Listed property investment in the Australian Securities Exchange (ASX), however, expose the underlying investments to share market volatility despite accessibility. To avoid market risks, some investors opt for unlisted property investments.
What is an unlisted property investment?
Unlisted property investments are professionally managed property investment products. It gives retail investors the opportunity to benefit from managed retail, commercial or industrial properties.
Unlisted property schemes are investment products that are neither listed in nor monitored by the ASX. Investors would have to approach fund management companies to find them and rely on the product disclosure statement (PDS) to assess its risks.
Unlisted property investments are solely influenced by real estate market movements, unlike real estate investment trusts (REITs) and Australian REITs (AREITs) that are open to sharing market risks.
Types of unlisted property investments
Unlisted property investments can be classified as open-ended or closed-ended. The difference lies with the availability of units and the investment duration.
Open-ended funds allow the fund manager to issue new units for new investors when funds are needed, but the investment is held in perpetuity. There is no definite maturity or exit date from the fund and it will continue to operate as long as income remains stable and the real estate market does not force the fund to freeze.
Closed-ended funds, often called syndicates, are fixed-term funds that have one or very few properties managed by the fund. These are usually held for five to 10 years but may be renewed for another fixed term if all investors agree. Syndicates have a fixed number of units for the life of the fund.
How do fixed-term unlisted property trusts work?
Unlisted property trusts may only be offered by Australian Financial Services (AFS) licensed fund managers.
In a syndicate, the trust purchases a property and the fund manager operates it until maturity. These managers offer units or shares of the property to potential investors, and each shareholder receives income from the property in exchange for their investment.
This income, which usually comes from rent, is called a distribution. Some fund managers may also pass on tax benefits to the investors as part of the distribution.
Once the syndicate reaches maturity, the property is sold, the investors are paid according to the proportion of their investments, and the trust is wound up.
Fixed-term unlisted property funds usually require investors to keep their money in the trust until maturity, but some fund managers may allow withdrawals. This may be done by purchasing back the investor’s units and charging a fee for the premature exit.
When the fund reaches maturity, it may be renewed for another fixed term with the same fund manager and investors, provided that all the investors vote for the renewal before it matures.
Things to consider before investing
Investors should read and understand the PDS that fund managers are required to provide.
To help potential investors determine if an investment is risky, the Australian Securities and Investments Commission (ASIC) has listed eight disclosure principles and six benchmarks to look for in any syndicate. The fund manager must supply a satisfactory explanation for any unmet benchmark.
All 14 items are discussed briefly below.
8 Disclosure principles
- Gearing ratio
Information on how much of the scheme is funded by debt, so investors have an idea of how much risk they are exposed to.
- Interest cover ratio
Investors must be informed on how much loan interest a fund must pay and where payments will come from. This should serve as proof that the fund has the capability to pay distributions even if the loan interest increases.
- Scheme borrowing
Information on all loans the fund has, as well as when the credit facilities expect payments. This must be disclosed because these can also affect distributions and stability of the fund.
- Portfolio diversification
If the scheme involves more than one property, the fund manager must disclose information about all the properties in the portfolio, as well as each property’s most recent valuation. This should give investors the information they need to understand how diversified the portfolio is and if there are any high-risk properties within the fund.
- Related party transactions
Non-commercial arm’s length related-party transactions are frowned upon. The fund manager must inform potential investors if there were any related party transactions made in the process of purchasing the property. The relationship with the creditor and all arrangements that were made must also be disclosed.
- Distribution practices
Investors should have an idea where distribution payments will come from, how sustainable the source is and how the fund manager plans to make distribution payments if tenants leave the property.
- Withdrawal from scheme
The PDS must disclose if early withdrawal from the fund is allowed, how it will be processed and how long before investors receive the money.
- Net tangible assets
Fund managers should disclose the financial situation of the fund by providing the net asset value of its underlying investments. This should be calculated based on the fund’s most recent financial statement.
Potential investors must check for the following benchmarks in the PDS:
- Gearing policy
The fund manager is required to disclose the syndicate’s gearing ratio—or its level of debt and assets—at an individual credit facility level, as well as in written policies to manage and monitor it.
- Interest cover policy
Fund managers must provide information with regard to how well it could pay loan interest payments from the property’s income. This is important because a fund that cannot pay loan interests may endanger income distribution.
- Interest capitalisation
Interest capitalisation refers to the arrangement wherein, instead of regular interest payments throughout the life of the loan, the interest is added to the loan principal. Payment for both are made at the end of the loan, regardless if the fund is still ongoing.
Unless a payment strategy is already in place to address this expense, interest capitalisation may raise a red flag for investors. It may mean the fund does not have enough money to pay off the loan and interest. If this is the case, investors could lose distribution payments and their principal investment.
- Valuation policy
Fund managers must provide a written policy for maintaining and complying with valuation requirements. They must show how the underlying assets will be assessed and how often the assessments will be done so that investors have an idea of the fund’s financial standing.
- Related party transactions
What are the fund’s policies with regard to related party transactions? Are there special arrangements involved or are transactions made at market value?
This is an important consideration for investors because the fund must be managed in the best interest of the investors, not for the benefit of related parties or the fund manager.
- Distribution practices
The fund manager must be transparent about where and how it will distribute income. Investors must know this, so they have an idea of what they will receive (Will they receive cash only? Cash and some tax benefits?), when to expect it and where it would be sourced from (Will it come from operations only? Income from operations and some loan?).
If any information is missing, the fund manager must explain the lack of information, how they plan to address any and all issues and inform investors what kinds of risks they will be exposed to.
This information has been sourced from ASIC, ASIC’s Moneysmart and Property Funds Association.