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Pre-Construction Sales Incentives

Rental Guarantee or Property Management with Rental Assurance 

 

WHAT IS A RENTAL GUARANTEE (aka LEASE GUARANTEE)?

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A Rental Guarantee also known as a Lease Guarantee (RG/LG) is a monthly rent payment from the Developer/Builder to the Purchaser commencing on occupancy and expiring on the final month of the agreed term. Typically, RG/LG are for two years and are calculated annually as a percentage of the pre-tax purchase price of the property. For example: if a property is valued at $380,000 pre-tax and has a rental guarantee of 5% of the purchase price for two years, the annual payment would be $19,000 which equates to a monthly payment of $1,583.33 for 24 months. An easy way to understand the value of a RG/LG is to see it as the Builder being your tenant for two years.

 

The payment is normally a gross monthly fee which means that the Purchaser is still responsible for condo fees, HOA fees (if applicable), property taxes and utilities on top of their normal mortgage payments.

 

A deeper dive into the RG/LG reveals a Head-Lease and Sub-Lease structure typically found in commercial tenancies. The Builder as the original tenant to the Owner/Purchaser (Head-Lease) has the opportunity to Sub-Lease to any entity or individual at their unfettered discretion (without notice to the Owner/Purchaser) during the term of the agreement. The intent of the Builder would be to sub-lease the property, however, in the case of higher sub-lease rent the builder will retain any difference and in the case of lower sub-lease rent the Builder will top up the payment to meet the agreed upon Rental/Lease Guarantee amount.

 

Things to Consider for a Rental Guarantee (aka Lease Guarantee):

 

PROS:

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  1. The rental guarantee provides a multi-year peace of mind to the purchaser especially to those who do not live in the same city. Two to four years for the construction timeline plus two years after closing.

  2. The Builder is your tenant: Having a signed contract for the Rental Guarantee / Lease Guarantee can be seen as favourable by many financial institutions and can help with mortgage qualification. The financial institution looks for the fixed amount for income attached to a long term tenancy agreement as the key here.

 

CONS:

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  1. In the case of increasing rental rates (usually dictated by increasing interest rates), many Purchasers will find themselves asking to cancel the RG/LG at the time of closing due to the fact that the market rental rates have increased during the construction period.

    1. The net result of this is that the Builder is released of its pre-sale incentive obligation by way of the Purchaser opting out.

    2. In many cases, unless negotiated and agreed to otherwise within the Purchase Agreement, there is no reimbursement of any value back to the Purchaser in the case that the Purchaser opts out of the RG/LG at the time of closing on the property.

  2. In a growing or strong market some builders will use the RG/LG as a tool to create peace of mind for themselves, knowing that the majority of their RG/LG obligations will be terminated by Purchasers at closing due to their foreseen direction of interest rates and market rental rates aka the market.

  3. Tax rebates such as HST rebate or GST rebates will not be eligible during the term of a RG/LG. This is due to the “Tenant” being a corporation (Builder) and not an individual.

  4. The gross lease amount results in the Purchaser covering utility costs during the Rental/Lease Guarantee term, where in a typical market Lease Agreement; a Tenant would be responsible for their own utilities.

 

When is a Rental/Lease Guarantee the best option?

 

Rent Guarantees are usually a great incentive during slower markets where rents and interest rates are stable while market activity is slower.

A RG/LG purchased in a growing market will lead to an obsolete guarantee at completion as Purchasers will be able to rent the units individually for more than the guaranteed amount at the time of completion.

However, a declining market allows for a purchaser to participate without fear that their monthly costs won’t be covered by rent at the time of closing.

NOTE: the assumption of a declining market above considers interest rates to be stable or declining. In the case of a declining market and increasing interest rates, a Rental Guarantee / Lease Guarantee will likely be less than the monthly costs due to the higher interest rate at the time of closing. Consult with your PreSale representative and your advisors to make an independent conclusion before making any purchase decisions.

 

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WHAT IS RENTAL ASSURANCE WITH PROPERTY MANAGEMENT?

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Rental assurance is affectively a predetermined dollar value as agreed upon within the Purchase Contract which is released to the benefit of the Purchaser if conditions are met.

The conditions are normally determined by projected rental amounts based on Market Rent Assessments which are agreed upon by the Seller and the Buyer at the time of Purchase and outlined within the Purchase Agreement / Purchase Contract or Agreement of Purchase and Sale.

 

In the case that the pre-determined monthly rent is not met, the Rental Assurance will be released in the amount required to meet the predetermined annual rental value at the time of Purchase (up to the maximum benefit amount)

 

An example case of this would be the following:

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  1. Assumptions:

    1. At the time of Purchase, projected market rents are $2,000 monthly ($24,000 annually) as agreed within the Purchase Agreement.  

    2. Actual market rent is $1,950 monthly ($2,340 annually) at the time of closing

    3. It takes 1 month to find/sign a Tenant and commence a lease.

    4. The agreed upon Assurance is for the first year only

    5. The agreed upon Assurance max value is $6,000

    6. The Builder/Developer will provide 2 years of Property Management

 

  1. Calculation:

    1. The difference between the Actual Rent (b) and the Projected Rent (a) is -$50 per month ($-600 annually)

    2. The 1 month of vacancy is to find a Tenant (c) is = to one month of projected rent $-2,000

    3. The total Assurance amount to be released by the Builder/Developer to the Purchaser is:

      1. (c) + ( (b-a)*(12 - the months of vacancy) )

      2. ($2,000) + ($50 * 11)

      3. = $2,550          

 

Typically, Rental Assurance incentives come with the inclusion of Property Management by the Builder/Developer which creates the transparency between both parties for the actual values and timelines to achieve the outcomes above. In the example case above the Builder/Developer would release a cheque to the Purchaser for the $2,550 at the time of commencement of the Lease to the Tenant as a top up the Purchaser to achieve the projected annual income for the agreed upon timeline for the Rental Assurance.

 

Things to Consider for a Rental Assurance with Property Management:

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PROS:

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  1. The Rental Assurance with Property Management allows for market rent to be achieved at the time of closing.

    1. In many cases and historically, rents have increased year over year and increase tremendously when interest rates rise therefore creating an additional growth proposition with the asset value during the construction timeline for future rent when compared to a Rental Guarantee / Lease Guarantee which is capped at the guarantee amount.

  2. Tenants are direct and normally individuals which means that GST rebates (if applicable) can be applied for

  3. Tenants pay for their own consumption of utilities

  4. Purchaser has final say on Tenant and receives background details and credit reports on each application for consideration of tenancy.

 

CONS:

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  1. In some cases the maximum assurance value may not cover the vacancy timeline

  2. In some cases the timeline for the included Property Management is too short.

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