GRR schemes making a comeback

Focus MALAYSIA WEEKLY ISSUE 056

THE WEEK OF DECEMBER 28, 2013 – JANUARY 3, 2014

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By: V. Sanjugtha

Likely return of scheme with longer guarantee periods of 10-25 years

MARKET players are predicting the return of the notorious guaranteed rental return (GRR) scheme next year to lure in property investors, with longer guarantee periods of 10 to 25 years.

A source at a prominent real estate company, tells FocusM that the GRR will regain popularity and other similar schemes will surface next year as developers seek creative ways to increase the appeal of their property to investors after the government banned …. (DIBS), which were instrumental in aiding them to reach out to a larger portion of the market.

He explains that over the past two years many GRR schemes were offered, some by up to 25 years and the concern is whether the developer will be financially capable of honouring it.

“They will most likely meet the payments in the first year, but the real test will be the second and thereafter, whether they will have sufficient cash flow to meet the payment.  A lot of GRR schemes are already in trouble but it (the issue) is being played down to avoid raising an alarm,” he adds.

He opines that the incentive schemes offered by developers are an issue that should have been dealt with but Budget 2014 looked only into DIBS, leaving out the GRR, the issue of developers picking up the stamp duty and legal fees and the 100% loan offered to buyers.

When purchasing units with GRR, he advises buyers to thoroughly read the fine print and pull out immediately if they find certain clauses that are not to their advantage.

Paul Khong, executive director of CB Richard Ellis (Malaysia) Sdn. Bhd., too believes that developers will think up new incentive packages to attract buyers to their showrooms following the removal of DIBS.  He believes that GRR would be one of such incentives while more hybrid variations will eventually surface.

“Investors will be more eager to invest in property without worrying about repayments during the GRR term.  So it will obviously trigger sales,” Khong predicts.

GRRs, also known as leasebacks, buy-to-let, cash back or own-for-free are resultant of developers’ creativity in wooing investors with a GRR on yet-to-be-built properties.  According to the plan, developers will agree to pay buyers rentals ranging from 8% to 12% gross or net returns of the purchase price or a proportion of the purchase price for a stipulated period.

At housing loan rates of about 4.3% per annum (BLR-2.3%), such schemes appear attractive to the undiscerning investor  seeking a worthwhile investment.

He cautions the investors that the structure of the incentives such as the GRR scheme should be clearly understood, for example, buyers should find out the actual legal entity that is extending the guarantee and the credibility rating of the guarantor.  He advises a thorough analysis of the developer or the party giving he GRR, to ensure it is reputable and demonstrates the ability to withstand a continuous payment of guaranteed rentals over agreed periods.

Khong reminds buyers that over the years, many small players have defaulted in such GRR schemes.  He, too, stresses the importance of reading the fine print in the terms and conditions, especially the termination and renewal clauses to ensure buyers are not shortchanged.

Chang Kim Loong, secretary-general of the National House Buyers Association (HBA), echoes his fear of GRR schemes, warning that such agreements are not regulated by law.  He adds they contain a clause that allows the developer the right to terminate the GRR agreement by providing a written notice to the purchaser.

He advises buyers to also conduct a survey of rental rates in the vicinity to get a fair idea of the state of the local market.  If market prices are lower than the guaranteed rental, incentives and discounts being offered to woo the buyers are issues to be considered.

If the guarantees of rentals are higher than the existing market rate, then a rent decline after the end of the guarantee period is likely and buyers need to brace themselves for this as it indicates a potential drop in the value of the property.

Developers risk not fulfilling promised rental returns

Raising capital value compresses yields

Generally, yields in the current market conditions are compressed, owing to the rising capital value.  Khong says with a proper GRR scheme in place, it will make investors excited but there must also be real rental demand to substantiate this scheme or it will not be able to last through the entire term, especially if the units remain empty.

As such, industry players are worried the GRR scheme, should it return in force as an incentive to woo purchasers, could prove disastrous when developers face difficulty filling up the units to fulfil their promised rental returns.

However, market experts have expressed concern over the rising number of untenanted units due to compressed yields.  Many report that owners prefer to leave their property untenanted due to low rental rates and difficulty in obtaining tenants.

Property expert Ho Chin Soon, director of Ho Chin Soon Research Sdn. Bhd., cautions investors that the mismatch between supply and demand in the property market is expected to pressure yields further downwards.  Yields have been compressed for the past two to three years, especially in areas experiencing a high supply of residential property flooding the market in a short period, such as Mont’ Kiara and KLCC.

These are also the areas that have been reportedly experiencing low occupancy rates, with owners opting to let their property go untenanted.

Siva Shanker, president of Malaysian Institute of Estate Agents, says investors in the primary market are largely driven by the premise that the capital value of their property will appreciate exponentially upon completion with a buyer readily available or that rental income is higher or equal to the loan repayment and tenants are also readily available.

“Rental rates are not moving upwards.  With yields as low as 3-4%, some owners tell me they rather leave their units empty than go through the hassle of seeking suitable tenants,” Siva observes.

He adds that capital value is rising at a higher pace of about 10-15% on average and 20-30% in certain areas.

Allworth Real Estate Sdn. Bhd. principal and director Ong Goon Hong says rental rates are largely based on affordability, trending closely to factors like salary hikes and disposable income.  The prices of houses, on the other hand, have risen sharply due to inflation, mainly rising cost of material and labour.

Citing an example of a one-bedroom unit in Mont’ Kiara that would have cost about RM700 psf three years ago, today transacts for RM850 psf, signifying a 20% hike in price.  Rental, on the other hand, rose a marginal RM500 per unit over the three-year period.

Similarly in the prime city centre areas such as KLCC, Ong says there is a yield compression as prices of property rise more significantly than the rental rates.  A good location like V-Pod, for example, launched at RM900 psf three years ago with developers predicting rental could fetch circa RM4,000, translating to a yield of about 5-6%.

Today, prices have risen to about RM1,500 psf and the developer’s rental estimates hold, but the rising price tag on the property compresses yield at about 2.5%.  FocusM