11 Reasons to Avoid Interest-Based Rental Income
The current practice of interest-based rental income for HiRISE projects and other properties in the country may have some benefits for property owners during periods of low interest rates; it also comes with several disadvantages and difficulties. It leads to an unacceptable approach for the real estate market of the country.
In this informative blog, we will focus on the potential drawbacks of this practice. Read below the lines to get aware of this practice in detail.
The following are some disadvantages of interest-based rental income practice:
Unforeseeable Rental cost
The interest-based rental income in real estate projects can change with changing interest rates over time. These uncertainties make it difficult for tenants to bear the burden of unpredictable expenses.
Monetary load on tenants
In case of settled high-interest rates, the tenants would face higher payment liabilities for rent, posing stress on their sources. This would result in high tenant turnover as they seek more economical investment options.
The dependent market
The economic factors greatly influence interest rates which may change over time. So, the real estate project depending on the rental income becomes vulnerable to several changes in the market, which results in more difficult financial projects and trends.
High-risk factors for property owners
Increased interest rates result in abnormal increases in property value which in turn decrease the demand for rental property resulting in reduced or zero rental income. Hence, this situation can put greater risks for property owners.
Complicated lease agreements leading to legal disputes
Real estate interest-based rental income requires very strong legal and financial acumen to draw a lease agreement. This often leads to complicated rental agreements which a layman cannot understand. These results in a scenario; where the tenant and owner of the property face off to disputes and legal fights.
The tenant would not be satisfied
Usually after some time of agreement, the tenant feels that this interest-based rental income is not fair. They feel like; they are being charged high without any potential benefit in exchange, and this feeling leads to the termination of agreement before time and dispute between the parties.
Difficulty in attracting tenants
The higher interest rates make it very difficult for the landlord or the property manager to attract potential tenants. In consequence, the property remains without the rental income or settled on reduced rents.
Negative public perception
Interest-based rental income may be labeled in a negative sense in the general public and media eyes. This could lead to a loss of market traction for the specific real estate project, leading to monetary loss as well as a deteriorated brand reputation for the developers.
Default Probability
In cases where the tenants struggle to make rental payments due to variations in the interest rates, there may be an increased risk of potential defaults for the property owners and the developers.
Predetermined rental income and inflation
The Predetermined rental income for a fixed time frame, would not keep up with ever-increasing inflation. The growing cost of living would compel the tenants to search for interest-free properties to streamline their daily life expenditures.
Carrying-on cost
In established practice, the landlords are in charge of repairing and maintaining the property. The high-interest rates would decrease the rental income; therefore, it would be a real struggle for the owners to cover the maintenance cost.
Islamic perspective of rental income
As per the teachings of Islam, interest-based financial arrangements are rigidly forbade because they are assumed usury (Riba) which is damaging to the social fabric of society. These Islamic teachings also extend to interest-based rental income.
As a religion Islam offers solutions to every problem in the world; so is true in the case of real estate rental income. The practice of interest-free financing and rental arrangements is widespread in the Islamic financial system and is called Islamic or Sharia-compliant finance.
Here are two models to deal the real estate rental income in an Islamic way:
Musharakah
This is a kind of partnership in which the property owner and tenant mutually buy a property. The tenant has to pay the rent and step by step purchase the property ownership shares until they assume the charge of sole proprietor of the property.
Ijarah
Ijarah is a lease-based agreement in which the property owner has ownership of the property and proceeds with a rental arrangement for a defined period. The rental amount would be pre-defined and would not change during the lease period.