The hidden property sector

The hunt for yield has investors pouring into property. Investment loan approvals jumped 35% to $27.8 billion in the June quarter, according to APRA, and there’s already talk of house prices moving into bubble territory in some areas, especially Sydney.

Now, investors are looking beyond residential property and A-REITs and finding opportunities in the lesser-known unlisted property space. Indeed as you can see from the graph below the investment dollars have been flowing back into unlisted property funds.

So, why has this return to favour of the unlisted property market not made the headlines? Well, the key reason is the very nature of this investment class: It is ‘unlisted’ and difficult for the average investor to get a broad view of the market.

Unlisted property trusts are managed funds that invest in a particular property sector, such as retail, commercial or industrial property. Investors purchase units in the trust and their investment is pooled so the fund can purchase the property and related assets.

There’s always been strong demand for unlisted property from high-net worth individuals and wholesale investors due to the potential returns, and now retail investors are taking more notice.

Unlike the A-REIT market, which can be very volatile and more equity-like, unlisted property funds are typically promoted as a stable investment. However, the sector has also suffered from a lack of transparency. At worst the sector ‘freezes’ when there is a crash in the market: This occurred in the early 1990s, and more recently in the wake of the GFC, where many retail investors found themselves locked in unlisted trusts which were frozen, in some cases for several years.

Nonetheless, the steady income stream and the potential for capital growth are obvious attractions of unlisted trusts: The minimum investment is usually between $5,000 and $10,000, but it can go much higher than this.

Research group IPD compiles a performance league table each month, releasing details of the top five funds and syndicates. The top performing fund, Sentinel Property Group’s Mackay Retail Trust, returned 61.5% over the 12 months to July 31. Sentinel took four of the top five positions for the month.

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This is a stunning result, but hardly reflective of the average fund. For the bulk of projects in the unlisted property space, the average total return is between 9-10% and 15%, says Dugald Higgins, senior investment analyst at Zenith Investment Partners. But it all depends on the risk profile. A high-risk opportunistic strategy, that includes high levels of leverage, could potentially return 30% or more. Most retail investors would shy away from such high risk strategies.

Distribution yields, which are like dividend yields, are also quite attractive at the moment, ranging on average from about 7%-11%, Higgins says.

The long-term nature of unlisted property funds and syndicates is one reason why they’re getting more attention from long-term investors, self-managed super funds included. And then there are the tax benefits: A lot of investors invest in unlisted property because there is an element of tax-deferred income to their distributions. When they move into retirement phase they can then make use of the tax deferred nature of those distributions. It’s important to have a financial adviser who is astute enough to understand the various tax components within a distribution

But there are drawbacks: The price of lower volatility is the illiquid nature of the investment. Unlisted property funds and syndicates typically run for a set term of about three to seven years, but can be longer. It can be very difficult to get an investment back before the term expires. Closed-ended funds are illiquid, meaning the investment is locked up for the entire term. Other funds can be open-ended, meaning there may be the option to redeem or liquidate a position, on say a monthly or quarterly basis.

Where’s the action?

Research group IPD compiles a monthly index that looks at the performance of 21 fund managers, operating 58 trusts or syndicates in the unlisted property space.

IPD also calculates the average return for each sector: As you can see from the table below, industrial funds delivered a 12% total return for the 12 months to July, with a distribution yield of 8.9%.

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Source: IPD
* Unlisted retail refers to the total number of unlisted property trusts available to retail investors, from the 58 covered by IPD. The remaining 16 are classed as syndicates.

Unlisted retail property funds (all funds excluding syndicates) returned 6.8% in the 12 months to July 31. The three-year average return was 7.1%, but the five-year return was a mere 0.5%. The distribution yield for the 12-month period was 7.2%.

Property syndicates, meanwhile, fared slightly better, delivering a 9% return over the 12 months to July, with a distribution yield of 7.8%. Syndicates are similar in concept to funds or trusts, but usually involve a small group of investors who pool their money to buy one or more commercial, retail or industrial properties. Over the three year period the average return for syndicates was 9.8%, while the five year return was just 0.8%.

