Big tenant, but weigh up the risks

A massive Mitre 10 Mega store being syndicated by Oyster Group is a good example of the returns property syndications can provide to mum and dad investors.

But like all investments, there are still risks to be weighed up against those returns.

The property is located on Lincoln Rd at Henderson in west Auckland, a busy arterial providing access to and from the north-western motorway, and is situated next to one of the largest Pak 'n Save supermarkets in the country and a Z service station.

According to Oyster Group, this particular store opened in 2005 and is one of the three largest Mitre 10s in the country (by revenue), with about 40,000 vehicles a day driving past it. It currently generates rental income of $1,949,023 a year and is being purchased for $24.75 million.

So it is a substantial property but one that would be well beyond the means of all but the wealthiest investors.

Oyster Group is planning to structure the syndicate as a proportionate ownership scheme, by offering 140 shares in the property's title to investors at $100,000 each.

This would raise $14m and the balance of the purchase price and the scheme's up-front expenses are to come from a pre-negotiated $11.6m bank loan.

Oyster has forecast the scheme to provide investors with a pre-tax cash return of 9.22 per cent.

Those are to be paid from the scheme's available cash surpluses. The forecast does not include an allowance for any increase or decrease in the property's value (capital gains or losses) or the effect of any depreciation allowances.

The cash distributions would be paid to investors monthly.

The attractiveness for investors looking for a steady income stream is obvious. It is a desirable property that can provide them with returns which are likely to be significantly higher than those currently provided by alternative investments such as bank deposits and listed property stocks.

Investors in residential rental property would also probably struggle to achieve a return above 9 per cent in the current market.

So what are the risks?

The main ones are the same that would apply to almost any commercial property tenant: any increase in mortgage interest rates and the threat to the rental stream that could come from the loss of the tenant or the lease being renewed on less favourable terms.

Oyster has negotiated a five-year, interest only, floating rate first mortgage, with interest set at the 90-day bank bill rate, plus a margin of 1.9 per cent. That is estimated to give an initial interest rate of 4.6 per cent, although the rate used in Oyster's cash flow forecasts is 5.05 per cent.

Both rates are extremely low by historical standards, so a prudent investor would probably try to factor in the effect that higher interest rates could have on the future returns the property could provide.

The property is leased to Mitre 10 (New Zealand), the umbrella organisation for the individual Mitre 10 stores in this country, which in turn subleases it to the store's operator, Magsons Hardward Ltd.

The lease runs until April 1, 2019, with regular rent reviews, and there are two rights of renewal of five years each.

Potential investors would need to form a view on the financial strength of Mitre 10 (New Zealand) and how readily a new tenant could be found if the current lease was not renewed.

The valuer's report points out that a number of restrictions affect the uses the property could be put to.

Foodstuffs, which is the umbrella organisation for the Pak 'n Save chain has a covenant on the property's title which prevents food or liquor outlets operating from the site until 2023, to protect the interests of the neighbouring Pak 'n Save supermarket.

Council zoning regulations further restrict the use of the site to offices, education and hospitality venues, and retailers selling hardware and builders supplies, furniture, home appliances and business and office supplies, with individual stores to be at least 6000 square metres.

So, under current zoning rules, the property could not be redeveloped as, say, a department or variety store, or fashion outlet centre.

In a letter provided to potential investors, Oyster Group said "Mitre 10 is committed to this property for a minimum 6 years and have indicated to us that based on their present thinking they will in all likelihood be there much longer than that."

It also said that in the "unthinkable" situation that Mitre 10 did not continue as the tenant", a queue of bulk retailers from throughout Australasia would quickly form, keen to negotiate a new lease. Apart from such normal commercial considerations, there some features particular to syndication arrangements which potential investors need to carefully consider.

The first is that investors are throwing their lot in with other investors in such schemes, so important decisions such as whether or not to sell the property and wind the scheme up, may not go their way. And if they want to recoup their capital prior to the scheme being wound up they may find their interest is difficult to sell when market conditions for the property are unfavourable.

Investors in syndicates are also very reliant on the abilities of the scheme's manager and, although Oyster Group is well regarded in syndication circles, the ownership and management of syndication companies can change.

If investors wanted to replace the syndicate's managers, 90 per cent of them would need to vote in favour of of such a move.

Such a high threshold could make it difficult to replace the incumbent management company.

Sunday Star Times