You have probably seen the promotions: guaranteed 9% rate of return for first 3 years. It sounds very tempting as it is a turnkey investment with a high cap rate. You, as an investor, do not need to worry about finding a tenant, setting rent, handling management, yet your rate of return is guaranteed. These deals are often promoted by large agencies with flashy online or printed brochures, sometimes in travel or lifestyle magazines. For example, you may have read of the France Leaseback Scheme or Tourism Residences. Spreadsheets showing how much money you are going to make are also usually provided.
Sounds like a good deal, doesn’t it? What could possibly be wrong with it?
Like with anything else that sounds too good to be true, these kinds of deals are also too good to be true. Here is how they generally work:
The asking price is inflated by enough to cover the guaranteed rent or at least the portion of it that is above market rent. To justify the higher price, these are often new or “luxury” developments so there are no comparables. Not that any are ever offered anyway.
After the 3 years or 5 years of guaranteed rent, the management company announces that there are problems. The area has not developed as expected, the city did not put in infrastructure, the economy is bad, or whatever. Or they simply declare bankruptcy. They have already made their money on the front end, at the time of purchase.
It isn’t until this point, after the guarantee expires, that you realize that the rental income potential is not as high as you were led to believe, and that you overpaid and will not be able to resell without taking a loss.
In addition these guaranteed income schemes, there is often a homeowner’s association that possibly has to be voted out by the homeowners. They may be in bed with the manager and you have to rally a majority of the owners to kick them out. Otherwise they may be diverting part of your association dues to operations that should be paid for by the manager.
As is normally the case, if anything sounds too good to be true, it probably is. Do not fall for guaranteed rent deals. It really isn’t that hard to hire your own property manager and still have an easy investment. When you do it yourself, you have more control. There is no homeowner’s association that needs to be changed. Doing that financial analysis yourself, and calculating cap rate as described in previous articles, pays off in the end.