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guaranteed rental property | Morality tales in bricks and mortar

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Failure is more instructive than success. That’s a lesson with which every investor – indeed, every human being – should be wearily familiar, but it often goes unobserved because success is much easier to talk about. So this week I’m focusing on a property investment that looks singularly bad: so-called ‘student pods’.

‘Pod’ is a marketing buzzword for an individual room in a student accommodation block. These are widely advertised to private investors on the basis of ‘guaranteed’ or ‘assured’ net yields of up to 10 per cent. Such figures sound exceptionally attractive – readers hardly need reminding how rare double-digit yields are in today’s low interest-rate world. But they come with at least four substantial risks, which in the unregulated world of buy-to-let investments are easy for developers and brokers to gloss over.guaranteed rental property

First, lettings risk. We have long vaunted the merits of the student-lettings market, but aggressive development may be leading to oversupply in some areas. Unite, the listed student accommodation player, this week warned that competition for projects was pushing up land and build costs in London. If embattled pod developer Middle England Developments is to be believed, the Liverpool market is also saturated.

Middle England’s management arm, which is called Penlake, has asked investors in its latest projects for a three-month “payment holiday” from their rent guarantees – a move that has unleashed a tidal wave of complaints on internet chat room propertytribes.com. Director Tracy Russell blames a combination of tuition fees, visa restrictions and overdevelopment. “Everything was running smoothly until September, but then we had a lot of students that didn’t show.” She is now trying to shut down Penlake, which she claims would cancel the guarantees.

The lesson here is that guarantees are only as good as the property market that underpins them. In the case of an off-plan pod development – whose appeal in the real-world rental market remains untested – the risk of an upset is significant. At the very least potential investors should call up a local estate agent to interrogate the developer’s rental assumptions.

There is also management risk. Unlike regular buy-to-let investments, student pods necessarily require professional management. If the management proves incompetent, it is extremely hard for the investors in a pod scheme to do anything about it. Without the manager’s help, they cannot find each other – let alone reach an agreement to employ someone else.

FreshStart Living, a Salford-based developer, last month agreed a settlement to hand over £131,000 in unpaid rent to 70 investors in a development called Montgomery House. Chief executive Charlie Cunningham admits it was a “balls up”, which he says arose when FreshStart decided to outsource management to a third party. He has since stopped selling to individual investors – a model he says is “very complicated to manage”.guaranteed rental property

The third risk is that a development is never built – or the land never even purchased. A number of investors have told me they purchased pods in schemes that were never started because the developer failed to complete the acquisition. In such cases deposits are supposed to be kept in escrow accounts with lawyers, but some still complain of lost funds.

guaranteed rental property

Finally, the resale value of the pods is unclear. The UK housing market may not be as hot as it used to be, but with about 50,000 transactions a month it remains reasonably easy to sell a home without taking an undue haircut. The same cannot be said with any confidence of student pods, for which no second-hand market has yet been established.

This problem is compounded by the widespread industry practice of subsidising the guaranteed rental yield. Take a proposed pod development in Canterbury. A company called Pinnacle MC Global is currently offering units for £59,995, with a 9 per cent five-year “assured net yield”. But that 9 per cent net yield is not fully covered by rental income, after management charges, until the sixth year of investment, according to the developer’s projections. The actual net rental yield, after ground rent, is expected to be 7.4 per cent in year one. “There is an element of subsidy in the first two years, until the rental increase year on year catches up,” the company confirms.

This model does not inspire confidence in the pods’ resale price, which will be based on rental income rather than a guarantee paid out of development profits. Pinnacle has given itself the option to buy back the property in three to five years at 115 per cent of the purchase price, which it says “offers an excellent exit strategy” – but it’s just an option. Investors simply have to hope the rental returns grow by 3 per cent a year, as projected.

When returns look too good to be true, they probably are – particularly when widely advertised in the mainstream press. I should know: market-beating deposit rates tempted me to put money in an Icesave deposit account in 2007, a matter of months before its Icelandic parent collapsed. No single experience has taught me more about investment.

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