10 things you should know about property syndications(part 2)
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| 10 things you should know about property syndications(part 2) |
| By Bruce Cameron of Personal Finance | www.persfin.co.za Over the past five years, unsuspecting investors have poured more than R5 billion into property syndications in South Africa. However, these investment schemes are fraught with danger, and the cracks are beginning to show. This is part two of a two-part article. 6. TENANTS The calibre of the tenants should be an important factor that influences your investment decision. The issues you need to investigate include: The actual tenants. A cursory examination of the tenants will quickly establish whether you are dealing with a quality syndication. If space is being rented by well-known, big-brand retailers, you have greater security, because these firms are not likely to close down and clear out without paying their rent, leaving empty shop-floor space. However, big-brand retailers will often negotiate relatively lower rentals than those paid by high-risk, small start-up operations. The lease conditions and term. The term of a lease is very important. You could have major problems if leases are subject to a few months’ notice. But even a long-term lease signed with a high-risk start-up business can mean very little. If the company goes bankrupt, the rental flow will stop. The potential for new tenants. You need to ask what the potential is to replace any tenant. For example, if the property is purpose-built as a motor vehicle sales outlet, this could mean that a replacement tenant will also have to be a motor vehicle dealer, limiting the choice of new tenants. The rental will be undermined if major alterations have to be made to a building to accommodate new tenants. 7. LIQUIDITY It can be difficult to sell property investments, particularly shares in a property syndication. There is no formal market in which to trade property syndication investments, and you will probably have to depend on the person or syndicator who sold you the investment in the first place if you want to sell. The two questions you need to ask yourself are: Will the syndicator, the syndicator’s agent or an intermediary be interested in selling my investment, when they can get better profits from selling new syndications? There are only so many buyers out there. What costs will I incur when selling? Syndicators in most cases charge you the same commission that an estate agent can charge, namely up to 7.5 percent of the value of the sale. In the case of Sharemax, it is seven percent, while Blue Everest charges 7.5 percent. The price you receive will also depend on the property market and the popularity of property syndications in general at the time of selling. For example, you would probably have taken a hard knock if you attempted to sell an investment in a property syndication in the mid-1990s. In its analysis of Magalieskruin Holdings, Sanlam says even after the sale of the units (shares and linked debentures), it can take more than two months for you to receive your cash. Compared with an investment in, for example, a unit trust fund or a life assurance policy, where you could receive your cash within three days, Sanlam says the Magalieskruin syndication’s liquidity is “extremely poor”. Although Du Toit agrees that the shares of syndicated properties are not as liquid as those of listed property funds, he says “investors nevertheless have more liquidity than when they are the sole owner of a single property”. Du Toit argues that the current increase in property prices makes buying a “second-hand” share (a syndication share owned by an investor) in a property syndication attractive to other investors. He says the purchase price of a share being sold by an existing investor will be dictated by current property prices. The degree to which syndicator companies create a secondary market for their investors’ shares differ. Some syndicators will do a lot to help you sell your shares while others will not. Du Toit says this is an issue that SAAPS will be addressing in future. He also claims that demand for an existing syndication can also be higher in, say, year three of the project, because the income stream connected to a specific share might have escalated three times, and is therefore sought-after compared with other income-generating investments. Du Toit says investors must realise that, as with most other investments with predetermined investment periods, you are penalised for exiting early. You should accept that a property syndication investment is for the long term. “We are of the opinion that liquidity can only be a problem if the product is marketed incorrectly. The investor must be informed of, and agree to, the exit terms and conditions of the syndication.” 8. MANAGEMENT AGREEMENTS You need to scrutinise the management agreements very carefully. The issues you need to consider include: The property manager. Some syndicators provide the administration services themselves, either directly or through an associated company. Others farm out the job of administering the property to another company, but the syndicator will still take a cut of the rentals. The contractual conditions. The problem with many management contracts is that they are put into effect before the syndication is sold to investors. So, in accepting the terms and conditions of the investment, you also accept the contracts that have been signed between the various parties. This will include the appointment of the property managers, how much they will be paid and how the costs will escalate (in most cases by 10 percent a year). The contract conditions will probably make it almost impossible for investors to fire the property managers. You will often find that administration charges are not limited to a percentage of the rental, but will include a wonderful list of other expenses, such as secretarial charges, office expenditure, telephones and travel costs. Most seem to duplicate or even triplicate a charge for the same service. All this reduces your potential return, but serves to skim off ever-greater profits for the syndicator and its associated companies. 9. COMMISSION You should always get full details of the commissions and other incentives given to financial advisers selling property syndications. There is plenty of evidence that intermediaries tend to sell products that pay the best commission, and the high commissions being paid by property syndicators are a driving force behind these schemes. Documentation supplied by syndicators, even to intermediaries, is often vague on what commissions will be paid. Most commissions appear to be in the six-percent-plus bracket. And commissions are not the end of the story. There are also profit-share incentive schemes whereby intermediaries receive a share of the syndicator’s profits for achieving sales targets. This can take the commission to above 10 percent. This is extremely high when compared with the three percent paid by the unit trust industry. Du Toit says that, according to SAAPS’s knowledge, commissions currently paid by SAAPS members to brokers vary by between three and 6.5 percent. Some brokers opt for three percent immediately and the balance annually (justified by regularly reporting to their clients about how their investments are doing). Others opt to receive the full commission immediately. Du Toit says that in terms of the general code of conduct in the Financial Advisory and Intermediary Services (FAIS) Act, a financial adviser (broker) is compelled to disclose his or her remuneration or any incentive payable on any transaction. 