Too many structural defects in syndications

Posted On Monday, 28 November 2005 02:00 Published by eProp Commercial Property News
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Over the past few months, I have been warning you in passing terms about property syndications. There are just too many funnies attached to this high-risk investment avenue, which, unfortunately, has undergone a revival of late.

Property-Housing-ResidentialIn simple terms, a property syndication means that a number of investors purchase a single property or number of properties, normally through a syndication promoter.

In recent weeks, I have been inundated with requests from readers to give my views on these so-called opportunities, which are being sold aggressively, particularly to pensioners. Here are a number of points for you to consider:

Some of the biggest investment scams in South Africa were perpetrated through the property syndications of the Owen Wiggins Trust and Masterbond. So be very wary before you put your money in a property syndication. I am not saying that all property syndications are crooked. What I am saying is that the structure of syndications can make you vulnerable to scam artists.
Some reputable companies, such as the Board of Executors and Seeff Properties, pulled out of property syndications in the 1990s when some of their syndications turned sour.

Rising markets hide all sorts of evils. You might have heard the saying, "All ships rise on an incoming tide." Well, it is much the same with an investment market. If an investment market in general is rising, all the offerings on that market improve in value, even the more dubious or ill-considered ones.

We have seen a massive increase in property values over the past 24 months. This has papered over the potential hazards posed by many syndications. The biggest problem is the high profit margin that syndicate promoters add to the value of a property when they syndicate it. If, for example, the syndicators purchase a property for R20 million, it is not unusual for them to syndicate the property for R30 million.

Syndicate promoters use all sorts of fancy arguments to justify these horrendous add-ons. They have got away with it so far, because the property market has been booming.

But now that property prices are levelling off, the syndicates' exorbitant profit margins will not be sustainable. This means that if you need to sell your shares in the syndication, you will find it very difficult to recover your money.

The yields (returns) being offered by the syndicators seem, in many cases, to be excessive. You need to exercise caution when you are being offered returns of 15 percent a year in an interest rate environment of less than eight percent. You need to look very carefully at rental income projections (which seem to be very optimistic) and the cost structures (which seem to be excessive, particularly the annual increases).
Intermediaries are being offered high commissions to sell you syndications. Commissions seem to be about six percent of your investment, which is double the three percent paid in the case of unit trust funds.

But this is not the end of the story. It seems that a number of syndicators are paying "secret" commissions by way of "profit share" arrangements, which take the total commissions to more than 10 percent of your investment. This also explains the high-pressure tactics being used, such as "sign up today, because there are only a few units left".

False claims are being made that there is no need for syndicators and people selling syndications to be registered in terms of the Financial Intermediary and Advisory Services (FAIS) Act.

Most syndications involve you being sold a share for one cent and a debenture of R999.99 (or something similar). And, in terms of the FAIS Act, anyone selling or promoting the sale of shares must be registered under the Act.

Many people promoting and selling property syndications are not registered in terms of the FAIS Act. And to make matters worse, a number of property syndications continue to trade even though the Financial Services Board (FSB) has turned down their applications to register.

To protect yourself:

* Do not invest in a property syndication where neither the intermediary nor the syndicator is registered with the FSB in terms of the FAIS Act.
* Ask both the intermediary and the syndicator for their Financial Service Provider registration numbers. Check with the FSB that the salespeople/syndicators are actually registered. Telephone the FSB on 0800 110 443 or 0800 202 087 to check.
* Don't be bamboozled by the mixing of acronyms. In one lot of propaganda I saw this week, the syndicator claimed it was safe for you to invest in the property syndication because it was compliant with the Financial Intelligence Centre Act (Fica). What this means is that the syndicator is registered in terms of legislation aimed at preventing money-laundering. Fica provides no protection for your money in the syndication.

Most of syndication ownership structures involve a number of different companies. Typically, you lend your money (via a debenture) to the first company. In other words, you have provided the company with an unsecured loan. Then the company in which you own shares, and to which have lent money, lends your money to another company - again, by way of an unsecured loan - to purchase the actual property. This arrangement makes it very difficult for you to reclaim your money if the company which owns the property goes belly up. There are no guarantees on your capital or income.
Syndications are normally created to buy a single property. This means you carry a greater risk than if you were invested in a pool of properties.

In a nutshell, be very, very careful when being offered any investment, including a property syndication, which uses shares in unlisted com-panies and debentures. Commit no more than five percent of your investible assets to minimise the risks of investing in such a scheme.

You have been warned.

Last modified on Sunday, 25 May 2014 16:44

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