Understanding the exit strategy for an investment is one of the most queried elements of any property investment purchase. The 360 Series takes a look at Guaranteed Buy Backs - and why they may not offer the best exit strategy for you.
Are ‘Guaranteed Buy Backs’ too good to be true?
Yes. Buy Backs tend to be offered to overcome a prospective buyer’s objections regarding the exit strategy of their selected investment, that is stopping them from making a purchasing decision.
Developers sell apartments, or, rooms within a development off-plan in order to raise capital for them to utilise the investor deposits for the construction. Traditional development finance can be very costly with an average of 12-15% per annum on the sum borrowed; private equity from off-plan sales mitigates the amount of more expensive means of borrowing; required to complete the construction of a development, in addition to providing them with an exit strategy.
The majority of developers selling units off-plan will require a mixture of both private equity and development finance and do not have cash in the bank to fund the build themselves. If a developer had full funding, they could simply build and retain for 2-3 years to optimise their own personal gain.
So, how would a developer be able to guarantee a buy back in 5-10 years’ time if they are selling units off-plan to raise capital for the build?
The answer is ‘they can’t’, unless they have an onward buyer, who has already entered into contract to buy the units during the period of the ‘guaranteed buy back’. If the onward buyer has not entered into a contract, the buy-back is by no means guaranteed and can be subject to many terms and conditions.
What type of ‘Guaranteed Buy Back’ have you been offered?
It can be extremely confusing to identify the credibility of a buy back; therefore, it is prudent to find out the legal mechanism for the advertised ‘buy back’ that you have been offered.
Generally speaking, there are two legal mechanisms in place that are marketed as ‘buy backs’:
If you are being sold a property with a ‘guaranteed buy back’, ask your property agent which type of buy back the developer is offering, so you know what you are buying before you commit to a purchase.
Collective Investment Schemes and ‘Guaranteed Buy Backs’
Property investments sold with guaranteed buy backs should also be queried, as this could also result in classification as a Collective Investment Scheme.
If the ‘guaranteed buy back’ is in the form of a Call Option, this removes control from the investor. If the Call Option can be executed within the duration of an assured rental period, this is likely to classify an investment as a Collective Investment Scheme. For example, if an investor is offered a specific percentage net return for a period of 10-years and the Call Option can be executed within the 10-year period, this could result in a CIS classification.
Which exit strategy does PrinvestUK recommend?
PrinvestUK believes in complete transparency and if a developer intends to re-sell a development in the future to a corporate investor, hedge fund or pension fund, we ensure that our literature is clear as to whether or not the buy-back is guaranteed.
We do not believe that developer buy-backs should be relied upon to exit an investment property; therefore, the open market, selling via an agent or a High Street Estate Agent, is the recommended route to exit your investment.
As the recommended exit strategy is the open market, you need to ensure that the rental yield advertised is achievable, as a minimum by the end of the rental assurance period and not just a high percentage net rental return that is deemed to be attractive to encourage investors to buy a product at an over inflated price.
How does PrinvestUK ensure that net rental returns and in-turn an open market exit strategy is realistic?
PrinvestUK undertakes thorough due diligence on a product before we launch to the market to ensure that the investment stacks up on paper.
This is for two reasons:
Of course, future performance of a rental property cannot be guaranteed as there are many external factors that are beyond anyone’s control that may impact the rental income and the cost of managing your property, however, we can make an educated estimation by thorough research of local markets, seeking rental valuations from the local experts, looking at supply versus demand for the type of property and also taking into account industry publications, which detail historical rental increases in specific areas or regions.
This research has resulted in us offering property in some well-known cities across the UK and also some lesser known areas, as the investment proposition works extremely well.
We also ensure that the operating costs of a rental property are realistic and are taken into account. Many of the student accommodation investments and residential property investments that we sell have operating costs based upon similar existing developments that are fully operation. We believe that by using figures derived from actual operating expenditure will provide us with a more accurate idea of the likely costs that will be incurred to manage a development.
For further information on property investment and exit strategy, please contact PrinvestUK.