No such thing as a sure thing

It sounds like a wonderful deal for nervous property investors: a 10-year guaranteed inflation-proof rental return of 5 per cent on studio flats in Belsize Park, north London. Even the prices sound good - £169,000 to £200,000 compared with the average price of about £225,000 for a studio flat in the area.

It sounds like a wonderful deal for nervous property investors: a 10-year guaranteed inflation-proof rental return of 5 per cent on studio flats in Belsize Park, north London. Even the prices sound good - £169,000 to £200,000 compared with the average price of about £225,000 for a studio flat in the area.

Better still, the flats are already tenanted by Camden Council and the likelihood is that Camden will want to extend its lease when the 10 years are up. The deal means that the biggest fears of property investors - no tenant or falling rents - are not a factor. The 10-year term also protects investors from the vagaries of the property market. Prices may soar one year and plummet the next but over a 10-year period it would be remarkable if values fell.

Yet David Galman, sales director of Galliard Homes, admits: "The big question mark is what happens when the agreement with Camden Council expires. We think that local authorities will still have problems housing people and Camden will still want the flats. We won't just walk away, we will try to set up a deal on the landlords' behalf and also help buyers to set up a landlords' association to manage their long- term investments."

The 5 per cent return is linked to the retail price index. If that goes up, so does the guaranteed rent; but if it falls, the yield will not fall below 5 per cent. A flat costing £175,000 will earn £8,750 in the first year, but if the retail price index rises by 2 per cent in 2005, the guaranteed net yield will rise to £8,925.

The phrases "local authority tenants" and "housing benefit" frighten many landlords but agreements with housing associations and councils have their plus side. Instead of the landlord or his agent having to cope with awkward, destructive or insolvent tenants, this headache is passed to the council. But it has to be said that these studio flats may not increase in price at the same rate as similar owner-occupied blocks and they will almost certainly be more difficult to sell.

Under the terms of the lease, owners cannot occupy the properties and tenants must be nominated by the council. This means that the only buyers will be other investors - just the type to be looking for a bargain and not likely to be swayed by the nice colour of the kitchen units and the newly painted walls.

The block itself, at the junction of England Lane and Haverstock Hill, is a pleasant red-brick, turn-of-the-century building, containing 169 studios, all equipped with bathrooms and kitchens. It was used as nurses' quarters and now accommodates students and the homeless.

Galliard reckons it has spotted a market for wannabe investors, gagging to join the property jamboree with a buy-to-let flat but only ready to risk or able to finance properties in the £150,000-£200,000 range.

Galman said: "It's really hard to find anything in a decent location for that sort of price. We think our prices are the ideal solution for those looking for a long-term and stable investment. As to capital appreciation, no one knows. In 10 years' time my guess is that a studio in Belsize Park would cost a lot more than £175,000."

Galliard is holding an open weekend on 18 and 19 September at the Hampstead Town Hall on Haverstock Hill, when it hopes to stimulate sales mania involving queues of people waving chequebooks. Barry Manners from letting agents Chards says: "I'm not a great fan of rental guarantees but this deal sound better than most. In fact, the best-yielding properties at the moment in London are small ones - some rents have gone up by 25 per cent this year - and buyers could probably get something offering better yields and also more likely to offer capital appreciation, if they got out there and looked for themselves. On the yield side this is a safe punt and there will probably be continuing demand for this type of property."

Many developers, particularly in the London market, have began to offer rental guarantees to investment buyers of 5 per cent to 7 per cent for one to five years. The guarantees are not inflation-proofed and are mostly offered on selected developments where builders want to sell quickly or where they think the market needs a boost.

Some property experts warn investors to be wary of these guarantees, saying they may mask the fact that properties are overpriced. The guarantee may also conceal the ugly news that the properties will not fetch an economic rent or may be hard to let because of the numbers of investment buyers who will be fighting for the same tenants.

Graham Gould of Residential Property Investment Management Ltd says that no incentive is worth as much as a price cut. "Guaranteed rents are a take-on in my view. A guaranteed rent for two years doesn't help if on the third year the rent drops dramatically. If you work out what the guarantee costs the developer it is usually very little."

He advises investors to work out the real cost of rental guarantees and to look for catches. Some guarantees are only available if the investor agrees to buy the developer's overpriced furniture pack and nearly all have to be arranged by a specified letting and managing agent whose fees may be higher than average. This prevents the buyer from cutting costs by looking after the flat himself.