What is a Rental Guarantee?

What is a Rental Guarantee?

‍
Rental guarantees are offered by some property developers, selling off-plan property as buy-to-let investments.

The rental guarantee pays the buyer of the investment property a fixed return for a specified period of time from legal completion, regardless of if the property is occupied or not.

‍

Why do developers offer rental guarantees?
As part of a property developer’s exit strategy, part of the development is sold off-plan to buy-to-let property investors, which could be anywhere up to 2-years from completion. Selling this far off-plan attracts developer incentives, such as discounted pricing, or, rental guarantees.

Buy-to-let property investors will know that a newly completed buildings can take a while for rents to stabilise and achieved the forecast rental yield. This is called the stabilisation period, where a number of similar properties become available at the same time and the local market will require time to absorb the increased supply.

The stabilisation period of a brand-new residential property development can be anywhere from a few months to a year. For student accommodation it can take up to a couple of years, depending on the number of units available, specification, communal facilities and location.  

Guaranteeing the rent allows the property developer to control the overall marketing and management of the building, releasing availability in stages to avoid oversupply, using tried and tested property lettings agents. This also provides them with the ability to avoid buy-to-let landlords undercutting each other in terms of rent, which only undermines the development and can attract problematic tenants.

The property developer will in most cases subsidise the rental guarantee, by allocating funds from the completion money to cover the deficit between the market rent and the rental income that will be achieved.

Remember that he property developer wants the development to succeed from a rental perspective, providing buy-to-let investors with a great product so they come back and buy more in their future developments. Rental guarantees are fixed, so anything above what the developer pays the property investor, they retain. 

‍

How are rents guaranteed?

‍
There are two common types of rental guarantee:

1. Rental Guarantee – The term “guarantee” would suggest that there are funds placed in escrow, an insurance policy, or, a bond, however, the security of the guarantee should be assessed to ensure that the escrow cannot be used by the developer for any other purpose, or, an insurance or bond is backed by a UK underwriter, as recourse against an off-shore provider can be difficult.

2. Rental Assurance – The rental “assurance” is the most typical form of rental guarantee. The developer contractually guarantees either the gross rental income, or, the net rental income. This is typically assured by means of an Under Lease, or, Common Law Tenancy Agreement (CLTA), where the developer becomes the Tenant for a specified period in return for a fixed annual rental, which is either paid monthly or quarterly.

‍

Are Rental Guarantees too good to be true?

‍
This will depend on many different factors, including:

• How strong the rental guarantee is – is a rental guarantee or rental assurance being offered?
• Legal mechanism – is the rental guarantee provided by an Under Lease, or, Common Law Tenancy Agreement?
• How realistic the rental appraisal is – has the developer done their homework and sought the professional advice from multiple lettings agents in the local market?
• Cash flow forecast – has the developer fully understood the costs of management and rental voids and been realistic with the revenue from rental income for the period of the rental guarantee?

Rental guarantees can benefit the buyer and the seller, helping developers secure sales off-plan, which can de-risk a development and can secure cheaper rates of development finance. If the buy-to-let investors in the development are delighted with the product, the rental returns and the capital appreciation achieved, they will come back and buy more, so the developer enjoys repeat business.

The buyer can benefit from the assurance that their rent will be paid regardless of occupancy during a stabilisation period, whilst enjoying capital appreciation during the period of construction, typically with a small deposit.

The developer is highly motivated to mitigate the level of subsidy for a rental assurance, so they ensure that they appoint the best lettings managers in the area, to ensure that the rental income is optimised and the rents are increased year-on-year. If the developer guarantees the net rental income, they must also ensure that they keep the cost of the facilities management of the development lean and interrogate service charge budgets.

At the end of the rental assurance period, the buyer will have the benefit of a high performing property lettings manager, who they can continue to use and have the confidence that they will continue to optimise their returns to retain their business.

‍

How to I know if the Rental Guarantee is realistic?
Buy-to-let property investors should, as best practice, perform their own assessment on if the product being offered by a developer is credible.

Some areas that property investors should consider include:

• What is the likely gross annual rental return?
• What is the forecast appreciation of the gross rental between now and when the rental guarantee ends?
• How much are the rental management fees?
• How much is the service charge?
• How has the service charge been forecast? Have costs been based upon a similar development?
• What is the likely NET rental income?  

Regency Invest undertake a high-level of due diligence on each and every development that we sell, before we offer to the market as we want to ensure that buyers return. We welcome property investors to conduct their own due diligence before committing and ask our team as many questions as you like to ensure that the property offered meets your requirements.

‍