Be cautious of guaranteed rental returns

Buy-to-let investors should be wary of property developments offering guaranteed returns, ensuring their cash flow can sustain lower rentals when the pledge period expires.

Andrew Schaefer, MD of Trafalgar, said in the market where the demand for affordable housing outstrips the supply, South Africa has experienced a burgeoning of the buy-to-let investor. Multi-million-rand investments were now luring investors into purchasing by offering a guaranteed rental income, some in the region of a gross rental income up to 10% in the first year after transfer. This was almost double the average currently earned by most buy-to-let investors.

Schaefer warned that these rental returns were built into the price paid for the development and that after the guaranteed period, investors had to consider whether their cash flow could sustain funding the short-fall. Tenant knowledge of market related rentals, he noted, was sound and should not be ignored.

He cautioned that most cities have an oversupply of rental properties in the upper-middle-income bracket and thus sustaining 10% yields in that market was unlikely. “Investors cannot be lulled into a false sense of security and must be able to match the negative cash flow from the second year onwards,” he said.

The guaranteed returns initiative evolved from a hotel development concept where investors own rooms rented back into the hotel pool. In return investors have access to that room for a specific number of days annually.

The concept has shifted to apartment developments - some of which Trafalgar manages on behalf of the bodies corporate – but the problem arises when market-related rentals come into play at levels lower than the guaranteed yields.

However, Schaefer acknowledged there was a silver lining in that Trafalgar anticipates rentals to experience double-digit growth annually over the next five years, particularly in the inner cities and areas ripe for redevelopment.

“Construction costs continue rising and that is bullish for rentals. An average two-bedroom flat is commanding monthly rentals of R4 000,” he said.
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