Oyster Group's latest property syndicate forecasts a 10% cash return

Oyster Group's latest property syndicate forecasts a 10% cash return
The NZ Racing Board headquarters

Oyster Group's latest property syndicate is forecast to pay investors a pre-tax cash return of 10%.

A 10% return is higher than most new property syndications have been offering recently and at least double what most bank term deposits are offering.

So the combination of a high return and the fact that cash distributions will be paid monthly, will likely appeal to people such as retired folk who are dependent on their investments for a large part of their income.

The syndicate will own the NZ Racing Board's head office building at Petone in Lower Hutt, and will be structured as a proportionate ownership scheme (the scheme).

The Racing Board (the board) owns and occupies the entire building and the scheme will acquire it under a sale and leaseback arrangement, under which the board will continue to occupy the property as the sole tenant.

The board is best known as the operator of the TAB and like many organisations has been going through a period of change, but it was in the news this week over the sudden and unexplained departure of its chief executive.

As a statutory body the board is required to publish its accounts, which means prospective investors in the scheme can access these either through the board's own website (nzracingboard.co.nz) or through the Companies Office website (companies.govt.nz), to help form a view on the scheme's tenancy risk.

The property is a six level office building in central Petone that was purpose built for the board in 1989.

It has a seismic rating of 70% of new building standard and a net lettable area of 6290sq m with 42 covered and 31 uncovered car parks.

The board will continue to occupy the building on two separate leases.

The first lease is for the lower floors up to level 2 and runs for nine years from the settlement date of the purchase and will provide 57% of the rental income.

The second lease is for levels three and four and also runs for nine years from settlement, but with a clause that would allow the lease to be broken by the tenant at year six, provided 12 month's notice is given. This second lease provides the remaining 43% of rental income.

The rent will adjusted to reflect changes in the Consumer Price Index plus 1.5%, every three years, with an adjustment to market rates at years nine and 12 (assuming the leases are renewed).

Given that a break clause has been included in the lease on the upper levels and that the tenant has been making significant changes to its business, it would be prudent to factor in a reasonable possibility that the building's two upper levels could become vacant after six years.

Tenancy risk & interest rate movements

With that in mind potential investors should pay particular attention to page 26 of Colliers' valuation report on the property (which accompanies the scheme's investment statement), which gives a broad overview of the leasing market in Petone and the Hutt Valley.

Apart from tenancy risk, another major factor prospective investors need to consider when a property is carrying debt, is the impact that movements in interest rates could have on future cash distributions.

The purchase of the property will be part funded by a mortgage from ASB, and the scheme's financial forecasts are based on an interest rate of 5.95% for the first two years, which is expected to be fixed via an interest rate swap arrangement with the bank.

Although interest rates could be higher than 5.95% after two years, that may be offset, and possibly more than offset at year three, when the first rent review takes place.

However property syndicates are generally regarded as long term investments and making long term forecasts about interest rates and inflation is notoriously difficult.

Potential investors should also carefully consider some of the particular features of proportionate ownership schemes.

Like most of such schemes, this latest offering from Oyster Group does not have a termination date. It will be wound up and the surplus funds distributed back to investors when 75% of investor interests (investors receive one voting interest for every $100,000 they invest in the scheme) vote in favour of such a proposal.

But there is no way of knowing when that will occur, so investors cannot be sure when they will get their capital back.

If they want to cash up early, they could try to sell their interest in the scheme, and in such cases its manger (in this case Oyster Group) will usually try and facilitate a private sale between investors.

That may work well when  market conditions for property syndicates are relatively favourable, as they are now, but investors may have trouble selling their interest at an acceptable price if market conditions change, making syndicates less attractive.

High set up costs, including fees

Property syndicates also tend to have comparatively high set up costs relative to the size of the investment.

The pronto costs of establishing the scheme for the racing board building are forecast to be $900,000, while the property itself is valued at $10.63 million. Included in the $900,000 are Oyster's fees of $301,500.

The scheme will have $4.7m of debt which means the net value of the property will be $5.93 million.

Investors will be contributing $6.7m into the scheme, which means the initial net tangible asset backing of their investment will be 88.5 cents for every dollar they invest.

However included in the establishment costs is a contingency of $385,923 relating to the interest rate swap.

If that money it not required it will be retained as working capital, and that would boost net tangible asset backing to 94.3 cents per dollar invested.

In either case, investors will be reliant on the value of the property increasing sufficiently to cover the scheme's establishment costs and any costs associated with selling the building, to be sure of recouping their original investment.

For more information on property syndications, see interest.co.nz's commercial property syndications page here.

Jackson Petone Proportionate Ownership Scheme:

Minimum investment: $100,000.

Forecast cash return: 10% a year.

Cash distributions paid monthly.

Property location: 106-110 Jackson St, Petone.

Tenant: NZ Racing Board.

Valuation: $10.63 million.

Purchase price: $10.5 million.

Loan to valuation ratio: 44.2%

Rental yield: 9.5%.

Initial net tangible asset backing: 88.5 cents per dollar invested (increasing to 94.3 cents per dollar invested if a contingent liability does not eventuate).

Offeror: Oyster Property Group.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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The weaknesses in these scheme are
1. An investors share decreases in value every day that passes as the clock ticks towards the end of the lease(s)
2. Sale of a share is difficult as it is not listed on the stock market but on the "grey market"
and hence buyers may be far and few between.
3.  Repairs, vacancies and defaults are caried by the investors, not the managers.
4. Typically the management agreement with the promoters is usually so water tight  that removing them for any reason is virtually impossible.
5. Investors have little or no control as a large majority is usually required for any action, and this is rarely obtained.
6. One tenant, one big risk.

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