10. LEGAL PROTECTION You are mainly protected by three laws: the Companies Act, the Unfair Business Practices Act and the FAIS Act. However, you must also do a number of things to protect yourself, including: Use the protection of the FAIS Act Ensure that any intermediary or promoter who is selling you a property syndication is registered with the FSB as a financial services provider (FSP). Refuse to do business with an intermediary who tells you that there is no requirement for him or her to register. Surprisingly, property syndications are excluded from the list of financial instruments that require a financial adviser to be licensed under the FAIS Act. However, this potential loophole is closed because many syndications are structured around the sale of shares of companies and/or raising cash through the sale of debentures. Anyone selling property syndications that involve the sale of shares and/or debentures must register as an FSP in terms of the FAIS Act, Warren Neale, of the FSB’s FAIS department, says. An FSP can be an individual or a body, such as a property syndication company, which ensures that its agents meet the requirements of the FAIS Act. Being registered under the FAIS Act places a requirement on a financial adviser to ensure that you are properly advised. Do not accept that someone is registered merely because they tell you that they are. Check with the FSB. Gerry Anderson, the FSB’s deputy chief executive in charge of the FAIS Act, says a number of syndicators have either not yet registered or have had their registration applications rejected. He says the FSB has concerns about the syndication industry in general. The FSB has received complaints about intermediaries “giving clients incorrect information about this type of financial product”. If you believe that you have been ill-advised by a financial adviser at any time after October 2004 (when the FAIS Act become operational), you can lay a complaint with Charles Pillai, the Ombud for Financial Services Providers. Anderson rejects a claim made to Personal Finance by Du Toit that, although SAAPS encourages its members to register as FSPs, intermediaries do not necessarily have to be registered under the FAIS Act. Du Toit says the most typical structure used for syndications is the company structure. It is therefore assumed that everyone selling shares in a syndication company must be registered as a FSP. “This is not correct. All syndication products consist of some form of property. Many syndication products, such as lifestyle syndications, fractional ownership or private club memberships are sold by estate agents, without them being obliged to register in terms of the FAIS Act,” he says. “Many syndication companies employ in-house brokers who will not be able to offer investors the required choice of three products in terms of FAIS, and are therefore not required to register as a FSP,” Du Toit says. Anderson says the requirement to register as an FSP depends on whether the sale of a particular product “is a regular feature of their business or not. Even if the product constitutes five percent of the business on an ongoing basis, it will be regarded as a regular feature.” He says that Du Toit’s claim about “three products” is a “fallacy”. “The FAIS Act does not prescribe three products. One is enough to require registration.” Ensure you are properly informed Coode says consumers have an “inalienable right to be informed”. Consumers also have the right to invest in any investment vehicle they wish, provided they are aware of the facts and make informed decisions to invest on this basis. “The withholding of relevant information, whether by accident or design, is considered an unfair business practice and, in terms of the Unfair Business Practices Act, consumers may lodge complaints with the Unfair Business Practices Committee to investigate,” she says. The steps you can take to ensure you are properly informed include: * Ensure you are provided with a prospectus. In terms of the Companies Act, you must be provided with a prospectus if you are purchasing shares. The prospectus must be approved by the Registrar of Companies and must provide you with full details of the company and how it intends to do business. However, having a prospectus does not necessarily mean that you will be protected from a scam. As has already been pointed out, many scams are camouflaged by the use of unlisted companies. The fact that the Registrar of Companies has approved a prospectus also does not mean that the business will succeed, or that it will earn the income projected or that your capital will be secure. Du Toit argues that an unlisted company does not automatically offer less security to an investor. “The level of risk will be determined by the purchase of shares and/or shareholders’ agreements used by the syndicator, together with the compliance procedures put in place to ensure that the funds flow according to these agreements. The company’s assets, liabilities and gearing policy will also play a role. The safeguards provided for in terms of the Companies Act (such as annual audits and annual general meetings) in most cases are sufficient to minimise risk. “We believe that properly structured and efficiently run syndications bear little risk to investors compared to other investments,” Du Toit says. Obtain independent advice. At the very least, you should have a lawyer check the prospectus and read any contracts before you sign them. HOW TO PROTECT YOURSELF The legal structures used for most property syndications are complex. You must read the prospectus and you should also get an independent expert opinion – for example, from a lawyer. Insist on being given a valuation certificate from a registered professional valuer who has at least three years’ experience. Beware of any limitation placed on the liability of the syndication promoter that may occur as a result of fraudulent, negligent, malicious or even unintentional acts by the promoter or its agents. Do not rely on any assurance that the property syndicator will find buyers for you if you wish to sell. Ensure that you place no more than five percent of your investments in a single property syndication. And do not invest more than 20 percent of your savings in property syndications. Do not be rushed. One of the favourite tactics of people selling property syndications is to tell you that you only have a few days or hours to make up your mind. This is rubbish. Property syndications are being launched all the time. Take your time and check everything before signing up. You could save yourself a fortune. Make sure that your money is placed in an interest-earning trust account of an estate agent, a lawyer or a certified chartered account before the transfer of ownership of the shares to you. Insist on written confirmation of the deposit and find out who controls the funds. For example, be very wary of the scheme if the property syndicator has full control over the funds. Establish whether the property has already been bought or whether there is merely an option on the property. Avoid investing where there is only an option to purchase the property. Establish what will happen if the syndicators cannot find enough investors to take up all the shares on offer in the syndication. NOTE OF CAUTION Take heed of the following cautionary note, from the Registrar of Companies, which you will find in the prospectuses of property syndications: “The Registrar of Companies has scrutinised the information disclosed in this prospectus. The Registrar of Companies does not express a view on the risk for investors or the price of the share. However, the attention of the public is drawn to the fact that the shares on offer are unlisted and should be considered as a risk capital investment. Investors themselves are therefore at risk, as unlisted shares and debentures are not readily marketable, and should the company fail this may result in the loss of the investment to the investor.” |
