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Property Syndication – the return of the old!

You can always tell when the property market is really active - everyone is an expert, the media is full of commentary and advertisements and syndication becomes the new buzzword.

It reached a peak when I recently received an unsolicited offer from a local accountant who was syndicating a new build commercial property worth approximately $6 million. He was looking for no more than 10 investors of up to $400,000 each and the balance of the purchase price secured by way of mortgage.

The property was fully leased and projected returns were in excess of 8% per annum.

At face value this had a lot of merit. The projected returns were well in excess of current bank deposit rates and given there was to be monthly distribution to investors it could be viewed as a bank deposit alternative.

On top of a steady income the prospect of capital gain during the time of investment was also appealing and expected.

I’ve not been a great advocate of property syndicates and while I am aware of folk who have done well from them in the past I can also recount various stories where people have lost a lot of money.

So what are the pitfalls if you are considering a property syndicate as an investment.

Liquidity

This for me is always a key to any investment. Investments should be as easy to exit as they are to enter. If circumstances change for investors they may well need their money “tomorrow”. In a property syndicate there is no readymade secondary market to trade out of your investment. Most syndicates usually have a requirement that an offer to sell is made to all other existing investors in the first instance. However, there is no obligation to buy.

Alternative exit options may include a built in finite lifetime of the syndicate - “the property will be sold in 10 years time” or “the property will be sold if 75% of investors vote to do so”.

Expenses

A property syndicate will have a range of expenses to be met from returns. These may include, but not be limited to, Property Managers, Investment Managers, Body Corporate, Rates, Insurance, Repairs, Maintenance, Valuations, Trustees and Accountants.

While many of these charges will be the responsibility of tenants this only applies if the property is fully leased.

Risks

While there is a general perception that property will always rise in value over the long term (hence the saying “safe as houses”) commercial property is subject to a few more trials and tribulations. Commercial centres can shift, so the old adage of “location, location, location” can be taken away by unforeseen market forces. In Auckland this can be seen in action as businesses continue to move closer to the waterfront leaving properties higher up Queen Street less desirable. This affects lease values and subsequent capital values.

Commercial properties (office, retail and industrial) are also subject to economic conditions more so than residential properties. In recessionary times commercial properties lose tenants and there is not an automatic replacement business waiting to fill the void. Whereas for residential property, there may be more mortgagee sales in a recession but there are the same number of families requiring housing. Ownership may change and rents may reduce but everyone still needs a home.

Lack of diversity

Often property syndicates are established with a single building. This tends to accentuate the risks noted above. Whereas an oft repeated rule of investing is not to have all of your eggs in one basket.

So, while a property syndicate can look quite attractive particularly in a low interest rate environment be aware of the pitfalls before making your investment. We would recommend talking with your accountant, lawyer and investment advisor before committing to any property syndicate investment.

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