Property investors line up for high returns

With interest rates at record lows, and the property market still running hot, many investors are being lured into unlisted commercial property funds offering attractive returns well above 10 per cent.

Promoted by some brokers and financial planners, these high-return real estate investment funds are being run by an assortment of non-bank lenders, property purchasers and project developers. Because they're not financial institutions per se, they are not regulated by the Australian Prudential Regulation Authority (APRA).

But that's not putting investors off. Indeed, to get in on the action, investors often need to join a waiting list.

The commercial property landscape concerns everything except single-dwelling housing – from high-density CBD skyscrapers, to hotels, retail, warehouses, medium-density residential, and even petrol stations.

There's no shortage of property developments needing funding around Australia, but due to the higher level of risk in commercial property banks and other regulated lenders are often not keen to approve funding.

Last year, authorised deposit-taking institutions (ADIs) increased their commercial property exposure by 6.9 per cent to $219.8 billion, according to APRA.

The major banks have around 80 per cent of the market, but are now starting to wind back their exposure. One non-bank lender interviewed by Eureka Report estimated a $40 billion funding gap in commercial property that ADI's aren't servicing. 

The opportunities for investors

That funding gap is proving lucrative for operators able to raise debt funding from private investors, which is then lent out to property developers at high interest rates. For participating investors, the high interest loan repayments received translate into high fixed income returns.

One non-bank lender proving mezzanine debt to developers is currently paying its investors an 11 per cent cash yield quarterly and tracking a 13 per cent return over the life of its four-year fund.

By their own reports, non-bank lenders have experienced a flood of loan applications in recent years. Other property developers and syndicators are also raising money themselves to build or buy up developments.

Assessing the risks

It sounds like a perfect investment combination for all parties concerned, but what are the risks?

Sydney-based financial planner James Gerrard gives weight to the age-old philosophy that higher returns equal higher risk.

“For many of these opportunities, the bank said no to providing finance, or further finance, for a variety of reasons such as a high loan-to-value ratio or not wanting to lend to developments in certain postcodes due to saturation risks,” Gerrard told Eureka Report.

“If a bank who has a credit assessment team looked at the deal and said no due to the risks, take this into account when considering the risk/reward ratio.”

Australia's real estate investment sector was hit hard during the GFC, with investors who channelled funds into debenture products offered by the likes of Westpoint, Fincorp, Australian Capital Reserve and others losing hundreds of millions of dollars.

Gerrard said the major risk of investing in commercial property development is “the project failing and the sale of the assets not being enough to pay back the investor, depending on where they rank as a creditor”. For funds used for purchasing properties, there's a risk that business conditions deteriorate.

“Investors can sometimes fail to appreciate the heightened level of risk associated with credit investments, and instead, see them as a somewhat secure fixed interest investment,” added Gerrard. 

A diverse property field

There is a lot happening in the commercial property space right now.

A high-profile unlisted retailer and a large property development group are rumoured to have joined forces to develop more outlets around Australia, and are using a debt funding structure that largely relies on private investment capital.

We also spoke with Melbourne-based Fawkner Property, which holds assets typically tenanted by blue-chip companies including BP, Coles and ANZ. Fawkner uses investor funds to buy properties in a trust structure, giving investors units in the trust.

The company buys properties in the $12 million to $50 million range, where “reduced competition from institutional buyers and individuals allows yield reach 7.5 and 10 per cent”.

Fawkner has nine fully subscribed trusts holding properties, and has a waiting list of investors wanting to hand over their money. Fawkner director Owen Lennie said investors are handing over an average of $250,000.

At a different end of the spectrum, non-bank lender MaxCap only deals with sophisticated investors, with a minimum investment of $5 million needed to participate in its funds. MaxCap had a stake in the recently completed Chanel HQ in Melbourne and the mixed-use Arc by Crown currently in construction in Sydney.

MaxCap founding partner and managing director, Wayne Lasky, said his team only signs off on about one in 10 investments after modelling a “highly adverse scenario”. Post-GFC Gold Coast is a yardstick for MaxCap's residential investments, where some properties depreciated up to 30 per cent.

“MaxCap is pure-play debt, that's our entire focus – we don't participate at the equity level,” Lasky said, adding “we're at the end of the equity cycle and the beginning of the debt cycle”.

MaxCap has around $1.5 billion in funds under management, up from $789.5 million in September last year. Former Prime Minister Paul Keating just took a financial stake and board position at MaxCap, and Australian Super (Australia's largest superannuation fund) is a major investor.

When asked to comment on the growing trend towards non-bank lending, APRA said it is “monitoring the growth” of this peripheral area that's outside its jurisdiction, but not the area as such.

A financial adviser, who preferred not to be named, said investors should be sophisticated enough to know what they're getting into before investing into commercial property funds.

This means getting familiar with how, and if, you can exit the fund, should a personal or financial crisis arise. He said memories of 2008 and 2009 are too fresh to be doing otherwise.  

And, if “simplicity is the ultimate sophistication”, this adviser's basic rule of thumb might be the handiest yet: “never invest more than 5 per cent of your net wealth in a single investment”.

It should be noted, in the case of commercial property funds, this advisor groups them as a single investment opportunity.