Recently I have noticed a spike in the number of property investors contacting me to pursue payment of ‘guaranteed rent’.
This is when investors buy properties with a contract in place guaranteeing them rental income, with a minimum amount specified, but the guarantor fails to make payment.
This arrangement can be put in place for any property type but in particular it is commonly used for student accommodation which we have seen a huge increase of in recent years in Liverpool. It typically operates through a management agreement being signed at the point of purchase which sets out how much rent is guaranteed and for what period (often three years from the date of purchase).
This arrangement is often used as a marketing tool to encourage investment on the basis that, whether or not the property is occupied by a tenant, investors feel secure because they can expect to receive a certain level of rental income.
Whilst on the face of it this may seem to be a perfectly appropriate arrangement, prospective investors must be very careful before proceeding.
Firstly, ensure you know exactly who your guarantor will be. This is often the developer of the site. Developers are often subsidiary companies of much larger construction companies. Investors can act on the false premise that guarantees are backed by the larger company, when in reality it is often the case that the entity providing the guarantee bears sole liability.
Secondly, viability of the guarantor is crucial. When you have identified your guarantor, try and assess their ability to pay. In the first instance it would be sensible to review the entries at Companies House and to conduct general searches about the guarantor.
The effectiveness of any ‘guarantee’ relies entirely on this point. If the developer has cash flow issues, a lack of assets or has provided security to lenders then enforcing payment could be problematic. Even if everything appears positive, there is still an element of risk as circumstances can change. Also, there can be hundreds of units within a single development and if the guarantor has guaranteed three years of rent for each and every unit, this can present an enormous liability.
Thirdly, you should ensure that the management agreement is properly and fully executed. I have encountered instances where such agreements have not been signed which can render its terms null.
As with all investments, there is always an element of risk involved. Having a signed guarantee may seem to offer you protection but that guarantee is only as effective as the viability of the guarantor. It is absolutely essential that investors complete the proper due diligence before committing. This is particularly important if an investor is relying on the payment of rent to satisfy a mortgage or a loan they have taken out.