Property syndicates are back in the limelight, with a plethora of new offerings forecasting annual pre-tax cash returns between 7.0 and 8.0 per cent. These represent extremely attractive returns in the low interest rate environment.
In light of this, what are the pros and cons of investing in property syndicates and are they more attractive than alternative investment options?
A property syndicate is where a property fund manager purchases an individual property and then on-sells it to investors. The property manager charges a fee for the purchase and sale, as well as an annual management fee.
Investors buy units in the syndicate, which are usually priced at $25,000 or $50,000 each. It is important to note that syndicate investors do not own separate parts of the property: they own a unit of the whole property.
Annual cash returns are based on the rental income of the property after deducting all costs.
Property syndicates are different to listed property companies as they usually contain only one property and there is no recognised market to buy or sell units. By contrast, listed property companies own multiple properties and their shares trade on the stock exchange.
This column assesses two property syndicates, one recently closed and the other opened earlier this month.
These syndicates, which are the brainchild of NZX-listed Augusta Capital, are essentially the same building that has been divided into two separate parts for the purpose of these public offerings.
The two syndicates are as follows. Building A is on Graham St, Auckland, which is off Victoria St West.
The building was developed by Mansons Properties, the ultimate vendor. Building A consists of six levels of office space with a rentable area of approximately 11,118sq m, along with 215sq m of basement storage space and 113 secure basement carparks. Building A has no retail space.
Building A's largest tenant is NZME, the publisher of the Weekend Herald, which has 49.3 per cent of the rentable area.
Graphic / NZ Herald
Building B, also on Graham St, comprises the Building B and Building C parts of the Mansons Properties development. Building B, which is separated from Building A by an enclosed atrium connected by airbridges, has six levels of 7147sq m of rentable office space. NZME is also the largest tenant in Building B with 43.5 per cent of the rentable area.
Building B also has approximately 792sq m of lettable retail area, 34sq m of basement storage space, 68 secure basement carparks and naming rights granted to BDO.
Building C is described as "a newly built structure located on Hardinge Street which comprises approximately 240sq m rentable area and is a separate retail block on the edge of the basement area of the BDO Centre with Hardinge Street footage".
The accompanying table shows the main characteristics of the two property syndicates.
Building A was purchased from Mansons Properties for $115.8 million. But the total cost to investors was $122.1m because of $6.3m of establishment costs, including $2.9m paid to Augusta.
This is consistent with most property syndicates, as investors, rather than the promoters, are responsible for the purchase, selling and legal costs associated with the public issue.
Thus, the total cost of Building A was $122.1m compared with a valuation of $119.85m.
Building A has borrowed $52.1m and successfully raised $70.0m from the public through the issue of 1400 units at $50,000 each. Augusta Capital announced on August 8 that Building A had "attracted substantial interest and has now closed oversubscribed".
Building A's product disclosure statement, which is far more comprehensive than the old "Offeror Statement" for property syndicates, identified the following risks:
• NZME default. If NZME experienced financial problems of a significant nature, and was unable to meet its rental requirements, then this would have a material impact on the syndicate's ability to deliver the forecast returns to investors. A Commerce Commission decision to approve the merger between NZME and Fairfax would be a positive outcome for the syndicate.
• Interest rate increases. Interest costs are the property's main expense. The all-up effective interest rate is 4.28 per cent for the first five years. A significant increase in interest rates after that would impact investor returns.
• Selling units. There is no timescale for property syndicates and no requirement by anyone to repurchase units from investors. The market for units may be illiquid and the sale of units may not be easily achieved. This could impact an investor's ability to recoup their investment in full.
The other issue is fees and costs, which are estimated at 3.90 per cent for the March 2018 year. There are a plethora of potential fees for activities including: new leasing, renewals or extensions, sale of building, wind-up, project management, assignment, refinancing capital raisings, legal, audits and the removal of the manager.
Augusta receives an annual management fee of $300,000 plus GST, increasing each year by the greater of 3 per cent or any CPI increase for that year. In addition, Augusta will charge 2 per cent to facilitate the sale or purchase of units by investors.
The Building B offering opened on October 12 and is due to close on November 21.
It was purchased from Mansons Properties for $88.4m but the total cost is $93.6m because of a $0.2m sinking fund and establishment costs of $5.0m, including $2.1m paid to Augusta. The total purchase price of $93.6m compares with an independent valuation of $89.6m.
There are clear differences between NZX listed property companies and property syndicates.
Building B will issue 1050 units to the public at $50,000 each to raise $52.5m. There will be additional borrowing of $41.1m at an effective interest rate of 4.22 per cent compared with 4.28 per cent for Building A. Building B has a forecast interest cover ratio of 3.12 times for the March 2018 year compared with 3.23 times for Building A.
However, Building B has a slightly lower forecast pre-cash return than Building A for the same period and its total fees/expenses are also higher as illustrated in the accompanying table.
Building B is probably more risky from a rental income point of view than Building A because of its retail space exposure. Small retail tenants are more likely to experience financial difficulties and Building B's product disclosure statement contained the following comment:
"A number of retail tenants are, in the manager's view, paying above market rentals for their premises. In the event that replacement tenants needed to be found, it is likely that the manager would need to offer rental incentives to any incoming retail tenant and/or agree to a lower (market) rate with the incoming tenant".
There is no one-size-fits-all product as far as investment opportunities are concerned and it is clear from the demand for Building A units that many individuals are attracted to property syndicates. However, these products have two major drawbacks -- namely, they do not have diversified property portfolios and have no termination or maturity dates.
There are clear differences between NZX listed property companies and property syndicates.
Augusta Capital has a gross dividend yield of 6.20 per cent and its shares are traded on the NZX while Building B is forecasting a 7.00 per cent pre-tax distribution for the March 2018 year and its units are expected to be extremely illiquid.
This is not a recommendation for Augusta Capital, but investors should carefully assess the tradeoff between annual income returns and liquidity when making investment decisions.
Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management.
