At the same time, property syndications have started to become very popular as investment vehicles with exposure to the property market ? but just how risky are they, and is this risk really worth it?

A property syndication is in essence an unlisted legal structure that is used to purchase properties. The shares in the syndication are sold to individual investors who earn proportionate shares in the income generated from net rental growth in addition to any capital growth from an increase in the value of the shares.

When considering any investment the expected returns and risks must be identified and compared. Investors often place more emphasis on the expected returns relative to the risks of an investment, but these two aspects of the investment need to be analysed together.

Little regulation

Expected returns from property syndications can be very high, but they are not necessarily sufficient to compensate the investor for the risks he is taking. There are four main risk areas in property syndications: the lack of regulation, excess costs, the fact that they are unlisted vehicles and their relative lack of diversification.

The property syndication industry is in the process of being regulated now and draft regulations on property syndications were recently published in the Government Gazette for public comment.

The regulations recommend prescribed minimum information that must be made available to investors in a disclosure document and will ensure that promoters of property syndications sign an affidavit declaring that they have complied with these requirements.

Once instituted these regulations should provide certain safeguards and will to some extent protect investors in the sector. However, there is no reason for individual investors to invest in property syndications when they have a perfectly good alternative in the property companies that are listed on the JSE.

Myriad of costs

The listed property sector consists of property unit trusts and property loan stock companies that have carefully constructed, well managed portfolios of properties which give investors access to commercial and retail properties in a well regulated environment.

There are a myriad of costs attached to property syndications. The three main layers of costs are the costs of setting up the syndication, costs of maintaining and managing the property and operating costs of the syndication. The first two are disclosed in the prospectus while the third will only become apparent when the syndication goes into operation and is largely determined by the decisions and actions of shareholders. These include the purchase and sale of shares or properties.

Costs must be looked at as a ratio of the value of the property to be purchased in order to compare costs across different syndications. Some syndications cost up to 16 percent of the property value to set up while annual management fees cost between 3.0 percent and 8.0 percent of the property value. Most unit trusts deduct a once-off fee of 5.0 percent when units are purchased and charge an annual management fee of 1.0 percent of the value of the investment.

These costs pertain to buying into the investment however the cost of selling out of the investment can also be exorbitant due to the fact that the shares are unlisted. A listed investment can be bought and sold easily at a low cost relative to unlisted investments.

You must diversify

A significant portion of the return from any property syndication is the capital gain on the underlying property value. This capital gain is however, just an intangible figure until it is realised through the sale of shares in the syndicate. Brokers can charge large commissions (6.5 percent to 10.0 percent) when selling shares in an unlisted investment due to the difficulty in finding buyers. This illiquidity can diminish the profits significantly. The hefty fees, both initial and final, make syndications extremely unattractive.

Also, as in any investment, you need to diversify ? something that property syndication does not allow as it invests typically in two or three retail properties. A well-diversified property portfolio should have properties in different sectors, in other words, in retail, industrial and office blocks, as well as different geographical locations.

Property syndications are suitable for a certain niche of investors who have an interest in owning a portion of a specific list of properties and have the expertise to analyse the merits of investing a property syndication. However for investors looking to gain exposure to the general commercial property sector then listed property companies are a far better alternative.

Gina Neoh is an investment analyst at acsis, a financial planning company.