Just days ago a colleague asked me about Guaranteed Rental Returns (GRR). He was about to buy 400 sq ft unit with a 6-year GRR return of 6 percent per annum. As it was his third property, he would put down a 40 percent down-payment. His main reason to buy? “Risk-free 6 percent returns every year for 6 years.” He added, “By the end of the 6th year, the developer told him that he could sell it back to the developer at the market price at that time or he could sign another GRR agreement with the developer.” The actual price per sq ft for the unit? Slightly over RM1,200 per sq ft. The targeted market for the unit would be visitors, both local and foreigners.
I told him that the decision is his to make but he should answer a few questions clearly based on his knowledge or do some due diligence. Assuming no GRR was offered, what was his thoughts for the property price. Are there other nearby high-rise which are similarly priced? Are they also on GRR? If yes, are the terms worse or better? Would the target market be the same as the new development? If the answer is negative for all the questions, I think the answer is very clear. This is not worth considering.
Next look at the entry price. If entry price is very high, would the next buyer be willing to pay even higher for it? Assuming the price today is RM600,000 and you would be selling it 6 years later, the price that you may want to sell should be at least mirroring the Fixed Deposit rate. (He was putting in HUGE downpayment…) RM600,000 x 4% compounded rate per year would be RM760,000. How ready is the buyer to buy it at RM759,000 and then to rent it out? Can the new buyer rent it out? Rental rates would increase over the years, definitely. However, can rental rates rise fast enough when the new buyer needs to buy it at RM759,000? This needs an answer too. It would always be best to buy into a GRR where the entry price is lower. In terms of unit size, this is still Malaysia, it is unlikely to be like the mosquito flats in Hong Kong. (180 sq ft) In future, no one knows but for now, not yet.
Can someone then buy over the unit for own stay? Sure but the question to all of us would now be, how close would the unit be to our working place? Would we want to buy the place for own stay if we are not working nearby? Due to the size limitation, it may not be a good choice for families. The unit MUST continuously have a good target market. For example, office professionals or students from a private university. I say private university because its students should be able to afford slightly higher rental than a small local college. Readers of kopiandproperty.com would note that I am pro-UK universities. Thus, in this case, Nottingham University in Semenyih as an example.
What about the area that he was buying into. Is this already a mature neighbourhood and his property happened to be the last one being built? If it is already the last one being built, then it would really depend on the popularity of the area currently. A popular area would always be popular and prices would continue inching up. A secondary area meanwhile would need time to rise since the whole area is still growing in both amenities, conveniences and even population. If the area is a totally new one without offices or even tertiary education institutions, who will he be renting the unit to? Look also at the developments nearby, are they integrated ones by big brand names. These help tremendously too. No one wants to have too many developers each developing a tiny little piece of land. Imagine the road networks…
Since GRR is everything about getting a good rental, do some due-diligence. How far is the unit from the rental market? If it is for office professionals, is this within a few km away? If this is for a private university, is this near enough so that students can even drop by their home in between classes? Students will always be students. Not all would love to stay in the university while waiting for the next class. Some may prefer to take a nap or even a good shower on a hot day followed by a cup noodle and playing computer games in their own room.
I told him that fortunately for many newer areas, the urbanisation is continuing with more jobs in the bigger cities. This meant that finding tenants from outside the state is definitely easier. Prices of homes nearby cities would rise first and in fact the average price per home in Kuala Lumpur was RM718k in Q3 2015. (Source: globalpropertyguide.com) Thus any property that we buy today, as long as the prices remain low by comparison should be quite safe. Unless some unforeseen circumstances happen which is beyond any calculations or expectations.
In conclusion, he has a BIG decision to make. Perhaps he can consider all the points before deciding or even make his decision ‘smaller’ by going for a lower entry priced GRR development instead. Even if risks are low in the sense that returns are guaranteed, it’s important to still manage them well. Happy thinking about a GRR project.