By Alex Tarrant
Savers frustrated with record low returns from bank deposits are diving into lightly-regulated commercial property deals that forecast nearly 10% cash returns, but can carry significant risks.
Advertisements for syndicated property deals have been prominent in newspapers in recent weeks, promising high cash returns for investments in syndicated property. The deals and advertisements are exempt from the usual requirements for prospectuses under the 2002 exemption to the Securities Act (Real Property Proportionate Ownership Schemes)
Bayleys Real Estate agent Mike Houlker has been promoting the deals for the last 6 six years. He told interest.co.nz that public interest in the syndicated investments had been rising, along with the number of syndications being offered.
"Before the change in the property market, they were less frequent, with fewer players in the market," Houlker said. "But now a lot more people have been through the numbers, and it's starting to work with interest rates being so low."
Six month bank term deposits are now averaging around 3.9% before tax, just above their early March lows of 3.6%, the lowest since 1966.
Bayleys is marketing a proportionate ownership scheme for an industrial property in Mt Wellington that is managed by Augusta Funds Management. It is promoting a 10% projected pre-tax return on a for the first year on a NZ$50,000 minimum investment in a share of the title to raise NZ$25.5 million.
"We've had a terrific amount of enquiries," Houlker said.
"The yield gap is more than it's ever been. It's a great time to buy. In the last five years the top quality commercial and industrial properties have been snapped up by the big national and multinational funds. And now they're not really in buying mode, which gives syndicators the opportunities to buy properties that had not been available to them before," he said.
"It's people coming from term deposits, shares, some selling residential investment property: Generally older people on fixed income because returns in banks are not very good at the moment, and you can't get capital gains on your deposits in the bank." More details on the Mt Wellington syndication are here at the NBR.
When asked if there was a danger of interest rates rising, Houlker said "potentially, but if you see that happening, you can fix your interest rates longer. If interest rates are higher, then inflation rates are likely to be higher, so the rent would go up."
"I think the warning I'd give people is that they should look at the property and ask " would I like to own it myself?'"
Houlker said there were a whole lot more players in the market now than he'd seen before: "There are some people in the market place now, and I think "˜who are they?' But we only deal with people who have a track record and are reputable, and Augusta is one of them."
He said he had always been able to sell any units on the secondary market. "I must have sold 40-50 on the secondary market myself. In the case of the Augusta syndications, they've all been over-subscribed so existing unit holders usually buy up whatever is available, either through Augusta or Bayleys."
Augusta's Mark Francis
Augusta Funds Management Managing Director Mark Francis has been promoting, organising and managing the syndication deals through Augusta since 2003. During that time he said they had set up over a dozen syndications, and currently had total assets under management of around NZ$250 million.
When asked about the issue of interest rate fluctuations, Francis said that the effects "depend on how you structure your debt."
"We mitigate against that interest rate risk through swaps," he said. "It's no different to what a private buyer would be doing "“ There are interest rate risks with any form of property investment where some debt is used, and we have hedging in place through swaps."
Francis said that he had seen a rise in the amount of participants in the market and cautioned investors to look closely at the track records of those offering deals.
"Opportunists are seeing fundamentally it's a good time "“ yields are high and interest rates are low, so that has seen new participants in the market," he said.
"We would caution investors in that regard. It's all about having a good track record and investors need to look at that when deciding who to invest with," Francis said.
"Before we take a property to the market, we've usually looked at about 20 to 30 properties. We look with a long term view, because we're in this for the long haul "“ syndication is not about selling and moving on "“ its about the long term management assets for investors," he said.
Francis noted that in the current market there were some good opportunities to purchase assets off those being forced to sell them. "We're buying the current one off St. Laurence," he said.
"There are lots of entities that are forced sellers of assets and we can often get them for less than they paid for them a couple of years back."
'Secondary market strong'
Francis said that the secondary market for investors' units was strong not only at the moment, but had been over the six years Augusta had been managing the deals. More background on Francis is available here in this Anne Gibson piece from 2006.
"Every single unit that has become available within any of the syndicates has been sold to someone else in that syndicate within a week, and that's either at the price the investor paid for it or at a premium."
"You've got to look at this as if you're buying the property yourself," he said. "You don't go into them as if you're getting out in three month's time "“ they're a long term investment."
"To be honest, these things are being over analysed. Fundamentally, they're just a mechanism for small investors to invest in big property." There will always be a market for syndicated property, he said.
