By Stephen Forbes
You might have seen the adverts and promotional material.
"Earn 8-9% pa (pre tax)."
"Targeted return 7.25 cents per share."
"This investment is forecast to return 10% p.a. from year 6, rising to 32% p.a. from year 10."
"A 60% higher return than bank deposits."
We live in a world of historically low interest rates. The Official Cash Rate is at a record low of 1.75%, and the average six-month bank term deposit rate is just 3.18%.
So how come some investment opportunities can still offer returns significantly higher? How are these investment opportunities being priced, and is this reasonable? What sort of investors are they targeting and attracting? What are the risks? And does anyone have oversight over the non-bank market?
The promotions above are from Alpha First Mortgage Investments, Pacific Property Fund, MyFarm Investments and First Mortgage Trust. They are among those touting what, by today's standards, are high returns.
Alpha First Mortgage Investments' website states that it will provide investors with a regular monthly income.
“As a registered investor you will be offered the opportunity to invest in Registered 1st Mortgages secured over saleable land and buildings. Your funds will typically generate between 8-9% p.a. net (less RWT) and be invested for short terms between 6-24 months, giving you flexibility and control. At the end of the loan term you simply have your funds returned to you, or elect to invest in another opportunity.”
How's the liquidity?
While such investments may be popular and can offer high returns by today's standards, they do come with increased risks. They often involve real estate syndicates, as well some infrastructure, energy and rural investments owned by multiple parties.
Their popularity is essentially based on the returns these investments can deliver. But the difficulty for investors can come if they try to cash them in before they reach the end of their investment life. A lack of liquidity in such plans means they may not be able to withdraw their funds without incurring a significant cost. And the lack of transparency involved in such investments can also be problematic.
First Mortgage Managers Ltd, which manages the First Mortgage Trust Group Investment Fund, is another player in the market and has promoted itself as offering investors a 60% higher return than bank deposits.
First Mortgage Trust describes itself as a bank alternative for property, finance and investments. Last year its total assets surged $148.933 million, or 30%, to $646.083 million. Net profit after tax jumped $7.863 million, or 35%, to $30.581 million.
First Mortgage Trust CEO Tony Kinzett says the organisation has grown a lot in the 22 years it has been in business and it is now the country’s largest non-bank first mortgage provider. First Mortgage Trust recently announced it's being acquired by private equity firm CapitalGroup.
Kinzett says the trust now manages $770 million worth of funds and it has $620 million in first registered mortgages and around $150 million, or 20%, in liquid assets.
“We currently have close to 4,000 investors and that number has grown consistently over a number of years.”
Kinzett says he doesn’t want to comment on First Mortgage Trust’s competition and whether they have enough liquidity for investors.
“I can’t speak for other companies in the market. But if you look at our trust, with 20% liquidity, that’s pretty impressive.”
He says the investors First Mortgage Trust attracts are generally mum and dad retail investors who are over 50 years of age.
“We don’t take institutional investments,” he says.
First Mortgage Managers Limited is a Managed Investment Scheme (MIS) manager licensed by the Financial Markets Authority (FMA).
“Licensing means that the manager has met minimum standards and the FMA has licensed the manager,” says FMA spokesman Edwin Mitson.
He says as a licensed provider it is able to make offers to retail investors, but it must comply with part 3 of the Financial Markets Conduct Act 2013, which relates to the disclosure of information to investors.
“A licensed MIS Manager also has a supervisor, an independent body who actively supervises the manager’s performance of its functions and obligations.”
In the case of First Mortgage it has two supervisors, Trustees Executors Limited and Public Trust.
In contrast Mitson says Alpha First Mortgage Investments is only able to offer its investments to eligible investors. To qualify as an eligible investor, a person must have previous experience in acquiring or disposing of financial products.
“An offer to eligible investors does not require disclosure under Part 3 of the FMC Act, and Alpha First is not licensed by the FMA. Therefore, an offer made to eligible investors has fewer protections.”
But he says all investors, irrespective of whether they are retail, eligible or wholesale, are protected by part 2 of the Financial Markets Conduct Act – which means that a company making an offer cannot make false, misleading or unsubstantiated representations.
He concedes that legal protections in place for wholesale and eligible investors are more limited, due to their experience. But the FMA can and will take action against any company that makes an offer to a retail investor, when it is only legally allowed to offer to wholesale, including eligible, investors.
