Caveat Emptor

Recently there has been much hype with projects being filled up at a much faster rate than the 2nd half of 2008. Many people have been talking of a recovery in the real estate rebound. I actually beg to differ. Rentals are still falling, home prices seem to be accelerating in their decline. Personally I feel that if buyers want to make a sound investment, PLEASE PLEASE do your homework on the URA website. They provide good real estate statistics. Anyway, I personally am looking to invest in a private residential property myself. I came across this very interesting concept which caught my eye. The concept of guaranteeing rental yields.

Basically there are some developers and some open market sellers who will guarantee that you will collect a fee from them AFTER you have taken possession of the unit. ie. for a period of perhaps 1-3 years. This seems very attractive as then you as the buyer will not have to worry about having a good enough rental to service the housing loan. Sounds good? Let me do a little example for you and then you decide...


Developer X is selling a property called Lucky Apartments.

Selling Price: $1,000,000
Expected rental yield of about 3% per annum: $30,000
Loan repayment (Assume 80% loan at 4% interest rate for 30 years): $3,819.32

Result: The buyer has to find a tenant to rent the place to cover the monthly installments. If he attains the expected rental yield of 3% per annum, he will have $2,500 per month as rental. This is still a shortfall of $1,319.32 from his monthly installment. Due to the worsening economic crisis, jobs are scarce, tenancy rates are falling and thus he is put off by this investment.


Alternative situation----- >

Developer X is selling the same Lucky Apartments with guaranteed rental yields

Selling Price: $1,200,000
GUARANTEED rental yield of 5% per annum for 2 years: $60,000 per annum, $120,000 for the 2 years
Expected rental yield of about 3% per annum (we must assume the same rental as if it were sold for $1,000,000. The house didn't change. Only the price): $30,000
Loan repayment (Assume 80% loan at 4% interest rate for 30 years): $4,583.19

Result for buyer: Buyer thinks that this is much more affordable. Even if he doesn't rent the unit out, the guaranteed rental yield promised to him will be $5,000 per month. It totally covers his monthly installment of $4,583.19. On top of that he can still rent it out and collect even more! There is a higher chance he will buy!!!

Result for the developer: New selling price - Old selling price - Payouts of guaranteed rental yields = $1,200,000 - $1,000,000 - $120,000 = $80,000. The developer MAKES $80,000 more!!!

Who wins and who gains? I would ask the buyer, "Do you have an alternate plan after 2 years?" Basically after 2 years the buyer will have to service $4,583.19 instead of $3,819.32. There is an excess of $763.87 per month for the next 28 years! If the economy recovers and the property prices appreciates then he's safe. If the economy continues to worsen or even worse degenerates to a point when there is a margin call from the bank (ie. bank asks the buyer to top up the difference between valuation and outstanding loan amount), then I fear for the buyer. Don't forget, my discussion only assumes that the markup was 20% of the original selling price. It can be so much more! The debt could be exponential!

My advice: LOOK CLOSELY AND DO THE MATH BEFORE JUMPING IN! A moment of folly could cost you a lifetime of troubles!