We were engaged to perform buy-side due diligence for a private equity fund. The target was a real estate company, well-presented, growth-oriented, and operating in one of the more buoyant property markets in Southern Europe. On paper, it looked like an attractive opportunity.
It did not take long for the picture to change.
The Product: Guaranteed Rental Returns
The company’s core offering was a buy-to-let investment scheme, a model that has become increasingly common in several European markets. The pitch is simple and seductive: buy a property, hand it over to the developer’s management arm, and receive a fixed annual return, often advertised at 6%, 7%, even higher, regardless of whether the unit is actually occupied.
The word “guaranteed” does a lot of heavy lifting in these sales conversations. It implies certainty. It implies security. It implies that someone, somewhere, has done the maths and is confident they can deliver.
As we reviewed the financials, we asked a straightforward question: where is the reserve for these guarantees?
The answer was silence. Not the uncomfortable silence of someone searching for a document. The silence of someone who had never been asked that question before.
There were no reserves. None. The company had issued contractual obligations to dozens of investors promising fixed returns over multi-year periods, and had set aside precisely nothing to fund them.
The Structural Flaw
To understand why this is so dangerous, you need to understand how these schemes actually work, or more precisely, how they only work under a very specific set of conditions.
The guaranteed return is not funded by a ring-fenced pot of money. It is funded by the ongoing cash flow of the business: new property sales, rental income collected, management fees. In a rising market, with properties selling well and occupancy high, there is enough cash in the system to keep everyone happy. The guarantee feels real because it is being paid. But it is being paid from operational revenue, not from a dedicated liability.
The guarantee is not a financial instrument backed by capital. It is a promise backed by optimism.
To be clear: a guaranteed return is not inherently problematic. If the developer has properly provisioned for it, whether through a ring-fenced balance sheet reserve, a bank guarantee, or a charge over a real asset, then the word guarantee means something real. What we found was the opposite. The obligation existed. The provision did not. For a PE fund acquiring the business, that off-balance-sheet liability is not an abstract risk. It transfers with the acquisition. You buy the promise along with the bricks.
When we modelled what would happen if the property market softened, sales slowing, rents stagnating, voids increasing, the numbers told a brutal story. The management company, which was thinly capitalised and operationally dependent on the parent developer, would be paying out more in guaranteed returns than it was collecting in rent within months. And the developer, facing its own cash flow pressures from unsold inventory, would be in no position to plug the gap.
The word “guarantee” would become, at that point, a legal fiction.
The Cycle Always Turns
Real estate is a cyclical asset. This is not a controversial statement. It is one of the most reliably observed phenomena in global finance. And yet, in the middle of an up-cycle, the cycle has a peculiar way of feeling permanent.
Markets with recent memory of sharp corrections know this well. Property values in some Southern European segments fell by 40 to 60 percent in the years following the 2008 and 2012 financial crises. Developers who had been fully invested and fully leveraged, as developers almost always are because idle capital is anathema to their business model, were wiped out. Banks were left holding distressed assets they did not want and could not sell.
The current cycle in many markets has been driven by real and legitimate forces: a significant influx of people and businesses relocating to avoid geopolitical instability across multiple regions, the growth of technology and professional services sectors, and a genuine shortage of quality housing stock. These are not imaginary tailwinds. But they are not permanent either.
When the cycle turns, and it will turn as it always does, the sequence of events is predictable. Properties stop selling. Developers, whose entire model depends on a continuous flow of buyers, face immediate cash pressure. Rents soften as oversupply builds. Voids increase. The management company, which was stretching to pay 7% guaranteed returns in a market delivering 3 to 4% actual yields, can no longer sustain its obligations.
The investor, who was sold certainty, is left with an illiquid asset in a falling market and a contractual claim against an entity that may no longer have the means to honour it.
A Question Worth Asking
During the due diligence process, we found ourselves returning to a simple test that any investor, private equity fund or individual buyer, should apply to these schemes.
Ask what backs the guarantee.
Not a contractual promise from a management company. Not a letter of comfort from the developer. A genuine backing instrument: a bank guarantee, a charge over a real asset, or a ring-fenced reserve on the balance sheet.
The economics of this question are revealing in themselves. If the obligation is properly funded and the developer has already reserved against it, the backing instrument exists and pointing to it should be straightforward. But if the obligation is not funded, obtaining a bank guarantee has a cost, and that cost would need to be absorbed somewhere. In practice it would reduce the advertised yield materially. A 7% guaranteed return, properly priced for risk by a bank’s credit committee, does not look like 7% anymore.
This is not a comment on any developer’s ability or willingness to provide security. It is a comment on the economics. A genuinely funded guarantee is inexpensive to back. An unfunded one is not. The pricing tells you which one you are dealing with.
That gap between the advertised yield and the risk-adjusted yield is the most important number in the transaction. It rarely appears in the brochure.
What Happened Next
In the end, the fund did not proceed. The decision was straightforward once the liability picture was properly framed. The fund wanted real estate exposure. It did not want to acquire an unquantified guarantee liability sitting off-balance-sheet, in a market facing cyclical risk, managed by a thinly capitalised entity with no reserves.
No amount of growth narrative or yield story could paper over that structural reality.
We tell this story not to cast judgment on any particular market or company. The model we encountered is not unique. Versions of it are actively marketed across several European property markets. And in the current environment, many of the people selling it believe in it genuinely. They have been operating in an up-cycle long enough that the cycle itself feels like the baseline.
But for the individual investor, the person who reads “guaranteed 7% return” and feels the relief of certainty in an uncertain world, the question is not whether the guarantee will be honoured next year. The question is whether it will be honoured in year three of a market downturn, by a company whose cash flow has collapsed and whose balance sheet never had the reserves to back the promise.
A properly structured guarantee, backed by capital or a real security, is a real commitment. The question worth asking, before signing anything, is which one you have been offered.
The answer will tell you everything.