Syndication – The Pros And Cons
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Most small residential investors, which is realistically most investors, would give anything to get involved in the commercial sector. The reason is the inherently more stable nature of commercial property when compared to its relatively volatile residential relative. There are other factors why commercial property is so sought after such as its hands off nature, long term contracts and lack of tenant contact. If a tenant decides to leave mid contract that’s their problem, not yours, the tenant has to find someone else to take on their lease.
The thoughts of being a residential landlord don’t actually appeal to a good proportion of investors in the marketplace so a contract where the tenant is responsible for virtually everything is a very attractive scenario. The longer term nature of covenants is also something which attracts investors, you are normally dealing with terms of five years or more. Even in Europe, where lease terms are traditionally shorter, you will come across ten year contracts but in the UK and Ireland you will often find terms of 15 to 25 years. On the residential side you could be looking for tenants every three months which is obviously not the most attractive scenario.
Of course commercial property isn’t without its downsides. For a smaller commercial investor, which can be anything from EUR2.5 million upwards, gearing is normally limited to 60% loan to valuation (LTV) which means having to come up with a lot of money to get off the ground at all. This very substantial barrier to entry is, understandably enough, what stops most people from entering the commercial arena.
A further problem with a commercial investment is that vacancy, if it does arise, is far more difficult to rectify than in a residential scenario. A vacant commercial unit reduces drastically the value of the property as the rental contract is in fact a very large proportion of that value. A residential property has the same value whether tenanted or not. If you are highly geared and a commercial unit becomes vacant, which can happen if a contract isn’t renewed or a tenant becomes bankrupt, then you run the risk of severe financial distress as the repayments will be very substantial, it can be difficult to re-tenant a building and if you do it usually takes a long time.
Allowing for these provisos a good commercial property investment is still obviously a highly desirable investment vehicle. One of the big problems for smaller investors is getting a foothold in the commercial property market. With levels of entry usually extremely high for quality product offering good covenants and in desirable areas it is very difficult for an investor with 100k or 150k to get a piece of the action.
This explains the enormous recent interest in syndication as a means of purchasing high value property both at home and overseas. Syndication is quite literally an association of people or firms coming together to invest in a specific project or projects. It is by no means a new concept but has, in recent times, been a real boon for the small to medium end of the commercial property market. Estate agents, banks, accountants, solicitors and private individuals have become involved in setting up syndicates often seeking to invest relatively modest sums of money in terms of commercial property, usually EUR100k or more, but looking to have the clout of a larger investor.
In a typical syndicate the investor purchases a share of the property investment and holds it for a specific period of time, normally between 5 and 10 years. It is usual for up to 85% of the value of the property to be financed with what is termed non-recourse debt. This allows the bank security over the property and rents emanating from it but contributors cannot be held liable for more than their investment stake. Such investments can be structured as a straight investment, through a pension fund or through a unit linked fund depending on what tax advantages are required and when income accruing is to be withdrawn.
By their very nature each individual investment will be relatively unique so it is difficult to be specific about exact returns, appreciation, debt repayment, mortgage arrangement or length of term as these are all project specific. A professionally organised syndicate will release a substantial information memorandum on a particular investment once an agreement has been reached to take on a particular property or properties. Having said that, most of these investment vehicles usually work in a range of 5 to 10% yield and 7 to 12% annual appreciation. It is not as exciting as some of the rates quoted for emerging markets, both commercial and residential, but it is far more likely that you will actually achieve the quoted figures.
Michael Moriarty of HOK Investors says that a project should not be considered unless proposed returns are based on current day yields. He says that if a project doesn’t work based on today’s figures then it shouldn’t be considered as you are second guessing the market if projected yield increases are a significant portion of the project’s proposed returns.
Unfortunately, as with anything else, when an industry, product or concept hits boomtime this is usually when applicable laws or norms can be overlooked or completely flouted. There are so many people involved in the syndication of overseas property at this stage that it is inconceivable that all of them are above board. The overseas property industry has no regulation of any description in this country, and most others for that matter, and as such it holds a magnetic attraction for companies and individuals intent on excessive profiteering or downright fraud. It is obviously not fair to tar the entire industry with the same brush but it is important to be aware that syndication is a concept which is very well regarded, with good reason, and there are those more than willing to take advantage of this good name to your detriment. Just because a company offers syndicated investment does not mean that you should not vet them thoroughly in advance. You should always check out a company’s bona fides and ask to speak with investors who have availed of their services before. It is also important to do some background research on the area being considered and then check out their knowledge of the marketplace, if it is not significantly better than yours then they are wasting your time and quite possibly your money.
