Unlisted property’s renaissance

15 October 2018

Unlisted property syndicates first came about in the 1980’s, where numerous investors pooled their capital to invest in commercial, retail or industrial properties that may have otherwise been too expensive for the investors to invest in directly.

Over the years, the asset class has grown and matured through many property cycles and – in my opinion – improved with age.

I believe there’s a number of reasons for this improvement – for example, transparency, performance and accessibility. But most importantly it’s been improvements to the structure and constitutions of unlisted property funds that put increased power into investor’s hands.

Improvements to structure, management and transparency

Lessons learned in the global financial crisis (GFC) prompted a wave of change, with positive consequences for unlisted property. The push for better management, more transparency and less risk has mitigated the risks of the past, making the appeal of the unlisted property sector greater than ever.

That said, it’s important to remember that not all unlisted property trusts carry the same level of risk, and not all managers are equally skilled and experienced. So, as with any investment, doing your due diligence is crucial.

Unlisted property’s evolution

In the lead up to the GFC, property prices rose sharply and a number of financial planners and investors turned to unlisted property trusts for their property exposure. Just as demand was increasing, however, risks were rising as well. Gearing levels went up – on the back of easy credit following a period of de-regulation in financial markets – and this increased overall risk. This meant that when the GFC hit, some managers found themselves, and their investors, caught: stuck with high levels of debt and properties they couldn’t sell.

The good news is that I believe the property trust sector is very different nowadays. To show how, I have outlined in general terms some of the key metrics in unlisted property trusts and how I have seen them change over time.

Unlisted property trusts: then and now

 

Feature 2007 2018
Distributions Paid from rents and debt Paid from rents only
Gearing level 60-65% 40-50%
Funding level 2-3 years 3-5 years
Constitution Manager friendly Investor friendly

So, what changed between 2007 and 2018 and what does it means for investors? The fact that distributions are more likely to be paid solely from rents / cash reserves rather than rents and debt, and that for most managers gearing levels are at a maximum of 50% compared with 65%, means that interest rate risk is less significant in unlisted property now than before. Lower gearing means a more conservative capital structure, and therefore a reduction in overall risk.

Despite today’s climate of low interest rates and cheap debt, investors are right to ask themselves what would happen in the case of a significant rise in interest rates. In my view, the ‘longer for lower’ scenario currently still holds true, and a major spike in rates remains less likely. Nonetheless, if and when rates eventually normalise, interest rate risk is likely to become more of a concern – so I believe it is key that rate-associated risks are lower for unlisted trusts, due to lower debt levels.

Funding tenure refers to the average length of the loan taken out by managers. Longer loan periods generally mean more stability and less uncertainty when it comes time to refinancing the loan.

I have witnessed the constitution becoming more investor-friendly rather than manager-friendly. I believe this is due to the typical terms and conditions of current trust structures favouring the investor, rather than the manager. In the past, so-called ‘poison pill’ clauses meant that managers were paid a small fortune if they were removed by investors – a process that typically required 50% of the entire register to vote and agree. The reality was that it was almost impossible to remove poorly-performing or unscrupulous managers, and if you did they would receive a large pay day.

The reality now is that there are fewer, larger managers – the majority of whom have both scale and experience. They have weathered the recession and GFC storms, and have learnt the hard lessons. And structures reflect this. Most unlisted trusts now have clear fixed terms, identifiable voting hurdles, and minimum internal rates of return before performance fees can be charged.

In the case of Centuria’s unlisted property trusts, the initial fixed term is five years. After that, 50% of the register must agree for the term to be extended by two years, and then 100% of the register must agree for the term to be extended further.

Unlisted property trusts, like all investments, carry a level of risk, and returns are never guaranteed. However, I believe that more conservative capital structures, less risky behaviour and better communication and transparency means that financial planners and investors do have a range of better quality unlisted trusts to choose from. It remains crucial, however, to look carefully at the track record and experience of the manager you choose, obtain the relevant offer documentation and consider seeking advice from a professional investment adviser.