Why You Should Avoid Rental Guarantees

Be wary of rental guarantees when purchasing an investment property.  A rental guarantee is where the seller of a property guarantees to pay a certain amount of rent every week for a year or two after you purchase the property.  This means that they will find a tenant for you, but if the tenant leaves (or they can’t find one to start with) they guarantee to pay you the agreed rental amount.  You have to ask why they need to offer a rental guarantee to convince you to buy the property?  If it’s a good property you should have no trouble getting a tenant at market rent.  This is why I recommend that you avoid rental guarantees.

Rental Guarantees
If you’re offered a rental guarantee when buying an investment property – ask more questions!

Do they reduce your risk?

A rental guarantee is really appealing to a new investor because it is presented as taking away all risk.  So the purchaser knows that the rent they were told the property could rent for is guaranteed for that 1-2 years so they have no worries about meeting repayments because it will work just as the salesperson’s calculations said it would.

That’s fine for the 1-2 years that you get the rental guarantee but when you get to the end of the guarantee period you now have to get a tenant in at market rental rates.  If the market rental is less than you expected it to be, suddenly you’re having to pay more out of your pocket to cover the loan repayments than you thought you would, or have budgeted for.  If the salesperson told you that it would cost you only $5 per week to own the property, and the rent drops by $30 per week, you now have to find $35 per week.  That makes it a very different situation to the original scenario they showed you.

What happens at the end of the rental guarantee?

A rental guarantee is sometimes offered with the sale of new or renovated apartment developments because it gives purchasers the confidence to buy knowing that they will have rental income even if the other apartments are vacant.  If 30 people do the same thing though, when you come to the end of your rental guarantee period, so do the other 29 people, and now there are 30 apartments for prospective tenants to choose from.  This will put the tenants in the position to ask for lower rent from several of the properties and take the lowest rent offered, and will reduce your rental income.

The way around this?

I would never again take a rental guarantee.  I want to know what the market rent is for a property and have a tenant pay that.  You need to make purchasing decisions based on reality rather than on a temporary guarantee.  Let’s face it, if the property is worth buying as an investment the true market rent should be one of the major factors that confirm that the deal will work for you.  You don’t want anyone giving you a false figure for a short period of time and then find that the investment doesn’t work like they said it would at the end of a rental guarantee.  Where will the salesperson be at the end of the rental guarantee when you want to ask why you can’t get the same rent for your investment?  Long gone.

The rental market will go through ups and downs, depending on where the property is located and what’s happening with the local economy.  But if you have done your research and bought well you shouldn’t need a rental guarantee to give you a stable tenant paying reasonable rent.  As a ballpark figure, if I buy a property for $400,000 I want the rent to be $400 per week.  If you get more than that, fantastic!  If you get less, then perhaps you can see ways you can improve the property and later increase the rent; or you think the area will go up in value and then the rents will get higher, or you’ve made a personal choice to buy in the area and accept a lower rent for now.  We’re all different and the way we make decisions about property are influenced by our own experiences, and comfort levels.  Regardless of how you make your property decisions though, you want to know what the market rent is for a property you are interested in.

Avoid Rental Guarantees
If your rental guarantee comes to an end when rental guarantees on lots of other, similar properties do, you may have to lower the rent to get a tenant.

Check the market rent

To find out what the market rent is, ask the agent what the property is currently rented for if it is an established property that is rented out.  If it is a new property or is not currently rented out you can ask the agent but also confirm it by doing some of your own research for similar properties for rent on www.realestate.com.au or www.domain.com.au   If you are purchasing a brand new property, when the property is valued by your lender the rental estimate will be included in the valuation with examples of similar properties.  If you are buying a unit in a big development check what the rent for units outside the development is.  You want to be sure that your development isn’t creating a ‘bubble’ of higher rents because the properties are new and being heavily promoted, compared to the rents in surrounding areas.

Rental Guarantees and Loans

If you are taking out a loan on a property that has a rental guarantee be aware that lenders use their own valuation to work out what the property is worth, and to estimate the rent you will receive on it.  This is the figure that will be used to assess whether you can afford the loan repayments.  The lender will not use the rental guarantee figure because they are only interested in what the market rent for the property is.  Remember, lenders always want to know what the value and rent of a property would be if they had to sell it at short notice.  If the person or company selling you the property with a rental guarantee went bankrupt tomorrow, the lender wants to know what rent the market would pay.

Property investing is very exciting but don’t trust anyone else to do the research that you should be doing yourself!   Simply being aware of the local market can help guide you in making the best decision.  And this doesn’t mean that you need to live in or drive through the area.  There is masses of information available online so make sure you use it.  Ensure that any property you buy will bring in the rent you need at market value rent rather than relying on what could be a sales gimmick like rental guarantee.  In my experience if someone is willing to guarantee to pay the rent on your rental property for 1-2 years they are either very confident that they can get a tenant for that period, or they have built the cost of the rental guarantee into the purchase price.  If it’s easy to get a tenant for that period, then you don’t need a rental guarantee; and if they’ve adjusted the purchase price to cover rent for 1-2 years you don’t want the guarantee because you’re paying too much!!

I hope you enjoyed my insights into rental guarantees and if you have any questions about them or want to leave your own comments please do so below.  If you want to get my advice on your particular circumstances contact me through my Enquiry Form.

Happy borrowing!

Rachel

2 Replies to “Why You Should Avoid Rental Guarantees

  1. Thank you for posting this article. It is a great guide especially for those people who are into rental guarantees. I believe not all who are offering this type of service could result in disastrous scenarios. However, this is a good eye-opener indeed to help us in making decision. Great job.

    1. Hi Chanan,

      Thanks for your comment. Certainly there are rental guarantees that may suit some investors who are willing to pay more to have a ‘set and forget’ investment, such as those offered by the Defence Housing Authority. As long as investors understand that they are paying for any type of rental guarantee through increased initial cost of the property and/or management fees then they can make an informed decision. If it prompts them to do some extra research to check that they are getting value for money then I’ve achieved my aim!

      Happy borrowing!

      Rachel

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