Here's what to watch for
Property investor and consultant Olly Newland said that there were a number of things investors should be looking at before entering into the property syndication deals. Newland, the author of The Rascal's Guide to Real Estate, was first involved in the deals during the 1980s when he set up and ran them as public companies, with investors' units being shares that could be traded on the stock market.
"You need to watch out for the building itself and the tenant, or tenants, that are in it," Newland said. "Some of the buildings just look like giant tin cans to me."
"What happens if the tenant leaves or goes broke?" he said, adding that it is safer for investors if a property has multiple tenancies.
"If you're putting your money in, how do you get it out? You may be stuck in there for the duration. Units are sometimes traded on the grey market, but that often depends on where interest rates are," he said.
"People would rush into these if they thought they could rush out. Most terms for syndicates are about 10 years. If there was a mechanism with which to sell out "“ like with public company shares through the stock market "“ you could sell easier. The major disadvantage to these syndicates is you can't sell out like shares."
"It will provide a passive income for people. But you can't just walk in the door and take out money as you can with the bank."
"See whether the building itself has recently been purchased by the promoter. For example, the promoters could have just bought the building for $8 million, but are selling it for $10 million, making a juicy profit."
"In the offeror's statement, you want to look carefully for what the owners paid for the place. It should be clear what they paid for it and you need to ask "are we overpaying for it?"," he said.
"Also, the promoters inevitably lock themselves in as managers. Getting rid of them can often be quite a monumental task. The managers usually have total control. If they're not doing a good job, how do you get rid of them?"
"Check the rules that the syndicate people have set up for how decisions are to be made. There can be lots of hoops for people to jump through."
Newland said that with the amount of investors often involved in the syndicates, to get everyone to agree on something "is impossible."
Newland said the overall price of the building should play a big part in investors' decision making, along with the amount of borrowing that was involved to help the syndicate make the purchase.
"Promoters often go for bigger and bigger properties in order to get more management fees," he said. "But it is often the biggest properties that lose value the most. Back in the eighties, there were groups that would buy the biggest building in the smallest town, and it would turn out to be unsellable."
The amount of debt being taken on by the syndicate was a key element.
"Work out the amount they are borrowing, 40%-50% is far too high," he said. "Inflation is always just around the corner. If that 40% gearing turns into a 15% interest mortgage"¦I would enter into ones with little or no borrowings, then they are much more bullet-proof," Newland said.
"New Zealand has a history of being a high interest rate economy."
"If I were promoting it, I would not promote one with the borrowings. The public deserves to be protected. When you're using the public's money and putting it together into a vehicle, your job is to make it as bullet-proof as possible," he said.
"It could come back and bite you. There were so many in the past that were bitten by it. The tenants were still there, but the borrowings got out of hand because of the interest rates. The bank might say 'we'll give you 40%, but it can't go above 50% of the value of the building'"¦but if the building drops in value by 10%, the bank could call it up and put it into receivership."
"No borrowing is much better. I'm quite hung up about that," he said.
Newland said that investors needed to look in depth at the lease agreements of the tenants to see what agreements they had, primarily regarding rent.
"You need to check what sort of ratchet clauses are in the lease," he said. The ratchet clause relates to what can happen to the level of rent at review times.
"A hard ratchet means that at the next rent review, the rent can never be less than the previous rent. A soft ratchet means that the rent can only fall back to the level it was at the beginning of the tenancy, but not lower; while no ratchet means the rent could drop to anything. If it was me, I'd have a hard ratchet clause," he said.
"Also, are there any guarantees in the lease? Perhaps there might be a bank guarantee for the rent?"
"Check whether the tenant is liable for maintenance outside of the building, ie. The yard, the carpark "“ asphalt can take up a lot of maintenance."
"You need to ask "does the tenant pay for management fees. Yes? No?" Does the tenant pay for exterior maintenance? Does the tenant pay for ground maintenance? Does the tenant pay for interior decorations? Yes, or No? The lease if often at least 30 pages long."
Newland said that ultimately, an investor should "stand back and look at the building "“ would you buy the whole thing yourself if you could? If the answer is no, then think again before jumping in to it."
When asked whether he thought the market for the deals could blow out, Newland said in a low interest rate environment it could go crazy.
"In the 1980's they did all sorts of things like mixing the syndicates with goat and ostrich farming. Tell me, how do goat farming and property investment go together?"
"Look, there are two main things you need to look for: Multiple tenancies and no borrowings. Then you'll be as bullet-proof as you can be."