Mention the words "investment disaster" to most NZ investors and they will automatically think of finance company failures.
Probably the only good thing that has come out of this sad episode in NZ financial evolution is that investors won't do it again, for a good few years anyway.
The same cannot be said however for Proportionate Property Investments (PPI). Despite these type of products being responsible for big losses in NZ, Australia and internationally, new local vehicles regularly appear indicating continued demand from retail investors. This column has warned about buying shares in securitised investment property that isn't listed on a stock exchange for years, most recently in March 2009 ('Price is not always right in finance') and as long ago as 1986 in the Whakatane Beacon.
The FMA is obviously concerned about PPI's too and has changed the law so that PPI's are now required to register a prospectus and an investment statement. Announcing the change FMA regulator head, Sue Brown, said in 2012 "there are significant risks peculiar to Real Property Proportionate Ownership Schemes that need to be better understood" and then "these changes will provide investors with the information they need to make informed decisions".
The FMA is sorting things out in lots of areas, not least of which are their excellent efforts to bring all the dishonest and/or stupid finance company directors to account, even if half of them only get home detention, but to hope that the investment statements of PPI's are going to disclose all the disadvantages of this type of product relative to listed entities is optimistic to put it mildly.
To really get the message across to retail investors financial advisers and the media need to get on-board - but with PPI's frequently offering 2-3 times the commission typical of NZX-listed products not everyone is going to sing from the same song book.
Exhibit 1 supporting these opinions is sitting on my desk and it is the prospectus for a new PPI selling $26 million of industrial property in my home town of Whakatane.
The property is known as the Hub and it was formerly the site of the Whakatane Board Mills Sawmill where my father used to work so I know the area well - well enough to know that the panoramic view of Ohope Beach featured on page three of the prospectus is about 30 kms from the Hub and, needless to say, has absolutely nothing to do with the property. Its relevance to the prospectus is thus not immediately obvious.
But let's get down to business and take a close look at this offer, particularly as it compares with NZX-listed alternatives.
First off we will look at the figure most retail investors focus on which is the income yield of the property. Here the Hub scores highly because the forecast yield, at 10.75 per cent, is well ahead of NZX-listed alternatives like Kiwi Income Property Trust (approx. 8.0 per cent) and Property for Industry (approx. 7.5 per cent) but finance company debentures also looked good on this sort of simplistic comparison so we need to dig deeper and consider risk.
Risk in a property context has at least five major components - the quality and number of tenants, the number of buildings, the average duration of the lease, the level of gearing and the method of price discovery also known as liquidity. On these measures the Hub scores poorly in my view and a reasonable person is likely to see that 10.75 per cent yield as high risk in comparison.
We will look at each factor in turn. About the only free lunch there is in the investment world, apart from accountants, members of the Institute of Financial Advisors, and various other unqualified people getting exemption from the AFA exams, is the risk reduction achieved by diversification - but Hub investors don't benefit much here because the Hub is one property, in one town, in one sector with just ten tenants.
In contrast the larger listed alternatives have 50 or more buildings with hundreds of tenants in lots of different areas so on this basis an investment in the Hub looks relatively risky. In terms of quality of tenants it is a similar story. Although some 71 per cent of the space is occupied by leading retailers like Farmers, Harvey Norman, K-Mart and Briscoes which is attractive but they are all retailers whereas the listed alternatives have a far greater spread of types of business as tenants.
Precinct Properties for example have the NZ Government renting more than a quarter of its space. Problems could also arise with less well capitalised tenants like Postie Plus whose share price at 15 cents suggests that things aren't going particularly well.
In terms of lease duration the average lease term remaining at 4.3 years is comparable with NZX listed alternatives but the valuation report points out that the Briscoes tenancy expires in three years time and that it represents 20 per cent of the Hub's rent. A further 40 per cent of leases expire the following year.
Gearing is another area where the Hub scores poorly as it is relatively highly geared. The Hub is valued at $26 million but borrowing at $11.5 million is 42.5 per cent of total assets. The larger listed alternatives have gearing between 20 per cent and 30 per cent. As a general rule lower quality, undiversified property investments should have lower levels of gearing. The architects of property investments are incentivised to maximise gearing when interest rates are low as this artificially boosts the income yield.
We don't have room to go into too much detail about price discovery and liquidity. This issue is covered in detail in the "Price is not always right" article but it is noteworthy that when you buy shares in a NZX-listed company the price is determined by the market which is dominated by professional investors so you can be more confident that the "price is right".
In the case of the Hub the price has been determined by an independent valuer but the seller is a major international property investor who presumably has more information and experience than most mums and dads. There will be no secondary market in the Hub shares should investors wish to sell and potential purchasers need to be approved by the Manager. One wonders why this is the case.
Last but not least transaction costs for the Hub are very high at $875,000 which on the equity being raised of about $15 million is a fee of 5.83 per cent of the funds raised. This compares with 1.0 per cent to 1.5 per cent to deal on the NZX. Ongoing management fees appear reasonable.
So there you go. The yield is better but it looks much more risky and we haven't covered all the issues. Given the huge advantages listed entities have over virtually all PPI offerings there is probably a potential PHD thesis here for someone in the field of behavioural finance explaining why anyone buys these things.