Property syndicates can offer high returns but investors need to be mindful of their upfront costs as well

Augusta Funds Management has launched its latest property syndicate, the Southgate Retail Centre at Takanini in south Auckland.

The property is a large format retail centre anchored by a Mitre 10 Mega outlet and Briscoes, which Augusta is packaging into a proportionate ownership scheme that is forecast to provide investors with a pre-tax cash return of 8% a year.

The main advantage of such schemes is that they allow mum and dad investors (the minimum investment in Southgate is $50,000) to access the relatively high returns that can be achieved from large scale property assets that would otherwise be beyond their means.

With bank term deposits generally offering less than 5% and gross dividend yields on NZX-listed property vehicles ranging from 4.8% to 6.8% (at today's prices) it is easy to see the appeal of a scheme such as Southgate, which as well as forecasting a return of 8%, will pay its cash distributions monthly, making it especially attractive to people such as retired folk who may be dependent on their investments for the bulk of their income.

On top of that there is the potential for some capital gain if the underlying property has increased sufficiently in value by the time it is eventually sold so that the scheme can be wound up, and the capital (after deducting expenses), is returned to investors.

In general, investors in property syndicates face the same types of risks as people purchasing an investment property directly, such as the potential loss of a tenant, unfavourable movements in the property market which could negatively impact rental income and capital values, or an increase in mortgage interest rates or other costs.

The other major factor investors need to consider is that syndicates do not usually have a fixed termination date.

The Southgate syndicate will be wound up and its capital returned to investors when 75% of its investor interests (there is one voting interest for every parcel of $50,000 invested) vote to do so.

That means investors cannot be sure when they will get their equity back and although they can try and resell their interests in a syndicate privately, that could prove difficult if market conditions are unfavourable.

Those sorts of risks are usually clearly spelled out in the investment statements syndicate promoters are required to provide to potential investors these days, and anecdotal evidence suggests investors are becoming more aware of their implications.

High set up costs

However one aspect of syndicate investment which does not receive so much attention is the effect that high syndicate set up costs can have on their investors' equity.

There are all sorts of costs involved in setting up a property syndicate and because these must usually be paid for upfront, they can have a significant impact on a syndicate's net asset backing and therefore on the investors' equity.

Listed below are just of few of the upfront costs for the Southgate syndicate:

• Offeror's fee $1.521 million. Paid to Augusta Funds Management to cover work such as locating a property suitable for syndication, undertaking due diligence and negotiating the purchase.
•  Lease incentive $700,000. Paid to the centre's largest tenant, Mitre 10 Mega. The Mitre 10 Mega store's lease was due to come up for renewal 2019 at which time it could decide whether or not to exercise a right of renewal for a further nine years.  Augusta negotiated a deal whereby Mitre 10 Mega would exercise the right of renewal early, giving investors the comfort of a lease that won't expire until 2028. In return for agreeing to the early renewal of the lease, Mitre 10 Mega's rent was reduced by $60,000 a year, the way rent increases would be calculated in future was changed from stepped increases to adjustments based on the Consumer Price Index and Mitre 10 would receive a one-off cash inducement of $700,000. So in return for the comfort of a longer term lease, investors are paying a substantial upfront charge and may also receive less rental income until the rent is readjusted to market rates in 2019.
• Underwriters' fees $943,250. Essentially the underwriters agree to subscribe for any unsold interests in the scheme if they haven't been taken up by other investors by a certain date. The advantage of this arrangement is that it would have strengthened Augusta's hand when negotiating the purchase of the property by allowing it to make an unconditional offer on behalf of the syndicate. An underwrite facility also gives potential investors more certainty that the scheme will go ahead. But the arrangements come at a price and investors should think carefully about the potential value they receive for parting with such a large amount of cash. The underwriters for the Southgate scheme are Augusta Funds Management's parent company, NZX listed Augusta Capital, and Cypress Capital, a company associated with Peter Francis who is the father of Augusta Capital's managing director Mark Francis.
• Legal costs $220,000.
• Accounting and audit fees $30,000.
• Brokerage fee $686,000. Payable to Bayleys Real Estate which has the contract to sell down the scheme to investors.
• Bank fee $15,000. Charged by ASB for providing the mortgage finance to help fund the purchase. ASB will also charge the syndicate $7500 to cover its own legal expenses in relation to the loan, taking its total charges to $22,500. Coincidentally, the vendor's existing mortgage on the property is also with ASB, so the bank's interest flow shouldn't miss a beat as it changes hands.

