Brent Sheather: Finding the right price for property

Brian Gaynor ruffled the feathers of the property syndicators a few weeks back when he contrasted the attractions of syndicated and listed property vehicles. The story provoked a rebuttal from Mark Francis of Augusta Funds Management, a property syndicator.

Unfortunately, anyone hoping to better understand the difference between the two alternatives will be disappointed as Francis' article failed to get to grips with the key issues. He argued that syndicated property and listed property both offer an underlying exposure to the property asset class, which is fair enough.

But CDOs and triple A-rated bonds both delivered exposure to fixed interest. The risks associated with each, however, were markedly different.

So it is with syndicated and listed property - both offer exposure to property but in quite different ways.

The risks of buying or selling badly and the sensitivity to adverse financial or economic conditions (due to greater levels of gearing) are higher with the former than the latter.

In addition, today listed property is much better value and, as it is more diversified, it is also lower risk.

The choice between the two really is a no-brainer.

So let's look at some facts: what's the biggest issue when Mum and Dad are buying an investment property? The price, what you pay for it, has got to be up there in importance.

But price discovery is one of the key differences between syndicated property and listed property.

The former is valued by a property valuer whereas listed property has the benefit of a property valuer's opinion but the last word on price comes from the stockmarket representing the consensus view of many hundreds of investors.

Price discovery is critical and there is every reason to believe that this function is more efficiently and fairly accomplished within the listed property market than via a syndicate relying on a discrete valuation.

That is certainly what the academics say and, incidentally, these academics don't manage listed property, nor do they flog syndicated property.

The historical evidence, too, shows that a property's valuation can diverge sharply from what the property is actually worth, causing all sorts of unforseen problems.

The key valuation metric for property is the capitalisation rate - rent divided by the price of the building. So the higher the cap rate, all other things being equal, the better the deal the buyer is getting.

The stockmarket dimension is critical because property values need to be determined having regard to the price of all other risky assets, not just relative to other properties.

We have had numerous unlisted property trust crashes where the real value of property was less than the valuer's estimate of the property, ultimately leading to runs on open-ended property funds in Australia and New Zealand (1990-91) and more recently in Germany.

For one thing, the valuer's number is historic, whereas stockmarkets look forward; and for another, the valuer doesn't take account of the capital structure of the vehicle owning the property, nor does he/she have regard to how much of the rental cash flow is lost via management and other fees.

These aspects are as significant as the size of the rental streams and ignoring them can lead to mispricing prime property just as easily it can impact B-grade buildings.

Listed property's attractions are compounded by the fact that today property companies listed on the stockmarket are much cheaper than syndicated property.

Syndicated property is sold at valuation whereas all the listed property companies are trading at double-digit discounts to valuation.

Remember, too, that price discovery is not only relevant when you buy but also when you eventually sell and the secondary market in syndicated properties is generally controlled by the syndicate manager, who will be an "insider", and that they will have more knowledge about the property than anyone else.

There is no evidence that this happens here but the potential thus exists for unfair trading to take place, in contrast to the NZX and ASX, where insider trading is illegal, disclosure rules apply and there is every chance that the buyer of the property shares you are selling is no better informed than you are.

Mark Francis then argues that Gaynor's assertions of liquidity problems with syndicated properties are without merit and that in the past his firm has been able to facilitate the resale of units of any clients who wish to sell.

This is all well and good but there is a lot more to liquidity than a limited number of people being able to sell their units. In order to determine how liquid an asset is, one should ask two questions:

1. How long will it take to buy or sell the asset?

2. What will be the effect of my transaction on market prices?

In an ideal world, transactions should be instantaneous and have little impact on market prices. High liquidity is thus a fundamental requirement if a stock is to attract the attention of most institutional investors.

Institutions typically don't invest in syndicated property schemes. They do buy listed property. One reason for them preferring listed is liquidity - you can sell $50,000 worth of AMP Office Trust without pushing the price around by more than 1c or 2c, anonymously, and you can do that five days a week. That's not the case with unlisted.

Liquidity also has implications for "price discovery", which is of particular relevance to retail investors. All other things being equal, the more liquid a market for an asset is, the more confident one can be that the market price adequately reflects the investment fundamentals of that instrument, due primarily to the research efforts of institutional investors, stockbrokers, etc.

All other things being equal, the less liquidity in an instrument, the less research will be undertaken, meaning that prices are more likely to lose touch with reality.

One of the key determinants of the riskiness of property is the extent to which the property is funded by debt. In New Zealand and overseas, listed property companies have undertaken steps to bring their gearing down to the 20-30 per cent level with AMP Office in New Zealand leading the way with just 19 per cent gearing.

In Australia, all the listed property trusts with excessive gearing (anything above 40 per cent) have had their share prices savagely marked down by the market and are now unable to raise new capital. Contrast that with syndicates in New Zealand recently being formed with an average 40-50 per cent in debt.

Their sensitivity to downturns in the economy or property valuation decline will thus be greater and there is no guarantee they will be able to refinance when the time comes.

Francis finishes by arguing that syndicated property lets you choose which building you want to own. But if you are not an expert, why would you want to choose to invest in one property over another when you can't tell which is better value and when all theory and common sense says that you should diversify?

Today listed property is both cheaper than the syndicated options and lower risk. Independent trustees charged with managing assets for retail investors need to be aware of the key differences between the two investments and the overarching need to ensure that investments are diversified appropriately and risks minimised.

Concentrating a family trust's investments in one or two syndicated properties would not appear to satisfy either of these requirements.

* Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.