The recent reports and comments involving a very prominent property syndication company provide a case in point. Due to the inability of this company to make a mandatory distribution to its investors recently, various commentators have not lost the opportunity to criticise the property syndication investment model as being bad for investors. The main critics blame the lack of liquidity in the model for the said company’s problems. I do not believe that is a fair criticism for many reasons, some of which I will attempt to outline below.
Wikipedia defines liquidity as follows: “A liquid asset has some or more of the following features. It can be sold rapidly, with minimal loss of value, any time within market hours”. Property by its very nature is very illiquid. Bricks and mortar, unlike equities, cannot be turned over a short space of time. Too many variables enter the equation here. Timing is one of the most important of these. Entering and exiting the market has to be timed perfectly. It is said that a property investment cycle unfolds over seven-year periods. So it takes quite a long time for investors to start realising any serious benefits. Or, as some would say, property is a long term investment.
During this time, investors can either leave their returns in the investment or withdraw them every month. If they choose to withdraw their distributions, then they forfeit the capital growth that accrues to the investment as a result of compounded growth. In such a case then at the end of their investment period they can withdraw their capital subject to the ravages of inflation, or the time value of money. Over a period more than seven years, an investor who has left their funds in the investment are typically rewarded with a positive balance. So, such an investor would have enjoyed a monthly “dividend” plus capital growth.
Investors who are in property investments for the long haul by and large come out as winners. Advisors who direct their retired clients towards property investments when the latter cannot afford the time required to realise full benefits are doing the industry a disservice.
Long term investments, such as property syndications, do not as a rule generate “superprofits” from the annuity income from the property. However, in the long term, investors do realise very good returns. One of the reasons is that most urban environments do become attractive for other investors and they also inject their capital into the area. Those who entered the market earlier at a lower price can then sell their holdings at the appreciated price.
The liquidity argument sounds like a contradiction in terms because the long term nature of property investments is that your capital is tied down in the property for a long time. So, there is no point in looking for liquidity where it is not likely to exist. The problem with leaving capital tied down for long periods of time in any asset class is that risk also increases correspondingly. However, property is generally considered to be a “safe bet”, or as they say, property is as “safe as houses”. So, in theory, the timing risk should be adequately mitigated by the safety factor.
Property Unit Trusts were set up specifically to counter the problem of lack of liquidity in property investments. Legally, PUT operators are required to distribute their properties’ income minus expenses to investors every month. Also, investors purchase shares or linked units in the fund rather an indivisible share in the property, as in the case of property syndications. So, if an investor was to require immediate cash, then they could easily sell their shares at the ruling price on the Stock Exchange, just like they always do with equities. In contrast, investors who are interested in the physical asset would put their capital into a property syndication rather than in shares. The syndication brings together people who want to invest in commercial and retail property but cannot afford exclusive ownership in their individual right because of the large amounts involved.
Property syndications are likely to be successful when investments are made into an existing property, as opposed to when a company develops a brand new building. This is because with an existing building, the majority of costs that are payable upfront in any building have already been dispensed with. In a new development, most tenants have to invest large amounts of capital expenditure upfront, on which they have to pay financing costs and earn a quick return. Every cent that the landlord gets from the tenant has to be fought for with others. This puts pressure on rental negotiations, including turnover rentals.
When it comes to property developments, timing is of the essence too. The development profit equation is quite easy to follow – development income less development cost gives development profit. The most difficult thing in attaining maximum profit is to conduct proper research. If a developer starts a multimillion Rand development when building costs are very high, probably the highest in recent history, then the projected profits are not likely to materialise. On the other hand, when the tenant market is depressed, as most recent reports have highlighted, profits are likely to be squeezed even further.
Existing buildings are also far more preferable to new developments due to the certainty that a firmly established property management regime brings about. The process of running a management operation on a large property is a daunting task. The level of uncertainty that is brought about by forecasting the running costs of a new building can rattle even some of the most seasoned property management companies.
As with all other investment classes, the standing rules of investing in property have to be followed meticulously, otherwise the investment is likely to fail. To blame the property syndication model for failed investments when the rules were not followed properly is not fair.