“The FMA will generally only look at these offers when concerns are raised. The FMA is able to take action against any company which makes an offer to a retail investor when it can only offer to wholesale, including eligible, investors.”
Investors with 'frustrated capital'
Alpha First Mortgage Investments director Olivia Fraser says the company has experienced a lot of growth in the last year and she attributes it to the low interest rate environment investors are facing.
“The growth of the property investment market is largely attributed to investors who have frustrated capital. They might have $1 million to invest, but current bank interest rates aren’t returning enough for their liking. Last year we saw an increase of 25% to 30% in investors with Alpha First wanting active investments in the property mortgage field.”
She says demand for new housing remains strong and some developers are turning to non-bank alternatives for money as banks have high benchmarks and tight credit.
“Banks often want up to 50% equity which is tough for small builders,” Fraser says. “Land and property has always been popular security with Kiwis and most investors are keen to help the good borrowers out there who are turned away from traditional sources such as banks.”
And Fraser says some of the recent construction company failures could impact the market further if banks tighten their lending to small scale developers. She says Alpha First Mortgage Investments' target market remains eligible and wholesale investors.
She says the company’s investors are often retirees who have been in business, or owned land and accumulated a reasonable amount of wealth.
“They’re knowledgeable about investing and savvy with how they invest their funds. For example, they might have $1 million in the bank but it’s not earning them anywhere near enough income to live on at the current 3% interest rate, whereas our investment opportunities are returning 8% to 9% - so instead of an income of $30,000, they’re receiving closer to $80,000 - $90,000 a year.
“While our investors want to spread their risk and make sure their portfolio is diversified, they don’t want, at this stage in life, a large part of their capital locked into long-term five to 15 year investments where they will suffer large break fees or on-selling costs when they require their funds released. They’re also wary of the sharemarket and other investments where they lack control.
“Our investors invest for lifestyle reasons – they’ve worked hard to create the lifestyle they’ve achieved and they want their money to work for them.”
She says the criticism that the mortgage investment and non-bank alternatives market lacks liquidity is valid but can also be applied to the lending market as a whole, with banks and non-banks included.
Risk pricing subjective
Fraser says Alpha First Mortgage Investments does adequately price risk into its investments, but admits it’s somewhat subjective and also most lenders use comparative rates and fees to price their lending.
“We have experienced large growth in the number of loans we’ve issued in the past 18 months, with a large percentage of investors participating in multiple investment opportunities. Because there are no fees or deductions from the returns, we believe our customers like our loan selection and management process, the property security we offer and the returns received.
“Our investors can invest any amount upwards of $50,000 with investment opportunities ranging from $500,000 to $4 million, with loan terms of six to 24 months. They receive at least 8% to 9% return on their investment, more than double what term deposits are currently paying. We stringently vet our borrowers and the security offered to make sure that we understand the risk aspects of each loan.”
'The higher the return the higher the risk'
Martin Hawes is the chairman of the KiwiSaver Summer Investment Committee and an Authorised Financial Adviser.
He says it’s important that investors realise the risks involved in such investments.
“The old maxim is as true as ever, the higher the return the higher the risk. So I would urge caution,” Hawes says. “A lot of these sorts of offers are a one off and they aren’t diversified.”
Hawes says this means it might involve an investment in a single commercial property or project.
Hawes refers to one of the offers mentioned at the start of the story offering a forecast return of 10 % p.a. from year six and 32% p.a. from year 10.
“An awful lot can happen in six years,” he says. “And it probably means you are going without any notable return for a significant amount of time. So I would be mindful of that.”
Hawes says the longer the period of time involved with such investments often means a bigger chance of something untoward happening.
“But I guess that’s for the investor to find out on a case by case basis.”
Hawes says which investors are being targeted and whether they are registered as licensed providers is an important factor in such offers.
“If they are targeting wholesale investors they would be more astute and aware, but I would still be very careful.”
'Wholesale mum and dad investors'
MyFarm Investments CEO Andrew Watters says the fact investors have to wait six years for their first return is due to nature.
“If you’re investing in a greenfield orchard that’s [the] biology of it. You plant a tree and that’s how long it will take to grow.”
He says the company has already raised $12 million to $13 million from investors for the cherry orchard development.
Watters says the company is also offering investors other horticultural investments in everything from avocado orchards, to hop growing and manuka honey production. He says every project is different.
