This article is from the Australian Property Journal archive
The unlisted property market has had a couple of disappointing results recently with the demise of Westpoint and the revelation of a Challenger Syndicate winding up early with investors losing a large amount of their capital over just a few years.
Questions continue to be asked in the media. Along the lines of “who is responsible” and “who monitors these investments”. In short, “Who are the gatekeepers?”
The property syndication sector comes under the Managed Investments Act. Basically, it is the responsibility of ASIC to enforce this Act. However, they are responsible for a massive monitoring task.
Prospectuses (or Product Disclosure Statements – PDSs) are required to be lodged with ASIC when a scheme is launched. When this happens there is usually not too much investigation undertaken by ASIC. imagine the delays if that was the case. No one really does a full due diligence on the offer.
Therefore the independent experts are asked to confirm what is in the PDS in their reports, actually checking each lease and confirming things with each tenant etc.
Plus there are many statements of intent which are not actionable.
Therefore the real gatekeepers at the start of a scheme are essentially the research houses.
Whilst no research house undertakes full due diligence, they do all undertake a lot of work. PIR for instance inspects all properties where practicable, and in the case of mortgage funds we view a significant amount of the properties/developments against which the fund has made loans.
PIR also has a compliance specialist do a full compliance review of each of the Managers whose funds we rate. If the compliance review is more than a year old and we are evaluating a new fund we do the compliance review again.
PIR models the financials of a syndicate and in doing that we get to view the Managers’ financial models, which normally go out well beyond the forecasts in the PDS. Financial forecasts now rarely extend beyond a year or two in accordance with ASIC’s requirements. While PIR remains cognisant of the Managers’ figures, our model uses the cash flows that we feel are reasonable, not the “perfect world” figures often seen in Managers’ models.
All the quantitative factors go into a rating model and we are also cognisant of those qualitative factors such as the experience of the manager and portfolio diversification. In the end we produce a rating. Not all offers we rate gain an investment grade rating and some that rate at the low end of the investment grade rating system are not circulated by the manager who is naturally upset at the result.
So, at the start of a fund’s life you could well say the research houses are the gatekeepers.
However, it must be remembered that we can only rate what is presented to us, and we must believe that if a manager has put something into a PDS then they are being truthful.
Importantly, if a manager says they intend to do something different to what is in the PDS, such as extend the syndicate or finish it earlier than the time frame in the PDS, then PIR will still only model what is in the PDS.
What happens beyond the evaluation of the initial offer – who is the gatekeeper then? It is certainly not the research houses. Research houses do a point in time rating and the reports are only valid for a defined time (6 months for a PIR report) and any material change makes the report nul and void. As far as ongoing monitoring of a fund is concerned research houses do not perform this role as no-one would be willing to pay for it and staff numbers would have to be huge.
PIR does however provide an annual profile on the actual performance of most unlisted trusts and syndicates, but they are not re-rated. ASIC also does not really monitor the funds on an ongoing basis, bar perhaps reading the auditors’ reports. The auditors could be considered the gatekeepers, but in reality they check the numbers and do not pass judgement on the management of a fund.
One would assume that the government would appoint a body to oversee the ongoing performance of these funds, but in reality this would be a mammoth task and who would pay?
Besides, no amount of monitoring can perfectly insulate investors against fraud. After all, Westpoint told PIR they were raising $15 million against York Street and it appears they went on to raise over $80 million!
Aside from big brother having to approve every transaction there is no fool proof monitoring system that any gatekeeper can have that will prevent such behaviour.
Also, how does a gatekeeper handle the situation when the manager loses interest in property as Challenger did?
The Challenger Penrith Homemaker centre has recently been sold by the manager on behalf of the syndicate members well below the purchase price of three to four years ago despite a booming retail property market in the ensuing years; and well before the planned end of the syndicate.
They did not even put it to members to vote on, as they were rushing to secure a sale given that the purchaser wanted certainty, not the subjectiveness of a unitholder vote.
Retail property is management intensive and Challenger had decided to get out of property. So, questions could be raised as to why this step was taken rather than use the full syndicate term to work on the property.
When a fund is rated, it is rated for the term specified in the offer document. In the case of the Westpoint promissory notes, the terms of the investments from 2001 varied around two years.
These were the periods we assessed the offers on believing that the investors could get out on sunset.
The fact that investors must have decided to roll over their investments without a PIR report is regrettable as we would have known that the construction projects were mired in delays and that the risks had increased dramatically, whilst the compensation for taking those increased risks, the interest rate, had not moved commensurately.
Likewise the Challenger Penrith syndicate was rated on the basis of a fixed period (to amortise the upfront costs) and the manager had a strong property team then (now mostly at Mariner), with the ability to work the property and address the key risks that PIR pointed out (that it required intensive management to make the investment work and that the investment was at the mercy of the bulky goods market).
That brings us to the subject of rollovers of syndicates and funds. There are a significant number of property backed vehicles that are due to end their syndicate term over the next three years.
Mostly, the manager suggests that the investors roll over the fund for another term. For the most part the investors have done very well for themselves, given the explosion in capital values over the past couple of years.
However, at rollover each investment is in reality a new investment and should be viewed as such. We do not believe that the capital growth experienced in some syndicates will necessarily be repeated, given the fact that yields are inching closer to the risk free government bond rate.
Any investor who decides to roll over an investment without independent point in time research is exposing themselves to the same potential risks that the Westpoint investors accepted when they rolled over their investments. If a manager asks an investor or adviser to roll over a syndicate without showing them an independent research report then the investor or adviser should seriously ask themselves why?
A Manager who presents an investor or adviser with an independent report can generally be considered to have the interests of the investor at heart.
So in summary, research houses are the initial gatekeepers. Beyond that there is very little monitoring from any gatekeepers as in reality most of the Managers out there are very good and very professional.
To insist on a big brother overseeing regime is to impose significant needless expense on the majority of investors. After all, as mentioned it still will not stop fraud or mismanagement. It is only at roll over of a fund that there is any real gate keeping opportunity, and that is only if research houses are appointed to produce a new report on what, in reality, is a new investment.
By John Welch, head of research with Property Investment Research.*
