Money: Alarm bells on property funds

By Philip MacAlister

Like moths to a lamp, investors in New Zealand have been flocking to syndicated property funds.

The double-digit returns offered by many of these investments are the equivalent of an outside light left on overnight.

However, many of the investors, like the moths, have been burnt by the bright attraction. In the hard light of day the survivors have fled the scene while the scorched remains of the not so lucky ones are a warning to those who follow.

Syndicated property investors have found that promised returns are not eventuating in a number of these funds.

The biggest player in this sector, Waltus, has decided to suspend, or reduce dividend payments to investors in some of its syndicates. Cascara Group did the same with its Three Kings fund in Auckland.

Property syndication has been one of the most popular forms of investment for many years, attracting strong fund inflows since the mid-1990s.

Ernst and Young Real Estate Group estimates the syndicated property market at about $1.04 billion, while the listed property market is $2.6 billion in size.

Waltus has about 40 per cent with Dominion Investment Trust and St Laurence Group at 21 per cent and 10 per cent respectively.

The offerings raised $251 million in 1997, $196 million the following year and $131 million in the year to date.

The market is made up of "mums and dads" with between $10,000 and $20,000 to invest, and almost all of them are introduced to syndicates through financial advisers.

"The seemingly unlimited demand from retail investors attracted to the high initial yields offered by the promoters has been further fuelled by the continued fall in bank deposit rates over recent months, and the uncertainties which abound in the equities markets," says Ernst and Young research analyst Brenda Stokes.

"The demand for syndicated property and its associated attractive yields is such that each new offering brought to the market is generally being well over-subscribed."

However, with promised returns not happening, many investors believe that they may have been better off putting their money elsewhere for a lower return, but one that was more likely to be paid.

Investors in Cascara Group's Three Kings Fund have had their cash distributions suspended for at least 12 months because three of the property's tenants, Farmers, Stevens Gifts and Street Seen, left. The fund's profit for the year was 40 per cent below forecast and investors received only $220 on each of their $5,000 parcels, which is the equivalent of a 4.4 per cent return.

To make matters worse, the manager is now having trouble "finding suitable replacement tenants," and there is likely to be unplanned costs in attracting new tenants.

Three Kings is not alone. Waltus is either reducing or suspending payments on a number of its 37 syndicates for similar reasons.

The company says it is setting up an "asset protection fund" to help pay for the costs of keeping and attracting tenants.

"Companies with a lease expiry in the next 12 to 24 months are temporarily reducing interest paid to investors," says chairman Rod Lidgard.

These companies will continue to make interest. But the money will not go to investors as it will be going into the new fund.

This is on top of the sinking fund which Waltus syndicates already run. Under this process, 2 per cent of rental income is put aside each year to help deal with lease expiries.

Waltus director Shayne Hodge says the asset protection fund has been formed because there is a problem, particularly in the provinces, of keeping existing tenants or finding new ones once a lease expires.

Of the 64 properties which are owned by Waltus' 37 syndicates, 25 of them are in the provinces, and the balance are in either Auckland, Wellington or Christchurch. A number of the syndicates have had their returns to investors halved (to around 5 per cent) and three have had all the money redirected to the new fund.

Mr Hodge says the fund is a short-term cost for a long-term gain. He points out that the value of a building tends to fall as leases approach the end of their term but once new leases are in place property values increase again.

"It's a timely wake-up call to realise that this is what can happen with property-based investments."

He is also concerned that property syndicates, because of their high advertised yields, are being sold as an alternative to fixed interest. That has become more pronounced as bank deposit rates have tumbled to historical lows since late last year.

"No way should people use [syndicated property] as a proxy for fixed interest," Mr Hodge says.

Another key point people buying syndicates need to realise is that the advertised returns of 10 per cent or more are not guaranteed.

"Just because it's an income stream don't think it's an income stream for life," Mr Hodge says.

Tower Trust managing director Jim Minto says people need to understand the characteristics of syndicated property investments.

"Essentially they are an equity interest in a property. They are promised a rental stream, but if the tenant goes there's no income."

While property is an essential element of a diversified investment portfolio some firms will not touch syndicated property.

"We won't touch it simply because of liquidity," says Craig and Co research analyst Cameron Watson.

"We don't care how good the property is. Liquidity is the biggest issue."

And the issue is simple - if you put your money in, you want to be able to get it back.

The answer, according to the syndicators, is running a secondary market for units. They all offer such a service, but it is not as liquid nor, arguably, as transparent as the sharemarket for listed companies.

Figures from secondary market operator Sharemart show that Waltus syndicates are rarely traded. However, Waltus operates its own market as do the likes of advisory firm Equity.

Waltus says a transaction takes, on average, about 25 days, and the company handles about 500 trades per quarter.

That is pretty slow compared with the almost instantaneous liquidity of the sharemarket.

Mr Watson says the sharemarket offers investors far superior liquidity.

"If a listed property company experiences a downturn at least investors will, via the sharemarket, have an efficient method of exiting their investment."

Mr Watson says investors seem to have short memories about the liquidity problems of property investments.

He points to the unlisted property trust crash in Australia in the early 1990s and the on-going problems unit-holders face with the New Zealand Rural Property trust. In the latter, investors can only exit the fund through the secondary market and that is at prices around half of the fund's net asset value.

The concern with property syndicates is that there is an incredibly high level of risk in having one syndicate, one building and one tenant.

Equity's managing director, Phil Briggs, says the beauty of syndicated property is that investors can mix and match their property portfolio to their own tastes.

Instead of going into a listed property trust and having no control over the fund's assets, people can buy into areas and sectors they like through syndicated property.

"The glory of syndicated property is that you can take the good and leave the bad," he says.

"It allows me to tilt my portfolio the way I want."

Mr Briggs says while the minimum investment is usually $5000 per syndicate, his clients own holdings in a range of syndicates to give their property portfolio adequate diversification.

The average Equity client has holdings in about 10 syndicates.

"Property syndication is not for a person with just $5000 to invest."

* Philip Macalister is the editor of online money management magazine Good Returns (www.goodreturns.co.nz)