What is a Property Syndicate?
Property syndication is a direct property investment where the smaller property investor with limited available capital has an opportunity to invest in commercial, retail or industrial properties.
The main objective is for investors to participate in properties with quality tenants, long-term leases, strong returns and good potential for capital growth. There is more risk when investing in only one property though it can provide a regular cash flow, tax benefits and potential capital gains.
Sophisticated, Wholesale and Overseas Investors can now participate in what has traditionally been the domain of developers. Well, we find the BEST deals and often invest in them ourselves, not as a manager but a shareholder. In fact, each of the investors have a say in the day to day running of the project or investment.
Checklist for investing in property syndicates
Here is a suggested checklist to consider before investing in a property syndicate:
- Property type – Is it an existing development? It may be developing a shopping centre by buying land, building it and then renting it out: in which case there would be no return for the initial period during the development stage.
- Capital – Is it an illiquid investment? Capital could be tied up for the fixed period of the syndicate, which could be as long 5, 7 or 10 years. What are the criteria for redemption, if available, before the end of the term?
- Tenants – What is the quality of the tenant? The quality and stability of the tenant will affect overall returns.
- Interest rates – Will any changes in interest rates affect the syndicate’s investments?
- Government policy – Will any changes affect the syndicate’s operation?
- Yield – Check the expected yield.
- Costs – Factor in other costs such as insurance. Check management costs, marketing fees and exit fees shown in the prospectus.
- ASX regulations – Does the property syndicate meet all Australian Securities and Investments Commission regulations?
- Due diligence – Have the prospectus checked by your own legal and accounting professionals.
- Management – Investigate the experience and qualifications of the management of the property syndicate. They should have a proven track record of managing a large portfolio of properties.
WHAT ARE THE OPTIONS?
There are essentially two types of property funds – registered property funds and unregistered property funds. Generally, any property fund that doesn’t fall into one of the exemption categories in the Corporations Act and/or class orders issued by the Australian Securities Investment Commission (ASIC) is under ASIC’s iron fist and must be registered with ASIC and will require a product disclosure statement and the fund manager to hold an Australian Financial Services (AFS) licence. The cost involved in setting up one of these ‘regulated’ funds is prohibitive for a mum and dad investor arrangement.
Unregistered funds are ‘small property syndicates’ and ‘participating property syndicates. These are terms given by ASIC to two types of investment structures which can be structured with minimal regulation, provided certain conditions are satisfied. It’s much easier and cheaper to establish an unregistered property fund; although there are some limitations associated with ‘small property syndicates’ and ‘participating property syndicates’, for example, the ASIC exemptions these syndicates operate under limits their use to passive income-producing property investments, which means they can’t be used to carry out a property development.
ISSUES TO CONSIDER
Generally, two issues drive the property fund structure: the Corporations Act requirements and tax.The key issues for mum and dad investors to consider when establishing a small property fund are: structure, licensing, whether an offer document is required, and tax and stamp duty.
Determining if a small property fund fits under one of the exemptions of the Corporations Act or ASIC class orders and is exempt from forking out big bucks for ASIC registration and licensing is as unpredictable as a ‘snakes and ladder’ game and as mysterious as a ‘choose your own adventure’ children’s book. Apparently even many solicitors and accountants are a little baffled about how to interpret the ASIC rulings.
THE MOST EFFECTIVE LEGAL SET-UP?
For a property fund intending to develop a site, the most common structure used is a unit trust, (recommended). If it’s a very closely held development and each of the investors have an active role in the development, then a joint venture (JV) structure can be used. However, that you need to be careful to make sure that the JV structure isn’t the type of ‘managed investment scheme’ that ASIC considers should be registered, because the penalties can be severe.
For a group of mum and dad investors looking to purchase a passive property investment, or alternatively if the syndicate set-up falls into the ‘small property syndicate’ category i.e a unit trust structure, but he this arrangement is more cumbersome and restrictive. For those who are looking to turn property funds management into more of a long-term option, then creating a ‘participating property syndicate’ can be a good starting point, before moving to applying for an AFS licence and establishing larger property funds.
WHERE TO START?
Usually with a smaller property fund structure, a few of the individuals are responsible for effectively bringing the fund together, acquiring the dwelling to renovate or a site to develop or redevelop. Then:
- The initial parties setting up the property fund place a call option for a fee over a development site.
- Once the property fund is formed and all the funds are contributed then the corporate trustee (acting as trustee of the property fund) enters into a contract to purchase that site from the landowner.
- Once the settlement of that sale is completed a development manager (or project manager) from the property fund is appointed and that development manager is responsible for development managing the project right through to completion.
A typical passive investment through a unit trust would also have a similar scenario, with the difference being that the site wouldn’t be developed, instead the property would be held and the rent collected by a property manager. The importance of carefully preparing the development management agreement or property management agreement, so that there are controls placed on the development or property manager (in the way they can spend money and take important decisions regarding the development or the property). Generally, the development manager or property manager will receive a fee (or, in the case of a development manager a unit in the development) for their efforts. We prefer not to allocate a dwelling (or apartment) to each investor because at sale time each dwelling might have a different value dependent on many factors, suggesting instead to allocate a percentage of profit in proportion with the initial investment.
- DIY Property Syndicate
- Name: St Lucia Townhouses
- Current property syndicate development value:$3.5 million
- Number of investors:12
- Development type:8 townhouses
- Estimated development time:18 months
- Estimated return to each investor:$70,000 each
- Project management fees:$15,000 per townhouse
- Type: Joint venture with a ‘tenants in common’ title.
- Profits divvied up at the end of development (Everyone received equal share).
WHAT DO LENDERS THINK OF SMALL PROPERTY FUNDS?
At the moment lenders have limited funds and are heavy on their discretion on what business they want. Anything that even hints of being complicated will be difficult to get finance for.
Many of the larger banks have indicated a solid preference for existing clients and nothing messy. Although it may be possible to get funds for property funds or joint ventures, it’s more than likely to be a commercial loan with commercial terms. For those inexperienced who just see the large potential of collective buying power but don’t understand the full risk and complexities as joint applicants guaranteeing liability for one another, the reality is, in the finance application the co-borrowers are each liable for the full amount as they are guaranteeing each other’s loans.” For example 5 people borrowing $2 million for a small townhouse development; If one of these investors then applies for another loan for their own individual investment, the lender will already see that that investor has a $2 million debt, rather than just the share that investor has in the total investment.