Unlisted Property Funds 101
What is an Unlisted Property Fund
Unlisted Property Funds, also known as Direct Property Funds or Property Syndicates, pool money from individual investors to buy property and share the rental income. Mostly these funds are focused on commercial property.
Funds are set up through a formal legal structure and most Fund managers (or Responsible Entity’s) are licensed by ASIC, which means they need to meet certain minimum standards. Investors in the syndicate buy units or shares in the fund that represent a portion of the property. The number of units available depends on the price paid for the property and the number of investors in the fund.
The performance of the fund is directly impacted by the underlying performance of cash flows and values of the assets in the Fund, and the skill of the manager to manage the Funds capital. Investors receive these returns in the form of fund distributions and changes in the unit price.
Types of Unlisted Property Funds
Direct Property Funds have evolved over time to also include more active types of investments such as property development and property repositioning. These more active funds typically aim to provide investors with a capital growth style return rather than ongoing income.
Direct Property Funds can own a wide variety of assets including: office buildings, shopping centres, industrial buildings, data centres, childcare centres, service stations, self-storage, and land.
Open-Ended vs. Closed Ended
Direct Property Funds can be structured with a single asset investment for a defined fixed term, such as seven years, or can be open-ended and continually raise capital and acquire multiple assets over time.
Retail vs Wholesale funds
Retail funds cater for individual retail investors with a minimum investment from as little as $5,000 (depending on the investment manager).
Wholesale funds are targeted towards more “professional” or “sophisticated” investors and typically have more complex structures or return parameters, and have a minimum investment usually greater than $100,000.
Investors in Unlisted Property funds are required to pay the Fund Manager fees for the ongoing management of the fund. These fees may include some or all of the following:
- Management fee – an ongoing fee paid as a percentage of the Fund’s Gross Asset Value.
- Acquisition fee – a percentage of the total consideration (excluding stamp duty and taxes) paid to acquire a property.
- Disposal fee – a percentage of the of the gross sale value of a property sold by the Fund.
- Performance fee – a percentage of the outperformance of the Fund above a target IRR hurdle.
Returns to Investors
Investors in Direct Property Funds receive their returns in the form of income and capital growth. Income is returned as cash distributions to investors which are generally quarterly or monthly, while capital growth is recognised in changes in the fund unit price which is impacted by changes in the value of the underlying properties.
Unlisted Property Funds typically use debt in conjunction with investor’s equity to acquire assets in the Fund.
Leverage is a two edged sword and can magnify both gains and losses. Gearing within property funds is widespread and investors need to understand that prudent use of leverage, with appropriate capital management strategies (covenant levels, type of debt, principal and interest or interest only, debt duration and hedging) can be an effective financial instrument. However if abused, then the ramifications can be significant.
Unlisted Property Funds are considered illiquid, by virtue of the fact that the underlying assets are difficult to trade in comparison to listed securities.
Investors should therefore consider what happens at the end of the syndicate’s term, and what happens if an investor needs liquidity? For funds with fixed terms this may be clear, however for open-ended funds the answer is vaguer.
Over time Unlisted Property Fund Managers have come up with a wide variety of innovative techniques to handle liquidity constraints, including: holding higher cash levels; investing in a hybrid of listed and direct property; offering fixed or percentage dollar withdrawal amounts per annum; and listing on secondary exchanges like the Newcastle Stock Exchange.
Most managers now use structures that require unitholders to vote to amend the fund term and incentivise the manager to recommend to unitholders to wind-up the fund early if they believe the returns from the asset have been maximised or the cycle is nearing its peak. Managers have also inserted early wind-up provisions into the terms of the fund typically based on a Special Resolution i.e. at least 75% of votes cast by unitholders on the resolution to be in favour of the resolution for it to be passed.
To find out more about different alterntives of property funds click here.