​All up, the upfront costs detailed above and a few others such as promotional costs and valuation fees, take the total costs the syndicate will have to pay to $4,316,390.

So how will that affect its investors?

The scheme will raise $34.3 million from investors and obtain a $28,716,390 mortgage from ASB, taking the total amount to be raised to $63,016,390.

From this, $58.5 million will be paid to purchase the property and $4,316,390 paid out in upfront costs as detailed above, leaving the syndicate with working capital of $200,000.

The property has been valued by JLL at $61.5 million, so with $200,000 of working capital the scheme will have total assets of $61.7 million.

Deducting ASB's (interest only) mortgage leaves net assets of $32,983,610.

The scheme is raising $34.3 million from investors, so their net asset backing is 96.2 cents for every dollar they invest.

JLL has also prepared a valuation based on selling the individual shops in the centre separately, which suggests that could give them a combined value of $65.7 million.

If that figure is used, net asset backing increases to $1.08 per dollar invested.

Capital gain targeted

However experienced property investors can be a hard nosed, sceptical lot and some may take the view that when it comes to investing their money, the only measure of a property's value that really matters to them, is the price at which it actually changes hands.

They might also take into consideration that Southgate's current owner (the vendor) is an experienced retail property investment company and it is understood that several potential buyers showed an interest in the property, so there would be an expectation that the vendors negotiated the best deal they could get.

And of course it is the actual selling price that will be used as a comparison figure in future valuation reports for similar types of properties.

So if the selling price is used as the benchmark for Southgate's value, the scheme's net asset value after the upfront costs have been deducted reduces to 87.4 cents for every dollar invested.

Investors also need to allow for that fact that when Southgate is sold, Augusta would be paid a termination fee of 1% of the sale price and the agent's commission on a sale is estimated at 2%, taking around 3% from the sale proceeds.

Property syndicates are typically set up to be long term investments and there is no way of knowing how much the property will fetch when Southgate is eventually sold and the scheme is wound up, perhaps some time in the next 5-10 years.

Hopefully when that does happen, the property's value will have risen sufficiently to have more than covered the initial upfront costs and later selling expenses, so that investors will make a capital gain.

But the syndication market is competitive.

As well as looking at the cash returns different syndicates provide, potential investors should also look at the upfront costs involved to satisfy themselves that they are getting value for money. 

Southgate Retail Centre, Proportionate Ownership Scheme.

Key Facts:

Property to be purchased: The Southgate Retail Centre at Takanini in south Auckland, which has Mitre 10 Mega as its anchor tenant and 28 other retailers including Briscoes, The Mad Butcher, ANZ Bank and Carl's Jr.

Purchase price: $58.5 million.

Valuation (JLL): $61.5 million.

To be funded by investors taking up 686 proportionate interests at $50,000 each ($34.3 million) and a $28,716,390 limited recourse mortgage from ASB.

Total to be raised: $63,016,390.

Establishment costs: $4,316,390 (including a $700,000 lease incentive payment). 

Loan to valuation ratio: 46.7%.

Net asset backing: 96.2 cents per dollar invested.

Forecast pre-tax, cash return to investors: 8% pa.

Distributions to be paid monthly.

To view the prospectus for Southgate Retail Centre click on this Link. And see our beginners guide to property syndicates here.

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