Watters says while investors can put their money into lower risk options the returns won't be as good. But he concedes that horticulture is inherently more of a high risk investment, even if the returns are higher as well.
“That's why people want a 10% to 20% return,” Watters says.
But he's keen to emphasise the company’s offers are based on realistic projections.
“There are some obvious risks, but if it’s part of a portfolio investors can make some good returns.”
Watters says MyFarm Investments' target market is wholesale mum and dad investors.
An overview of the investments
First Mortgage Trust
The First Mortgage Trust says funds are only lent on first mortgages over land and buildings. Investment funds are pooled and diversified across multiple properties to ensure any risks to investors are minimised. In the event of a borrower defaulting on payments the trust has the right to sell the property.
The trust distributes interest returns to investors every quarter and people can choose to have these deposited into their bank account or reinvested into the fund.
Investors have the choice to either invest a lump sum or make investments of various amounts at any time that suits them. The trust says investor's money isn’t invested for a fixed term, but it does encourage people to allow their investments to grow over the medium to long term. It states that under its Trust Deeds and Product Disclosure Statements it has up to 90 days to allow First Mortgage Trust up to 90 business days to repay withdrawal requests.
It says it doesn’t have any upfront fees and all management and trustee fees and other related costs are deducted prior to declaring the quarterly rate of return. The total fee to the investors is a charge of 1.8% of the net asset value of the fund. This is made up of 1.5% which goes to the manager of the fund, First Mortgage Managers Ltd. While the remaining 0.3% covers supervisor fees and administration charges. It also deducts withholding tax, which for most investors equates to 17.5%.
“There is also an option to invest under the PIE regime which caps tax paid on investments by individuals at 28%. This allows investors in the 33% tax band to save tax of 5 cents in each dollar of income from their investment compared with a direct investment in First Mortgage Trust.”
Alpha First Mortgage Investments
Alpha First Mortgage Investments also specialises in first mortgages over “saleable freehold land and buildings”.
It says investors will have full loan disclosure and will know who the borrower is, where the property involved is located and what the purpose of the loan is for. They can also personally inspect the property before investing. They will also receive financial information and valuation material on the property involved. Multiple investors may invest in a single property, but their names will be separately registered on the security documents. The funds will then be held in a bank trust account, not by the investment provider. Investors are only expected to deposit funds once they have agreed on a property investment they want to finance. It takes investments of $50,000 plus and has a range of investment options between $500,000 and $4 million.
Alpha First Mortgage Investments says it makes no cost or fees deductions from the interest payable and the returns are handled by a dedicated trust account. Investment terms range from 6 to 24 months and investors receive monthly interest on their investments. The company says it doesn’t charge investors any fees and any related charges are paid for by the borrower.
The company offers investors shares in various horticulture, farming and commercial operations. Its Central Cherry Orchard LP offers investors shares in a Central Otago cherry orchard. The MyFarm Investments division is the offeror, while the MyFarm Business division is the manager of the partnership. Central Cherry Orchard GP Limited is the general partner and provides oversight of the investment and will be governed by Grant Rowan and Brian Cloughley from MyFarm Investments. Its website says Freshmax NZ will develop and manage the orchard and export the fruit.
The total cost of buying and developing the orchard has been estimated at $19.9 million. The offer is for 1,350 shares at $10,000 per share with a minimum investment of $100,000. Investors are asked to provide 70% of their investment in the first year and 30% in year four.
It says the rest of the projected costs will be funded by debt and cash flow from year six. Returns are forecast to start at 10% p.a. from year six onwards and grow to 32% p.a. once the orchard reaches mature production. It says the offer is only open to wholesale investors. Its website states:
“Producing cherries is a higher risk crop and it’s generally considered there will be a materially poorer harvest 1 out of every 5 years. This has not been taken into account when modelling returns – sensitivity analysis in the information memorandum cover this off.”
The prospectus lists various establishment fees that will need to be paid for by the partnership, including $768,600 for “due diligence and marketing (excluding third party costs), pre-purchase assessment, budget forecasting and industry information, marketing, promotion, referral fees (if any), contract negotiation and management of the syndication process”. Another establishment fee of $104,500 is for third party due diligence, legal work and underwriting.
While there is another annual fee of $120,000, this is for “more intensive supervision requirements during the development phase of the orchard”.