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Property Syndication Finance

Property Syndication Finance

What are property syndicates?

The cost of commercial and industrial properties is often too expensive for individuals to acquire. A
property syndicate is a structure which allows individuals to invest in commercial and industrial
property assets which would under normal circumstances be out of their financial reach. In essence
the property syndication gives investors direct property exposure.
The typical property syndicate has the following characteristics.

  • A group of investors who invest under a structure to purchase direct property.
  • The funds contributed by the investors are used as the equity component towards the purchase of the property.
  • The fund / structure may or may not using gearing. The higher the gearing the higher the risk, at the same time the higher the gearing the greater the potential returns.
  • In a lot of cases the fund is an Unlisted Property Trust. The Trust is managed by a fund manager. Investors subscribe for units in the Property Trust.
  • Owning a property in a Unit Trust structure allows units to be issued to investors, much like shares in a company.
    A crucial difference between a Unit Trust and a company is that a Unit Trust is not directly liable for tax but rather is a ‘flow through’ entity placing the burden of tax on the individual or entity that owns the units.
  • Unit Trusts are managed according to their own particular set of rules, as set out in the Trust Deed.
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If a property syndicate uses debt there is greater risk and potentially higher returns. Debt can be used strategically and as an effective tool to increase returns and minimize the downside.

  • There is greater risk because interest rates can change over time. High interest rates with high gearing can lead to the inability to service debt.
  • There is also the risk that if tenants do not renew their leases the drop in rental income could result in the inability to service the loan repayments.
  • There are many banks and lenders who provide loans to Property Syndicates to acquire direct property investments.
  • Banks and lenders have different policies and different approaches to the way they provide finance in this area.

A recourse loan is a loan where personal guarantees are provided. As a general rule investors in property syndicates do not want to provide personal guarantees. Banks will generally provide Non- Recourse loans if the Loan Value Ratio (LVR) is 55% or less. Once the LVR exceeds 55% banks and lenders seek personal guarantees or additional security.

The term of the loan provided by banks and lenders is directly linked to the WALE – Weighted Average Lease Expiry.

As a general rule they will approve an initial loan term up to 75% of the WALE. Depending on the tenant mix and the location of the building they may approve a loan term up to 100% of the WALE.

A shorter loan term can have a number of consequences:-

  • You would need to renegotiate the loan, and if tenants have not renewed their leases this could result in the bank reducing the loan amount approved, and in turn require investors to top up with more equity.
  • This could also result in new establishment fees and other costs.
  • The bank may or may not be happy with the quality of the new tenants.

The Interest Cover Ratio (ICR) is a key ratio that banks and lenders look at when accessing Property Syndicate Loans. The ICR is calculated using Net Rental Income. Typically the banks want an ICR of 1.5x – 2x. The higher ICR the less risk there is to the bank or lender. The less risk the lower the interest rate charged.

Each property syndication deal is priced for risk. There is no standard rates for these types of transactions.

  • The higher the Interest Cover Ratio the lower the risk, which in turn can mean a lower interest rate.
  • The higher the Loan Value Ratio the higher the risk, which in turn can result in a higher interest rate.
  • The quality of the leases (tenants) can impact the risk and alter the interest rates charged.
  • As a general rule the longer the loan term the higher the interest rate.

It is important to be able to compare bank / lender offerings and compare apples with apples. Banks use different reference and benchmark rates and charge am margin over these rates. The benchmark or reference rate used can have a significant impact on long term effective rates.

There are a number of fees associated with these types of transaction, and all of them are negotiable.

  • Establishment Fee
  • Valuation Fee
  • Legal Fees
  • Ongoing loan maintenance fees

In essence Property Syndication Finance is similar to standard commercial and industrial property finance. The major difference is the ability to obtain a non-recourse loan if the LVR is at acceptable levels.
Gearing can be used as an effective tool for property syndication, in fact it can enhance investor returns. This must however be overlayed with increased risk to investors.

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