A rental guarantee can seem like the icing on the cake when you’re a property investor. You get guaranteed rental income for an agreed period if you can’t find a tenant for your off-the-plan apartment. What could possibly go wrong?

Unfortunately, the deal might not be quite as attractive as it first looks. That’s not to say all rental guarantees aren’t worth the paper they’re written on. Rather, you need to consider the potential pitfalls as well as the positives.

How do rental guarantees work?

 Imagine you’re considering buying an off-the-plan apartment priced at $600,000 as an investment. However, you’re concerned you might not find a long-term tenant so are rightly concerned.

To get the deal over the line, the developer promises you guaranteed rent if you can’t find a tenant for the property– say $690 per week for two years. In return, you’ll probably have to pay property management and/or administrative fees.

What are the advantages of rental guarantees?

 At first glance, the scenario above sounds like a no-brainer. The guaranteed rent gives you a safety net as it will likely cover your mortgage repayments. This doesn’t just provide peace of mind, but also means your investment is paying for itself – at least for the first two years.

What are the disadvantages of rental guarantees?

However, scratch below the surface and the gloss might start to come off. So the first thing you need to ask yourself is ‘‘who is really paying for the deal?’ After all, the money has to come from somewhere … and it’s unlikely the developer is footing the bill.

Unfortunately, in many cases, the guaranteed rent is factored into the initial purchase price of the property – which is bumped up higher than the market value. So, in the above example, the property might be worth, say, only $520,000 – $80,000 less than the price you paid. You may struggle to make up this difference when it’s time to sell.

The next question you should consider is ‘what happens when the rental guarantee comes to an end?’ You will have to find tenants in the open market – who may not be prepared to pay as much as the developer guaranteed. This shortfall in rent can impact your future cashflow.

Finally, consider whether the developer will even be around in a few years. If the developer runs out of cash or gets wound up for failing to pay its debts, you might be left whistling dixie.

Make an informed decision

 If you are tempted by a rental guarantee, always do your homework on comparable market values and vacancy rates first. This way you can make an informed decision on whether the deal is as good as it’s cracked up to be – rather than rely on the information the developer gives you.

Your due diligence shouldn’t stop there either. An expert conveyancer can give you advice on both the contract of sale and rental agreement – so you know exactly what you’re getting into before you sign.

Freya Southwell is a property lawyer at SLK Lawyers.