By Bernard Hickey
Augusta Funds Management Managing Director Mark Francis came into our offices this week to talk about property syndication and Augusta's latest syndication.
I asked him in the video above and here to explain how property syndication works and why it's different from mortgage securitisation or investing with finance companies.
Augusta and Bayleys are currently offering 87 units in a 'Big Box' retail warehouse style building at 14 Birch Avenue in Tauranga that is tenanted for the next 9 years to the Carters Building Depot chain, which is owned by Graeme Hart's Carter Hold Harvey.
Francis explained how Augusta arranges for investors to group together to buy the building (in this case for NZ$6.6 million, including NZ$2.7 million of bank debt) in chunks of at least NZ$50,000 each. The property has a lease to Carters for 13 years from April 2008 and has rights of renewal for two periods of six years each after that. Rent increases of 3% a year are locked in for each of the next 5 years.
This is the 17th such syndication organised and managed by Augusta Funds Management, which is owned by Mark and his brother Chris, who also an executive director. Auckland-based Augusta manages over NZ$270 million worth of commercial properties, which typically carry bank debt of around 40-50% and offer pre-tax returns of 9-10% to unit investors.
"It's a mechanism that allows smaller investors a vehicle to get into large scale commercial property," Francis said.
Previous deals included 587 Great South Rd (leased to APN with a pre-tax return of 10% and a 50% gearing or loan), 8 Airpark Drive in Auckland (leased to Bendon with a 10% pre-tax return and 50% gearing), Countdown Fraser Cove in Tauranga (leased to Woolworths with a pre-tax return of 9%) and Countdown Westgate in Auckland (leased to Woolworths with a pre-tax return of 8.5%). Augusta tended to focus on industrial or bulk retail 'big box' properties with big name tenants. It had stayed away from typical office buildings.
Gearing or borrowing levels had dropped from around 50% before the Global Financial crisis to typically around 35-40% now, he said.
Augusta itself is charging a NZ$250,000 +GST fee to the investors in the 87 units in the Carters Tauranga site once the deal is done, plus an annual management fee of NZ$35,000 + GST from the second year. The offer statement for the syndication (attached here) states the total establishment costs are NZ$440,420, which includes audit, legal, accounting, valuation and brokerage fees. Augusta is projecting investment returns (after fees) of NZ$4,500 per year for each NZ$50,000 unit, which represents a cash return net of fees (but before tax) of 9%.
Francis said property syndications are different from investments in finance companies in that the unit holder owns a stake in the title of the building, rather than a debenture. It is an equity stake in a property, rather than a 'secured debenture' or bond with a claim over a first, second or third mortgage.
He said, as with any leveraged property investment, there was a risk the value of the property fell, reducing the equity held by unit holders.
"At the end of the day, syndication is an investment in property. Your number one risk is tenant risk, and that has the biggest potential to impact your overall value," he said. "It's an investment in real estate. It's not a bond."
"We use some conservative debt (levels). At 35-40% and with a tenant covenant like Carter Holt and with 9 years remaining, and with some growth built in along the way, that's a picture I'm really comfortable with in terms of how we see the valuation playing out," he said.
Francis said property syndications were completely different to mortgage securitisations, which have been blamed for the collapse of the US housing market and the onset of the Global Financial Crisis.
"Securitisations or finance companies are essentially an investor lending money to a finance company to onlend for whatever use, we don't know. Your security is a debenture and history has shown us that is not worth a hell of a lot," he said.
"Property syndicates simulate direct ownership of an individual buying a building. If you put money into a syndicate you are buying a building. You're buying land, you're buying buildings and you're buying a tenant paying you rent," he said.
"Unlike buying into a listed property trust, with syndicates that's all you're buying. It's a single asset. You're not going to be tapped on the shoulder later for a rights issue to buy another building."
Francis added that interest rates were hedged for 3 to 5 years and the management fees were locked. "Other than that, there's not a lot that can occur, while the property is tenanted."
Fees, liquidity and regulation
Francis said the estabilishment fee from Augusta for such syndications was typically around 3% of the value of the asset, which was in line with a commercial real estate agent's fee. Ongoing management fees were around 0.3%, which was around half what the listed sector charged.
Investors wanting to exit their unit could use the secondary market that Augusta ran for its 2,000 investors. Augusta has reported NZ$11.4 million worth of units had traded on its secondary market over the three years ended March 2011.
Francis said most of the secondary market trading of units was at the original 'par' price paid for the units, with some trading above and a few below par.
Property syndicators operate under the Securities Act regulated by the Financial Markets Authority. They operate under an exemption notice which means that each building syndicated needed to include a registered valuation and an offeror's document, but did not have to include 5 years of past results or 5 years of financial forecasts. The syndication must also be sold through an agent such as Bayleys for the exemption to occur.
For example, the full offeror statement (the offer closes on March 30) for the Carters Tauranga syndication is here while the full valuation is here. The offeror statement includes details from the building's Land Information Memorandum (LIM), which included notes that an internal office and two mezzanine floors did not have building consents and that council flood modelling indicated a possible risk of flooding in a storm, although there was no record of prior flooding issues.
More details on Augusta are here on its website.
Augusta Funds Management is transferring its business into the NZX-listed Kermadec Property Fund Ltd.
A shareholder vote is due to be held next Wednesday March 14 on the plan, which involves the internalisation of the management of Kermadec, which will be 17.8% owned by Mark and Chris Francis.