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Remember back in late 2021, when bank deposits were earning around 1.5% and property syndicates were tempting us with returns of roughly 6%?
It was a period when yields for top-tier investment properties—think those with blue-chip tenants and lease terms of 9-12 years, especially in the industrial sector—had dwindled to just above 4%.
Many of us in the investment community believe that was the moment when property prices hit their peak.
Mortgage interest rates at that time hovered around 2.8%.
This environment enabled syndicates to offer a return to investors that exceeded the property's purchase yield through a bit of financial magic known as gearing.
In layman's terms, this meant borrowing a portion of the purchase price at an interest rate lower than the property's yield.
So, what if, back in 2021, you decided to invest $100,000 in one of these property investment syndicates promoting a return of about 6%?
Let’s explore a scenario that might just reflect reality.
Follow the journey of a $100,000 investment.
Purchase price: $10 million.
Property yield: 5% = $500,000 net rental income
Investor contribution: $6 million
Remaining amount borrowed at 2.8%: $4 million - resulting in an annual interest cost of $112,000.
Income return to investors:
Rental income: $500,000
Interest cost: $112,000
Net income: $388,000
This represents a return of 6.5% on the $6 million invested in the syndicate by investors.
Keep in mind that the actual return to investors may be slightly lower due to management fees deducted by the syndicator.
While rates and building insurance have increased since the syndicate's establishment, it's not a problem as tenants would typically cover all outgoings for larger properties like these.
Given the rise in rentals in recent years, it would be safe to assume that the yield is now higher than the initial purchase yield.
Now, mortgage interest rates range between 7.8% to 9%, and in some cases, possibly even higher than 9%.
The breakdown
A $4 million mortgage at the new interest rate, let's say the midpoint of 8.4%.
Interest costs have escalated from $112,000 to $336,000.
Assuming a 4% rental increase per annum, the rental income now stands at $562,432.
The net income payable to investors has dropped from approximately $388,000 to $226,432.
Please note that this calculation does not include any deductions for syndicate management fees.
For an investor who initially put $100,000 into the syndicate, their income has dropped from $6,500 (before deducting syndicate management fees) to $3,800 (before deducting syndicate management fees).
This means it's no longer a return of over 6%, but rather a circa 3.8% return.
You might be thinking what has happened to their $100,000 capital investment?
In today’s commercial property market, buyers are now seeking a higher return than they would have accepted at the peak of the market. As a result, the example property’s value has dropped, possibly selling at a higher yield of 6.25%, which equals a value of $8 million (see note below).
The $2 million drop in value is deducted from the $6 million the investors initially invested in the property.
This adjustment means that the $100,000 initially invested is now valued at $67,000.
But wait, there's more.
The mortgage may be subject to a review.
At the time of purchase, the bank was willing to lend 40% of the purchase price, i.e., $4 million. They are still willing to lend 40%, but not on the purchase price; rather, on the property's new value, which is $8 million.
40% of $8 million is $3.2 million.
When repaying the original mortgage of $4 million to the bank and receiving the new mortgage of $3.2 million, there is a shortfall of $800,000.
In a case like this, the syndicator would more than likely go to the investors, asking them to invest more in the property to meet the shortfall.
In this scenario, the $100,000 investor would need to contribute $13,333, resulting in a total investment of $113,333.
With the reduction in the mortgage amount, there would be a slight increase in the income the investor receives, around $1,120.
On their investment of $113,333, they now receive a return of $4,920 (4.3%) before deducting any syndicate management fees.
Note
Given the initial lease term is no longer in the 9-to-12-year range but now falls between 5 to 8 years, investors looking to buy the property today would be seeking a higher yield. It’s important to note that the drop in value for this reason is partly offset by rental growth.
This scenario isn’t exclusive to syndicators. It applies just as much to private investors who enter the market at its peak and borrow 40% of the purchase price.
It simply reflects movements in the property market. With that comes the risk of buying at the peak of the market and borrowing at record low interest rates.
The best way to deal with a scenario like this, if you can afford to, is to wait it out.
Whether you’re buying the property yourself or through a syndicate, it’s important to ensure that:
The tenant is financially strong.
The building will always attract good tenants.
The building is a sound, modern building.
You have funds in reserve you can call on.
Most syndicates only buy properties with long leases to blue-chip tenants. They often establish a fund from some of the rental income. This fund is then used to cover expenses, such as during periods of the building being vacant.
Plenty of syndicates bought properties pre-2019 and have since seen significant growth in both the property value and rental income. They’ve been excellent investments, particularly appealing to investors wanting to invest in commercial real estate but may not have the capital to buy one on their own.
Syndicates also appeal to investors who don’t want the perceived hassle of dealing with tenants, compliance issues and insurance. Plus, some investors may just want to spread their investment portfolio.
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