Guaranteed Rental Yields–Sweet, Risk-Reduced Opportunity Or Scam?
Years ago, I knew of a development project in New Zealand where the developer had offered investors a guaranteed yield from the rental of their units for the first three years of operation of 12%. Development sold out quickly.
After three years of operation, the 12% yield the investors had been enjoying plummeted to around 5%. That was all market rental rates at the time could generate on the original amount of the investment.
Meantime, other rental properties in the same market were yielding more–around 8%. In other words, not only had the yield fallen for the investors who’d bought into the guarantee, but the capital value of their units was less than they’d been led to believe (and than they’d paid).
Bottom line, the investors had overpaid for their units by enough to allow the developer to be able to return them the 12% per year yield he’d guaranteed. He’d paid them back with their own money.
Several months ago, a consulting client wrote to ask me about a development project he was considering investing in. The developer was offering a guaranteed yield, in this case of 19%!
My client is neither stupid nor naïve. He’d done his due diligence. What he had discovered was that the management company the developer had put in place had negotiated a contract with a travel agency that guaranteed to fill 80% of the rooms with their tour groups. He’d run the numbers, and the guaranteed yield panned out, as did a comparative analysis of purchase prices for comparable units in that market. My client invested. After he bought, unit prices increased, and the guaranteed yield was reduced for new investors, signs that the developer hadn’t padded the original unit prices to be able to pay the yield he was guaranteeing first investors.
So how can you tell when a guaranteed yield is a sweet, risk-reduced opportunity…and when it’s a scam?
Sometimes the amount of the guaranteed yield should tip you off. Too high is anything over 10%. Of course, that’s contrary to the example I’ve just shown you of a 19% guaranteed yield that I believe will play out to be a super-sweet play. Those kinds of opportunities come along but not often. More typically, a guaranteed yield in the double digits should make you suspicious.
Less than 5% is too low. Obviously, a 4% yield isn’t very attractive anyway (though, in our current 0% world, yields of even 4% and 5% have their charms). However, when a developer offers such a low guarantee it makes me wonder about two things–either the project isn’t a viable rental option…or the developer will be skimming the returns. If you find a guaranteed yield investment opportunity where the amount of the yield is less than 5%, one option is to state in the contract that the minimum yield is the guaranteed amount, but, if net revenue is higher than expected, you get the upside.
Just right is between 5% and 8%. This is the reality of what you should expect in the way of average net yield in an ordinary typical market.
Of course, extraordinary markets exist. These are opportunities to net more than 8% per year if you time your buy correctly. I’ve been earning net yields of 12%+ per year for more than three years from my rental investment in Panama City. It’d be super tough to buy today for that return, but, up until a couple of years ago, this qualified as an extraordinary market. Yields from an apartment bought more recently are going to be more like the norm (5% to 8%).
With some exceptions if you’re looking closely enough.
I told members of my Global Property Investor’s Marketwatch service about one such exception last month. It’s a condo-hotel opportunity in Panama City with projected average yields over the first five years of operation of 10.7%. Note that this yield isn’t guaranteed; it’s a projection that I was persuaded to find realistic after carrying out my due diligence. I like the developer, and I like what he’s building. His property will fill a viable and interesting niche in this marketplace.