Augusta's latest commercial property syndicate offers high returns but there's a sting in the tail with high set up costs

Augusta Funds Management's latest property syndicate is offering a forecast cash return of 9%, but investors also need to consider the effect its high upfront fees will have on their equity.

The syndicate is being structured as a proportionate ownership scheme, which will acquire an industrial property on 30-32B Birmingham Rd, in the Middleton industrial estate in Christchurch.

The property is leased to PMP (NZ) Ltd and is the South Island base for the company's printing and magazine distribution activities.

The lease is for 10 years (plus two rights of renewal of five years each) and is guaranteed by PMP's ASX-listed parent.

The minimum investment is $50,000 and Augusta is forecasting the scheme to provide an initial pre-tax cash return to investors of 9% a year, with distributions to be paid monthly.

That's significantly higher than banks are currently offering on term deposits and better than the dividend yields of any of the listed entities in the NZX Property Index.

Which means the scheme is likely to appeal to investors such as retirees and others who are dependent on their investments for a substantial part of their income, and its monthly distributions will make that even more attractive.

Of course property syndicates are subject to the same general risks as any other commercial property investment, such as a downturn in the market or the loss of a tenant and the effect they could have on its income stream and capital value.

But two of the most important risks investors in property syndicates need to consider are the uncertainty about how long the scheme will run for and the effect that upfront costs can have on their equity.

Investors in property syndicates get their money back when the property is sold and the scheme is wound up.

Like most syndicates, the Birmingham Rd scheme does not have a fixed termination date - it will be wound up when 75% of its investor interests (each $50,000 investment parcel is entitled to one voting interest) vote to do so.

Investors who want to cash up early can try to sell their interest in the scheme privately, but there is no guarantee they will be able to do so, especially if market conditions are unfavourable.

Most property syndicates tend to be wound up within 5-10 years, so investors should be prepared to have their money tied up in them for a long haul.

Upfront costs

They should also take a close look at the scheme's upfront costs, because these will affect how much money they get back when the scheme is eventually wound up.

The Birmingham Rd scheme has set up costs of $975,000, equivalent to 10.4% of the property's $9.4 million purchase price.

The biggest of these costs is the offeror's fee of $329,000 which is paid to Augusta for pulling the scheme together.

The next biggest cost is the underwriter's fee of $300,000, which is split between Augusta Capital (Augusta Funds Management's NZX-Listed parent) and Riddell Enterprises, a company owned by brothers Brett and Ross Lornie, whose interests include a substantial portfolio of investment properties.

Then there's $120,000 in brokerage commissions (Bayleys Real Estate is selling the scheme to investors), $100,000 in legal fees (Chapman Tripp), $75,000 in printing and advertising costs, and $17,500 in fees to ASB Bank which is providing the mortgage.

After that there's sundry fees to be paid to accountants, auditors, valuers and so on, so there's quite a few people taking a clip, which all adds up $975,700.

Funding for the scheme is coming from two sources; a $4,475,700 interest only mortgage from ASB and $6 million from investors, which will raise $10,475,700 in total.

That will be used to pay the property's $9.4 million purchase price, the $975,000 in set up costs and provide a $100,000 sinking fund for capital improvements.

Investors pay

Because the bank will always expect to be repaid in full and will have first call on the scheme's funds, the upfront costs are effectively paid by the investors because there is a corresponding reduction in their equity.

This shows up in the scheme's Net Tangible Asset Backing (NTA).

If you assume the value of the property was its independent valuation $9.75 million, the NTA would be 89.6 cents for every dollar invested.

But some investors prefer to use the actual purchase price to calculate NTA, because that is the figure that feeds into the valuation system and that valuers would use to prepare valuations on other properties.

If the actual selling price is used to calculate NTA, it would come out at 83.7 cents per dollar invested.

Another way of looking at that is this: If the property was immediately resold for the same price it was purchased for, investors would only get back 83.7 cents for every dollar they put into the scheme.

If they invested the minimum $50,000, they would only get back $41,869.

Actually it would be a bit less than that because real estate agent's commission of 2% would have to be paid and whenever the property, or any part of it is sold, Augusta will deduct a termination fee of 1% of the sale price from the proceeds.

When those costs are factored in, it would reduce the payout to investors to $39,519 for every $50,000 they put into the scheme.

Fortunately, as detailed above, property syndicates are set up as long term investments and when they are eventually wound up, the investors will share any capital gains (after expenses have been deducted).

The benefits of a capital gain

Hopefully, by the time the Birmingham Rd scheme is wound up, the property's value will have increased sufficiently to have recovered the scheme's set up costs and pay for any additional selling costs and the termination fee, and also provide a bit extra for the investors.

But it does have quite a bit a bit of ground to make up before that happens.

And if it declines in value, the high set up fees will magnify investors' losses.

So while investors might be attracted by the scheme's high returns, they should also pay attention to its set up costs, because they could have a significant effect on the size of their capital payout when the scheme is wound up.

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