Despite all the time and effort that is going into behavioural finance these days it seems many investors still buy high and sell low, overestimate their tolerance to risk and buy junk bonds just because their interest rates are "high".

In fact the field of behavioural economics might get a bit more traction in the real world if it was rebranded as "dumb investment strategies that you should avoid" or "they are after your money, fool". Everybody makes bad investment moves including stockbrokers, fund managers, journalists and experts.

Anyway this week we will look at one investment product which, despite appearing stupid on just about any measure and being the subject of a warning from the FMA is, apparently, still very popular with mum and dad investors.

Yes you guessed it we are back on property syndicates again, also known as unlisted property or proportionate property schemes. This column has covered the topic several times before (see Price not always right in finance on March 14, 2009) and I even wrote about the subject as far back as 1986 in the Whakatane Beacon.


That latter article somehow attracted criticism from an Australian based director of an Armstrong Jones' unlisted property fund who said that you couldn't compare listed and unlisted property because listed property was really shares, which were risky, and unlisted property really was property, which was low risk. That made sense, not.

Subsequently Australia had a huge unlisted property crash and those few Armstrong Jones' property funds which didn't go bust decided to do the right thing and list themselves on the ASX.

Incidentally unlisted property trusts paid high commission and trailing fees and were, surprise, surprise, popular with many of the financial planners who then went on to promote finance company debentures.

But we are off track. To kick off the discussion let's see what the FMA has to say about property syndicates.

In a 2012 consultation the FMA suggest that some of the people who previously bought finance companies are now into syndicates and that syndicates tend to be popular with "the sector of investing public that seeks the apparent familiarity of property without appreciating the full implications of these products. Property syndicates have been the subject of a significant number of complaints covering a variety of issues including inadequate governance, deficient management and poor disclosure. The complaints demonstrate a failure of disclosure."

The FMA highlights disclosure failings as including the additional liabilities that accrue from maintenance, the issues and risk raised by common ownership and the fact that mum and dad are giving control to a manager whose objectives may be different to theirs.

Full marks to the FMA for highlighting these dangers but isn't it rather strange that an associate director of the FMA apparently is the principal of one of NZ's largest property syndicators. Only in NZ.

Governance and disclosure are problems but to be frank that really is just the start of the issues with property syndicates. The substantive failings of these schemes relative to listed alternatives are set out below:


With a property syndicate the price is determined by a valuer who works for the property syndicator. Coincidentally often the syndicator is selling the property! Listed property trusts are priced with the benefit of a valuer's knowledge but are also a function of buying and selling by institutional investors who analyse these things in a lot of detail.

So if they think the valuation is too high or too low they will price the fund differently and also have regard to the price of other competing assets like bonds, shares in real time. If the property trust is burdened with a terrible management fee or a stupid manager the market price will reflect this. All in all you would have to conclude the stockmarket produces a fairer price than one valuer and this difference is critical for mum and dad because most are not experts.

With a listed property trust you can sell out and get your money in 4 or 5 days for a brokerage rate of maybe 1.5%. With an unlisted property trust selling is more difficult and frequently the fee to exit is 2% and you may even have to get the permission of the manager to sell your units. More often than not there is a large bid/offer spread - 10% and more - and the buyers are often "close" to the syndicate managers so insider trading can be a problem.

With syndicates you normally buy one property with a few tenants in one town in one sector. With listed property trusts you get the benefits of diversification - lots of properties and diversified geographically. It is also fair to say that the quality of the buildings and the tenants of listed property is almost always of much higher quality than syndicates and, all things being equal, this means it is lower risk.

The average gearing of the listed property trusts is between 25% and 35%. Gearing on syndicated properties is frequently around 50% and high gearing equals high risk.

Note that less scrupulous directors are inclined to advocate high gearing to maximise funds under management and to artificially inflate the yield accruing to shareholders. Property is generally less risky than shares unless it has high debt in which case it can be much more risky.

Entry cost
It costs an average of about 1.5% in brokerage to buy a listed fund on the stockmarket. The all up fees for initial offerings of syndicated properties seems to average a huge 10% which is outrageous and ridiculous.

Let's look at a specific property syndicate currently being marketed to retail investors. It is called Bunnings Silverdale and it owns a Bunnings warehouse in Silverdale, Auckland with a 12 year lease and an 8% yield. On these metrics it doesn't look too bad - Kiwi Income Property Trust yields 7.95% and Property for Industry yields 8.03%. But before we part with our money let's take a closer look.

The first thing that struck me was that the capitalisation rate used by the valuer seems optimistic at 6.85% relative to the average of 7.8% implicit in the valuation of PFI's buildings.

We should note at this point that PFI is trading at a 4% premium to its NAV so the market may be applying a 4% lower cap rate to value the stock therefore that brings the cap rate down to 7.5% which is still a lot more attractive than 6.85%.

Simplifying things the capitalisation rate is used to capitalise the rent to obtain a value. The lower the cap rate the higher the valuation and 6.85% is a lot lower than 7.5%. In this case the syndicate is purchasing the property below valuation, at a capitalisation rate of 7.3%.

Next up is the degree of borrowing. Gearing on this syndicate is up there at 45.4%. The average cost of funding, fixed for a few years is 5.2% and because that is below the 6.85% yield of the property that's how the return on equity gets to 8%.

Note that the interest rate is only fixed for a few years and one of the good things that the FMA has done is compel syndicators to disclose what would happen if interest rates rose. In one table in the investment statement we see that if the interest rate rose to 6.5% the yield to investors falls to 7.00%.

We are running out of space here so the last thing we will consider is fees and the total initial fees associated with this offer amounts to 10% of the equity raised.

That sounds like fun.