The majority of the funds that IPD covers are in the office sector, followed by retail and industrial sectors. Newer offerings are usually based on office and industrial property because of the high-income yields they offer.

Getting involved

In spite of the sector getting into trouble a few years ago, there has been a noticeable pick up in interest from retail investors over the past year. But many are doing their research and being more selective when it comes to choosing managers.

“We’re seeing retail investors backing managers who have a good track record, with good governance and who work on behalf of investors to maximise returns,” says Property Investment Research managing director Dinesh Pillutla.

He singles out Charter Hall, Centuria and Cromwell Property Group as examples of established fund managers with good track records.

Higgins echoes this sentiment, also picking out Cromwell as a manager with an impressive track record. He says that for the most part Zenith doesn’t rate a lot of fund managers in the space, because they’re not “investment grade” but alongside Cromwell, he says Australian Unity and GDI are two others that Zenith rates positively.

Indeed the pick-up in pace is reflected in the popularity of newly launched funds. Earlier this year, Cromwell Property Group closed the Cromwell Box Hill Trust early due to it being oversubscribed. Today it launched a new open-ended fund, the Cromwell Direct Property Fund. Another two unlisted property funds are in the pipeline.

Australian Unity has four unlisted property funds open to retail investors: the Diversified Property Fund, the Healthcare Property Fund, the Office Property Fund and the Retail Property Fund, each with a minimum investment of $5,000.

Last year, distribution yields were: 12% for the Diversified Property Fund, 8.1% for the Healthcare Property Fund, 16.4% for the Office Property Fund and 5.6% for the Retail Property Fund. 

The yields for the Diversified Property Fund and the Office Property Fund were higher due to special distributions made to investors as a result of asset sales. Normalised distribution yields for both for FY13 were 6% and 7.7% respectively, says Ryan Banting, head of portfolio management at Australian Unity.

The Healthcare fund is the largest healthcare specific fund in Australia, both listed and unlisted, Banting says, and its aim is to capitalise on the growing demand for healthcare services. It currently has $483 million worth of assets.

Charter Hall and Centuria also have funds open to retail investors.

For those interested, speak to your financial adviser or contact the fund directly.

Five rules to follow

Before parting with your hard-earned savings, there are a few considerations to keep in mind:

1. Focus on the management. As detailed above, investors should look for management with a good track record, not only of managing assets, but also of disposing of assets at a good price for investors.
2. Look for managers with high levels of transparency. Post-GFC, transparency in the sector has improved substantially. Managers are now required to disclose anything substantial or material to the market. But some are much more transparent than others. “The better managers tend to have better transparency. If you’re not willing to be transparent [about your track record] you don’t deserve to be invested in,” says Higgins.
3. These are illiquid, long-term investments. If you want liquidity with an exposure to real estate, invest in listed REITs. To invest in an unlisted property trust or syndicate, be prepared to have your money locked away for a number of years. Find out your options regarding liquidating your position before you invest.
4. Look at the gearing policy of the fund. The lower the level of gearing, the better. Look for gearing below 40-50%, Pillutla says.
5. Know the fee structure. Before investing in any unlisted property fund or syndicate, make sure to study the fee structure, including upfront fees, performance fees, and fees that may be charged upon liquidating your investment.

Caution prevails

After two quarters of net inflows, IPD has noted a surprise outflow in the sector in the past quarter.

“Some investors have become a little bit more cautious and are waiting on the sidelines. At the same time, access to capital has become a little bit more difficult,” says IPD managing director Anthony de Francesco.

Nervousness about global growth has dampened investor sentiment, but money flowing out of the sector is just a transitory development, he says.

“Our view is that it’s a bit of a hiccup and we expect flows into the sector to improve and for momentum to pick up again towards the end of the year.”

*An earlier version of this article incorrectly stated that in fiscal 2013 distribution yields in Australian Unity's four funds (the Diversified Property Fund, the Healthcare Property Fund, the Office Property Fund and the Retail Property Fund) ranged from 7.3%-7.8%. This has since been corrected.