One of the problems in the market at this point in time is that investors are queuing up to get involved in any particular project. You will rarely see one advertised as they tend to be promoted by word of mouth from within networks of banks, solicitors, accountants and real estate agents. Consequently a company may not even bother with you if you are causing them unwanted hassle as they have plenty more to choose from. Nonetheless you should stick to your guns as any promoter worth dealing with will be more than happy to answer questions relevant to their product and reputation.
There are further limitations inherent in the product which must be considered. “Lack of flexibility and the difficulty of extracting oneself from a syndicate ahead of the final property sale is also a major deterrent from syndicate participation” says Michael Moriarty of HOK Investors. Michael Scully of Castlecarbery Properties says that the fact that a fund seldom returns any income during its lifetime, which usually spans 5 to 10 years, means that it is not a suitable product for all investors. All returns made on the purchase are used to pay down the usually substantial debt within the fund.
Most of these funds will also have a fixed time of exit. Although there is some room for flexibility the restriction of having to sell within a set period can mean that the property is not sold at the optimum time thus inhibiting the performance of the asset. It is usual to need a 75% majority to agree to sell the asset and most people will have banked on having a return on their investment within a specified timeframe. There is the option of rolling the investment over but having to leave when the market is in a dip is obviously not the way to make money so these should be treated as a medium to long term investment vehicle.
Consumer Association of Ireland finance spokesman Eddie Hobbs’ agrees that a good syndicated investment can be an excellent investment vehicle with certain provisos. His main bugbear about syndicated product is the potential for significant costs to be rolled up in the product, often going unnoticed by those without a fairly good financial eye. If the costs aren’t transparent he says you should either consider another product altogether or ask the company to outline in detail what costs are involved and also a justification for these costs. If you are not satisfied with the answers received you should simply move elsewhere. He also feels that product which is purchased and financed by a financial institution can lead to a conflict of interest. It can be the case that the product is launched to profit from the mortgage rather than because it is a particularly good investment.
It is easy to be overawed by the thoughts of a commercial property purchase but it is essentially no different from its residential relative, the prices are just higher. If you approach it as you would a well planned standalone residential investment you won’t go too far wrong. You should satisfy yourself that the property is in a good location, that appreciation rates are likely to be attractive and that borrowings are taken out at the best available rates. You should also ensure that covenants are of sufficient length with strong tenants and that rent reviews are at regular intervals and index linked. Upward only rent reviews are something to aim for but seldom achieved outside of Ireland and the UK. Buying into a syndicate which has a lot of covenants up for renewal during its term can be painful if the contracts are not renewed. Companies in some of the quickly growing Eastern European capitals exhibit distinctly nomadic tendencies enabled by high vacancy rates. It is easy for companies up sticks and move to a cheaper unit when a contract ends. Larger companies tend to like constancy so it is obviously better to have blue chip tenants in your property where possible. Just remember that many of the emerging countries will have sub-offices of major companies incorporated in that country, these are not nearly as stable as the actual corporates themselves.
From this point of view it is as important to visit the location and get a grounding on the market as it is with a residential investment, the problem here is that most syndicates only have four to six weeks to move on a property when an agreement has been reached, this means you don’t get much time to do your research.
It is possible to borrow outside some of these funds to increase your level of gearing but as there is no actual property against which to borrow you will have to use something else as collateral so you would typically be re-mortgaging your own home or an investment property here in Ireland. This does reduce the level of deposit you need to access one of these schemes and brings them within the reach of reasonably modest investors.
Some legal experts have expressed considerable apprehension at the amount of smaller syndicates now being set up by completely unqualified individuals. They feel that the legal structure of the agreements often do not stand up to scrutiny allowing too much scope for legal manoeuvre which is never a good thing. This is particularly a concern where a group of friends or family set up a smaller syndicate without a proper financial or legal framework. Be aware that this is a very swift way to lose friends or estrange family members, there is nothing like a money squabble to create a schism which is often permanent.
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Source by Diarmaid Condon
