Unlisted property: solid returns, but also risks

Unlisted property groups have generally been out of favour since the global financial crisis.

And that’s not surprising, with at least $7 billion of investment capital having been locked up in unlisted property funds following the GFC. Investors, in many cases, were unable to redeem their holdings due to funds not being available to pay out distributions and/or meet redemptions.

Some of the managers with the largest number of frozen funds were Centro Property Group, Becton Investment Management and Orchard Funds Management, with the near-collapse of Cento leading to a de-rating of unlisted property trusts and syndicates. Many of these were managed by listed Australian Real Estate Investment Trusts (A-REITs).

But with the A-REITs sector having undertaken a large-scale restructuring since the GFC, and investors in previously frozen unlisted syndicates and funds having redeemed some, if not all, of their investments, the investment tide has turned once again.

Indeed, many investors seeking an attractive return from property are revisiting unlisted property trusts (see The lure of unlisted property trusts), which have in most cases returned to more conservative investment practices, lowered their debt levels and are paying attractive yields.

The risk of investing in unlisted property vehicles may be higher if we look at past performance, so a comprehensive analysis is required with respect to the transparency of the management, the fees paid to the property managers, and the ability of investors to withdraw their funds.

Low volatility and correlations, but not always low risk

Some unlisted trusts and syndicates have paid strong returns, including funds managed by Sentinel Property Group’s Mackay Retail Trust (see Alan Kohler’s Sentinel video interview), and Mair Group’s 525 Stirling Highway. These funds have produced double-digit total returns over that last three years of 31.2% and 16.4 %, respectively. The total unlisted property market has seen returns of just under 10% in the last year (see Figure 1 for annualised returns to March 2014).

The other positives for unlisted funds are their lower volatility of returns relative to A-REITs, and their low correlation with returns from shares. This compares to rising correlations between the returns of A-REITs and shares.

Yet, although unlisted property trusts may seem less risky relative to A-REITs, they can in fact be more risky (see Unlisted property realm carries a warning). Risk does not refer to volatility – as unlisted trusts are definitely less volatile by virtue of not trading on the sharemarket.

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The reason for the low volatility of returns is that valuations (of the underlying properties) are carried out annually or every 18 months compared to A-REITs, which are valued daily on the Australian sharemarket. So more frequent movements in property prices are not factored into the returns of the unlisted vehicle, unlike A-REITs’ prices which are impacted immediately by market events.

In effect, unlisted trusts can be more risky as they do not take into consideration what is happening in the property market or the broader economy until a valuation is done. This could be 12 months out from market events that may already have negatively impacted property prices.

Liquidity is good, but sometimes not so good

The other issue is liquidity, which is positive for investors, especially during market downturns. The sharemarket sell-down in 2008 was possibly exaggerated for A-REITs due to liquidity, which allowed investors to sell immediately. Liquidity, for investors who wanted out, was a necessary evil.

But for unlisted trusts, as detailed above, the ability to liquidate holdings was constrained, so investors could either not get any money out or only minimal redemptions were paid. It was difficult for the unlisted trusts to raise the liquidity to pay investors.

Investment factors for unlisted property

The list of investment factors for unlisted property trusts is not unlike what I have recommended previously for A-REITs with respect to gearing, payout ratio and premium/discount to net tangible assets (see High-risk signs for high-yield A-REITs). But additional focus on other factors is important, such as the borrowing scheme (debt maturity) and interest cover (before 2008 interest cover of about 1.5x was common, but now it is closer to 3x). Also important is valuation policy (frequency) and the ability to withdraw (many unlisted trusts have changed how they handle withdrawals and hold securities that can convert to cash to provide liquidity). Investment guidelines for unlisted property have been published by the Australian Securities Investment Commission.

An unlisted property trust compared to an A-REIT

Charter Hall Direct VA Trust is an unlisted property trust in the form of a closed-ended fund or syndicate, with exposure to an ‘A’ grade office property in Brisbane, Queensland. It is a single property investment, purposely built for Virgin Australia which is the sole tenant. The term of investment is six years, which may be extended by a unit holders’ vote, with a minimum investment of $50,000 and an annual initial distribution yield of 9%. The yield, over six years, sounds attractive and is above the average yield for property funds, listed and unlisted, although low relative to other syndicates (see Table 1).

But a few other factors need to be considered such as:

• The quality of the management: Charter Hall is an experienced, well-known manager with property expertise.
• Fee structure: fees are in line with the market averages.
• Liquidity: close-ended structure, so typically illiquid - cannot be redeemed until the end of the term of the investment.
• Gearing: In line with the market average.
• Tenants: Single tenant risk.
• Diversification: No diversification as one property in the portfolio with one tenant.

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Charter Hall Retail Group is a stapled A-REIT listed on the ASX (CQR) with investments in neighbourhood and sub-regional shopping centres, anchored by big-name supermarkets. The focus on food sales and non-discretionary spending puts them at an advantage, with some recent weakness in discretionary spending. The current yield is around 6.7%, but strong price performance (Figure 2) has seen the price trading at a premium of around 20% to NTA.

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Other factors to be considered:

• The quality of the management: Charter Hall is an experienced, well-known manager with property expertise.
• Liquidity: average daily volume over the last year is 1 million with average daily turnover of $5 million.
• Gearing: ratio of total debt to total equity is around 49% above the market average of approximately 47%.
• Tenants:  lower tenant risk, with a couple of big-name supermarkets as the anchor tenants.
• Diversification: diversified across properties and tenants, but a single sector risk predominantly exposed to non-discretionary spending.

Listed or unlisted property?

A good-quality unlisted property trust or syndicate can provide solid returns. There are multiple unlisted property trusts and syndicates available for investment, but the difficulty for investors is to know the quality of the management, which in my opinion is one of the most important elements to consider. And this can be hard to determine, as during the GFC we saw some well-known names within the property sector, such as Centro, get into trouble.

The stapled structure of A-REITs, which allows non-property related companies to be included under the same structure as long as 75% of the A-REITs’ assets are in property, can lead to earnings coming from more volatile sources. But unlisted property trusts or syndicates can provide a purer exposure to good quality commercial or residential property.

In summarising whether an unlisted property trust is a suitable investment, the pros and cons are as follows:

Pros

• Less volatility relative to A-REITs.
• Lower correlation with shares.
• Can be tax effective (see Getting to know unlisted property trusts).
• Higher yielding.
• Purer property play.

Cons

• Illiquid.
• Less transparency.
• Higher transactions costs – buy/sell spreads can be wide due to liquidity factors.
• Less diversification.

Conclusion:

Unlisted property can provide an attractive yield, but the higher relative returns may be due to higher risk associated with the investment.

If, the return sounds too good to be true, it may be, and any investment should only be considered as a part of a diversified portfolio that includes shares and fixed interest.

There are many unlisted property trusts which generally can be accessed directly through the underlying manager by filling out the application form in the Product Disclosure Statement and returning it to the company. The other option is through a financial adviser, which means a fee may be paid to the adviser by the unlisted property trust manager.