Will property syndicates hit the wall?

Australian Unity has raised more than half of its $21.5 million retail syndicate in less than six weeks and looks like completing the capital raising well before the closing date. Meanwhile, the Australian Securities and Investments Commission (ASIC) has appointed a new responsible entity to Landmark Property Syndicates, one of the largest in the country, after the management company surrendered its dealer’s licence.

These are two very mixed messages coming from the property syndicate sector in the space of one week.

Added to this, the property market is booming, returns are running hot and it looks to be a safe haven after the rough ride investors have had recently on the stock markets.

The two major property research houses, Property Investment Research (PIR) and Lonsdale, are both recommending investors to be cautious in the syndicate sector.

“We are counselling caution. There is a migration into property as a defensive move, but under no circumstances should people be going into property blindly,” says PIR associate director Mark Wist.

Lonsdale consultant Rob McGregor says the warning signs are also appearing in the syndication sector.

“We have become concerned that some syndicates being offered do not stack-up for investors and advisers will need to do their due diligence on the management and the operator of the syndicate,” he says.

At Landmark, the problems arose with its Woodlands Shopping Centre syndicate and concerned some costings not being included in the prospectus skewing the returns.

The syndicate sought funds to redevelop the Townsville shopping centre, however, the $700,000 cost for this work was omitted from the prospectus. The prospectus also stated a fixed sum contract had been entered into for the work and this was not the case.

ASIC has now sought an undertaking from Landmark to guarantee the returns to the investors as per the original forecasts and pay for any cost overruns in the refurbishment contract.

The Queensland Supreme Court has also ordered that members vote on appointing new responsible entities to the syndicates.

McGregor says Landmark’s case is a good example of looking at the quality of syndicate management before investing.

Wist also agrees it is important to look at the structure of the management of the syndicate before investing. He also argues the importance of quality independent research into each investment.

Property, like managed funds, does attract more than one researcher looking at each syndicate. The Australian Unity syndicate has been reviewed by both Lonsdale and PIR, both favouring the offering.

Wist says when PIR is researching a syndicate, it looks at the manager, including the experience of the staff, and its capacity to manage the investment.

“This doesn’t mean the responsible entity has to have a long track record in property management, it means they have to have the right experience. It only becomes a problem when individuals leave, the experience levels then drop,” Wist says.

McGregor says Lonsdale looks at the projections for returns, as well as the quality of the management.

“You have to look at the total returns of a syndicate and a good quality property can play a significant part in achieving returns of between eight to nine per cent,” he says.

“However, some syndicates have traded off risk to achieve the returns.”

McGregor says the larger players in the syndicate market can source property at reasonable prices, which helps returns.

The syndicate sector is now worth between $5 billion to $6 billion, with MCS the major player with more than $1 billion of funds under management.

It is an industry that has grown from zero in 1994 to its current position and is still expanding fast. New syndicates are being launched almost every month and new players are entering the field.

Wist believes there will be further rationalisation of the industry and the next few years will sort out the surviving players in the sector.

“The old property rules will apply and we are going to see a few years where yields are tight. There must be an opportunity to roll over the investment at the end of the initial syndication period,” he says.

Syndicates have to put a time limit on ownership in the prospectus and most now include the option of extending this ownership period. This is designed to overcome the problem of selling the investment in a down market.

McGregor admits timing is difficult to forecast in the property market. Nobody is ever quite sure when the investment cycle is turning. The current cycle has run for almost seven years and looks like continuing for a few more yet.

Australian Unity general manager of property Tory Richards is predicting the sector is a safe haven for investors for up to at least the next 12 months and possibly beyond that, even though syndicates have been dominated by retail investments with little office and industrial offerings.

Wist says major property investments tend to be snapped up by institutional investors, and small to medium regional retail centres are just the right size for a retail syndicate offering, hence the dominance of retail in the syndicate sector.

“There is also a smaller market for the large retail centres due to the limited number of potential purchasers,” he says.

“The neighbourhood centres have a ready market with a steady stream of potential buyers.”

The smaller to medium centres often have room for expansion or refurbishment to enhance the returns for investors.

However, these retail centres have not been without their problems as the recent sell-off of the Franklins supermarket chain has altered the potential viability of some centres. The lucky owners had their Franklins turned into a Woolworths or Coles store, which will boost returns for the retail centre. The unlucky investors gained an independent supermarket operator, which are usually not regarded as prime tenants.

McGregor says the next 12 months for syndicates will depend a lot on whether they can buy the properties at the right price.

“If the syndicate doesn’t buy the property at the right value, then the risk increases, but buying is where the syndicates make their money,” he says.

Wist says the next 12 months will see more rationalisation in the sector and $200 million of Landmark syndicates could find new managers in that period.

“I think the syndicate managers will look at ways of merging or taking over an existing entity as their method of expansion, rather than buying more properties,” he says.

“Also, syndicates are starting to look like unlisted property trusts in some of their structures, which means the exit strategy is very important.”

Unlisted property trusts started the end of the last property investment cycle in 1991. The trusts also grew rapidly after investors fled from the stock market in 1987. The question that has yet to be answered is will history repeat itself?