment than it really is.

Earlier in 2023, Golden Homes were selling a 4-bed, 2-bath property priced at $869,500.

It promised a rental guarantee of $820 a week for 2 years. So Golden Homes marketed the property as though it had a gross yield of 4.90%.

But on closer inspection, the rental guarantee was higher than the rental appraisal.

Golden Homes supplied a rental appraisal, saying the property would rent for $650-$675.

That’s up to $170 less than the rental guarantee per week.

That means Golden Homes calculated the gross yield on an inflated level of rent.

The actual gross yield isn’t 4.9%. It’s closer to 3.8% once all the costs are considered.

This matters because the rental guarantee only lasts 2 years. But most investors will hold this property for 15+ years.

So, there’s a risk that an investor will buy this property based on misleading numbers.

Then, after 2 years, the rent falls by $155 a week.

Some developers use guarantees to make properties seem like good investments, even if they’re not.

Why don’t developers just discount the properties?

Some developers want to give investors a reason to buy without lowering the price. There are two main reasons –

#1 – Bank has said property must be sold at X price.

Some banks require developers to achieve a certain margin. So rather than reduce the price, they offer a cashback.

In our view, they should generally just lower the price.

#2 – They don’t want to devalue property already sold

Many developers build projects in stages. For a development of 40 properties they might have:

• sold half the properties 6 months ago
• plan to sell the rest in 6 months.

But if they sold 10 properties for $800k 6 months ago … they don’t want to sell the remaining 30 at $700k. That’s because:

• You’ll annoy the first 10 buyers
• The first 10 buyers may need to get a valuation when settling the property. The valuer may see the other properties selling for $700k, so some buyers may not be able to settle and pay for their properties.

This is why developers often don’t want to reduce the on-paper price. Instead, they offer incentives to get you to pay an above market value.

Should I avoid rental guarantees?

Not every rental guarantee is bad. But many are.

If the property stacks up as a good investment, then a rental guarantee can still be OK. But the property must make sense even if the rental guarantee isn’t there.

But just remember: there is a reason developers offer incentives.

They’re used to encourage you to buy a property that isn’t getting sold.

Don't make a long-term decision based on a short-term incentive.

This is why you should do 1 of 2 things.

1) Use a property investment company.

These businesses specialise in finding New Builds as investments, so their information is more credible.

(Yes, Opes Partners is one of these companies, but there are others too. They are just a Google search away).

or

2) Go through all the developer’s information yourself. In detail. This is to make sure you fully understand what you’re getting into.