Buy and leaseback

Mainland's fast-growing economy, especially in Great Bay Area cities, has attracted many Hong Kong buyers to its property market. In addition to the rosy economic outlook, buyers are also drawn by arrangements like "sale and leaseback" or "entrusted property management". While buzzwords such as "stable income", "high return", "convenient" and "worry-free rental" from developers or sales agents may seem appealing, investors should not overlook the risks and complication involved.

Shops, apartments and hotels are common projects featuring sale and leaseback or entrusted property management arrangements. Usually, a buyer will enter into an agreement with the developer or a third party in order to receive rental returns within a specific period of time. According to the laws in Mainland China, developers are not allowed to arrange leaseback during the sale process. As such, they would sign the leaseback agreements with buyers through associated companies, which may be of smaller scales. If these associated companies are not operated properly, they may not be able to perform their obligations. Should such companies go out of business, investors may not be able to recover their losses. Over the past few years, some Hong Kong property owners have complained about failing to receive the said rental returns from similar type of projects. In fact, there are uncertainties about the so-called guaranteed rental returns, and investors should think twice before making any decisions.

Investors may overlook other important issues if they only focus on the rental income of a leaseback arrangement. They may not really understand the financial strength of the developer, project location, transportation, project quality, construction status and the risk of ending up with an unfinished or subpar property (See the 3 pitfalls to avoid when buying properties outside of Hong Kong). Investors should also consider the reasons why the developer would offer a leaseback or entrusted property management arrangement, or why a sales agent or a third party would like to promote these services. Is it possible that the project quality is subpar that a leaseback option is in place to attract buyers? If the property is of poor quality, would the management company be able to deliver the agreed rental returns? Or is it possible that the developer has just increased the property price and rent it back to the buyer? Some apartments or hotel developments may have property management contracts with well-established hotel groups that could be terminated under certain conditions. Such contracts are usually only binding between the hotel group and the property developer, but not with individual buyers. As sale and leaseback and other similar arrangements can be quite complicated, the involvement of a well-established hotel group does not guarantee a safe and reliable deal.

Buying a property located outside of Hong Kong with a sale and leaseback or entrusted property management arrangement may constitute a Collective Investment Scheme (CIS), rather than being just a simple property transaction. A CIS typically involves the pooling of funds from various investors to invest in assets which are managed as a whole by an operator of the arrangement. Examples include investment funds, MPFs and real estate investment trusts (REITs). In Hong Kong, offering a CIS to the public is regulated by the Securities and Futures Ordinance.

If a property investment is a CIS, all of the property units will usually be managed as a whole by a management company which will have control over the units’ day-to-day management, with the aim to bring investors returns. This may involve a sale and leaseback feature to facilitate centralized leasing. Investors will have no control over key profit-generating decisions, such as choosing tenants, term of lease and rent, etc.

Under existing regulations, only CISs authorised by the Securities and Futures Commission (SFC) can be offered to the Hong Kong public. In general, unauthorised CISs can only be sold to professional investors. Operators of these unauthorised investment arrangements may not be qualified. Meanwhile, as such arrangements and their offering documents are not approved by the SFC, the products may not be suitable for the Hong Kong public and the product disclosures may not be clear and complete. As such, the investors may not be properly protected. Investing in unauthorised CISs, including those listed in the Suspicious Investment Products Alert List, involves high level of risk with very limited protection, and investors may suffer substantial losses