Low interest rates have people looking around for alternatives. Property Syndicates have become a popular way to eke out a better return on your money. But there are fish hooks. We explore some of the things you should consider when deciding if a Property Syndicate is right for you.
With low interest rates it is not surprising that many of us are looking for ways to get our money working harder. Property syndicates look like they might be the answer. They typically forecast attractive pre-tax cash returns of between 5% and 7%. They offer regular monthly income distributions. And they are backed by property, a tangible asset you can touch and feel.
Unfortunately it’s not that simple. There are fish hooks you need to be aware of. Syndicates are often propped up with high debt levels, the apparently attractive up front returns might not be sustainable and they can be hard to sell when you want your money out.
Just to make it even more confusing not all syndications are created equal. Careful research is required.
What is a Property Syndicate?
A typical property syndicate is where a property fund manager purchases an individual property, and then on-sells it, divided up into smaller interests, to multiple investors. Typically these syndicates are targeted at retail investors.
This is one of the key benefits of property syndication. It allows retail investors with modest amounts of capital to tap into the returns provided by larger commercial properties. Access to this kind of investment opportunity would be out of reach for most of us.
The returns are the carrot
Of course the thing that attracts investors to syndicates, and the most promoted aspect, are the returns promised. Returns of 5-7% in today’s low interest rate environment seem attractive. Especially given that investors typically compare these returns against current bank deposit rates.
This thinking is flawed. While 5-7% may seem attractive versus a couple of percent in the bank, to generate this return, property syndication introduces additional layers of risk often not fully appreciated by investors.
Most property syndicates fund the purchase of the property with a mix of money from investors and a loan from the bank or finance company.
Debt isn’t necessarily a bad thing, and if used prudently can increase an investor’s return on equity. However, interest costs are also a syndicated properties main expense. This means keeping debt under control, by ensuring both repayments and investor distributions are made, is critical.
The Global Financial Crisis taught most of us a lesson about debt – too much can be dangerous. Property syndicators heeded this lesson typically holding debt ratios of around 35% (that is they financed about a third of the property through a loan) in the years that followed.
Unfortuntely that was a decade ago. More recently, we have seen debt ratios rising back towards 50%.
More debt equals more risk. While interest rates are unlikely to rise in the near term, lenders can change other aspects of the loan facility. How long is the debt facility, and on what terms? What if, on refinancing the lender requires both the principal and interest to be paid down? These are all risks that should be searched for within the glossy pages of the offering document!
Buy now – pay later
Another fish hook you should consider is the sustainability of the return being offered.
While not unique to properties undergoing syndication, leases can be structured to generate higher initial returns, at the cost of long term under performance. An example of this may include leases with artificially high rental underwrites over vacant space.
Similarly, tenants may agree to a higher initial rent, in return for a ceiling on future market rental increases, or the waiving of end-of-lease financial obligations, such as reinstating the premises or removing specialist plant or equipment.
These measures all enhance the initial return at the cost of reduced returns in the future.
Property syndications do not have a finite term and typically require two-thirds of investors to agree to end the investment and sell the property. As an investor, you will need to wait until the property sells, and any loans repaid, before receiving back your capital. As you could imagine with multiple small investors, who have different goals and objectives, it can be difficult to get any agreement. Your money can be trapped.
Unlike the share market there is no recognised market to easily buy or sell your holding. Your interest a single property may be illiquid, and a sale difficult to achieve.
Some syndicators (but not all) offer a secondary market to help facilitate a sale. But these markets can be shallow, and can dry up should an event occur, and sellers exceed buyers.
Learn from the past
Property syndication is not new, having been big in the 1990's and again just before the Global Financial Crisis. Back then, companies such as Waltus Investments, Dominion Property and St Laurence offered attractive returns in an environment of falling interest rates – a market much like now. These providers ultimately found themselves in some difficulty and did not meet the expectations of many investors.
Since then, property syndicators have significantly lifted their game, coupled with increased overview by the FMA.
But the fundamental structure of property syndication hasn’t changed. These are primarily single asset entities offering a comparatively high initial return, by carrying higher levels of gearing, in some case less than attractive lease terms and offering limited liquidity to investors.
Do your research carefully
Property syndicates typically offer attractive returns st least initially. But they can be riskier than other forms of property investment over the medium to long term.
If the primary reason you are considering buying into a property syndicate is for income purposes, then beware of the fish hooks, ask lots of questions and if you don’t get clear answers it might be wise considering an alternative way to access to the commercial property market.