The ins and outs of commercial syndicates

PORTFOLIO POINT: Direct commercial property syndicates are becoming more popular, especially among SMSFs. But it’s important to know what you’re getting into.

When it comes to direct commercial property, investing in numbers can have its advantages.

Investment-grade commercial property, such as an office building, doesn’t come cheap, and very few investors have the available capital to go it alone.

But an increasing number of investors, including self-managed superannuation fund trustees, are examining commercial property – including commercial property developments – and finding it is not necessarily out of reach.

One possible solution is joint-owner syndication – being part of a syndicate that enables individual investors to pool their funds and buy one or more shares in a larger commercial property or development.

There are different ways of getting into a direct property syndicate, including through commercial property developers, licensed real estate companies involved directly or indirectly in developments, and through private investment channels. And there are also different ways of getting out, as detailed below.

Joint-owner syndicates come in two main forms. One is the simple, “passive” joint ownership of investment-grade commercial property, which facilitates a number of investors to get into higher-quality properties with strong tenants, long leases and high yields.

The second is the “active” syndicate, which gets involved with the delivery of commercial/mixed-use/residential developments.

Development syndicates come in three basic styles, each involving different risk and return positions. Below is an overview of development syndications and what they offer in comparison with passive syndicates.

Simple development syndications

The lowest-risk development syndicate comes about when a developer, often through an agent, offers a packaged development. The developer has secured the land, town planning approval and building approval for the plans. The corporation that is to be the tenant has been heavily involved in the plans and has signed an agreement to lease for an agreed period (e.g. seven years) at an agreed commencement rent.

The corporation tenant must be able to prove its financial health and prospects. In this case the purchaser (the syndicate) contracts to buy the land and the building contract that exists between the developer and the end user tenant. The big benefit here is the stamp duty saving.

Investors need to be aware of all the contract specifications, and that the yield and lease will provide an adequate investment return over time.

AFL development syndicates

The next level of development syndicate is where investors are introduced to a “build premises for a name organisation” project. In this scenario, you must research how good the three important parties to the project are:

a) the corporation

b) the builder, and

c) the syndicator/property advisor.

This type of development is driven by an Agreement for Lease (AFL, or ATL in some states). Within the AFL is an agreement to pay a percentage return on all costs of 9% to 9.5% net, depending on location. This establishes the commencement yield before getting into design and town planning and buying the land. You know where you are going on yield and length of lease. Leases of 10 to 15 years are often part of this AFL.

Many large corporations are working on a business return on capital of 30% plus, and see property as not their core business. Supplying national and international corporations with premises in the capital cities or major provinces is potentially a win-win for corporations and development syndicate.

The property syndicator will buy the land, subject to town planning approval, after it has the tick from the tenant and builder. The builder must be beyond reproach and very acceptable to the tenant. Together they produce the plans for lodgement for town planning approval. Meanwhile, the syndicator will bring the investors together under a structure compliant for SMSFs. Bank finance will be arranged, with each investor required to guarantee their share of the loan until completion.

The builder works for himself and for the syndicate to deliver what the corporate tenant has requested – shared benefits.

An example of this type of development syndicate is about to seek investors for a project in Kalgoorlie, WA.

Here is a set and forget investment with a secure income paid monthly. A strong alternative to equities and also an alternative to cash management without volatility and with built in growth in annual adjustments.

Speculative syndicate developments – higher-risk higher return

The third type is where the syndicate is a full speculative developer. Here the syndicate decides to develop a concept without a pre-commitment but based on research that the product will find a ready market. This can be in office/warehouse, strata offices or boutique residential.

An example is now under way in New Farm, Brisbane. Eighteen investors have combined their funds and have purchased a development site. The intention is to build 29 apartments in a luxury development, with each investor having put up $220,000 and agreed to finance with a limited guarantee for one-eighteenth of the building finance.

The project feasibility suggests a return on cash of 80% per investor within two years if conservative sale prices are achieved and a 100% return on equity if target prices are achieved.

The risk is in the strategy, the timing and the pricing as well as the delivery. Only invest with serious property experts who have a strong track record.

What makes some syndicates better than the stockmarket?

The passive syndicate, non-speculative development syndicates, have the following strengths:

• Complete knowledge of the property you are investing in;
• Proportional control as a director;
• Access to higher-quality property;
• Capital secure with long leases;
• Income secure with quality tenants;
• Income paid monthly;
• Access to non-recourse finance;
• Higher yields; and
• Agreed multiple exit strategies.

Development syndications other than the full speculative development type have additional advantages:

• Often can negotiate a longer lease (10 years);
• Produces a property of low maintenance;
• Excellent depreciations benefits;
• Builders guarantee – seven years;
• Stamp duty savings;
• Higher yields are negotiable; and
• Peace of mind, because all is new.

It is all about doing your homework and verifying the assumptions. This applies to the people involved as well.

A structure for syndication

Accountants generally are supportive of the following type of structure. Most joint owned syndicates are set up today to be SMSF compliant. Usually the syndicate has a trustee company as trustee for a fixed unit trust. Each investor gets a share in the company and becomes a director, plus units in the trust in proportion of the dollars invested.

Compliance for SMSFs

Being compliant means that all requirements of SMSF investing have been observed to Australian Taxation Office standards. This includes passing the control test – no one can have more than 50% shares/units. Also the related parties test must be passed, with no family members making up more than 50%.

Finance must be either limited recourse or non-recourse loans, and the trust must be available for annual audit.

Exit strategies for joint-owned syndicates

Within the trust deed of well organised syndicates will be a reference to exit strategies. There are generally four exit strategies whereby investors can get out of their investment.

First, an investor must offer their “share” to the rest of the syndicate. This step accounts for 70% of exits from syndicates.

If a sale of the existing share has not happened within 14 days, the seller can offer the share/units to anyone or group in the syndicate. This step is usually responsible for about 10% of exits.

If within this second 14 days a sale has not been achieved, then the seller can sell externally to a new investor proposing to join the syndicate. Approximately 10% of exits happen to new syndicate members.

The fourth exit strategy is when the majority of syndicate members decide to sell the investment and realise their profit.

A fundamental driver of all exit strategies is the quality of the property. If it is an excellent property then others will want in.

Conclusion

The serious property syndicators will insist on all investors being interviewed before being admitted to a joint-owned investment. This should be considered as a “good thing” and a quality control that looks after committed investors.

Gil Williams is founding director and land economist at the Property Advisory www.ThePropertyAdvisory.com.au. Email Gil@thepropertyadvisory.com.au