What to Look for in a Property or Investment Scheme

How the conflict didn’t flag the attention of finance watchdog the Australian Securities and Investment Commission is still a matter to be dealt with, according to industry experts and action groups.

But one thing is for sure – the term property scheme is a dirty one in Australia now.

In the last two years alone, it is estimated some 20,000 investors have lost a total of more than $800 million, after investing in collapsed property investment vehicles such as Westpoint, Bridgecorp, Fincorp and Australian Capital Reserve.

Worse still, ASIC recently admitted there are 83 property investment vehicles on the market – controlling some $8 billion in funds – it still considers high risk. This compares with just 24 investment vehicles – controlling between $3 billion to $5 billion – it considered high risk two years ago.

So how do property investment vehicles work, how do they go wrong – and what can you do to avoid investing in a bad one?

 

What they are and how they can go wrong.

Typically, property investment vehicles fit into two categories: a property finance company, or a managed investment scheme.

Property finance companies, such as Bridgecorp, Fincorp and Australian Capital Reserve, raise money by selling secured and unsecured “debentures” or “promissory notes” to investors. The debenture promises a fixed interest rate for investors, usually for a fixed period of around five years.

The lure for investors is the interest rate – which is usually between 8 to 10 per cent per annum – far higher than the alternative of putting the money in the bank.

The property finance company may use funds it raises from the sale of these debentures to either develop a property project itself, or loan money to another developer at a much higher interest rate than what it is required to pay back to its investors.

The arrangement turns sour when there is a delay in any one of the projects the property finance company is funding.

“What should be happening is that as a property finance company acquires new sites, it should be selling and getting cash from the profitable project it’s just completed,” said Brian Silvia, director at receiver Ferrier Hodgson. “If you have too many properties at the early stages of development, you have no cash flow coming in to repay your debts.”

This was true in the case of Fincorp, which at the time of its collapse, owned ten properties – only two of which were at any stage of construction.

“For many companies the only way to keep the scheme working is to use new incoming cash made from the public, to pay interest owed to its existing investors.”

Mr Silvia warns that once a property finance company needs to rely on new investor funding to pay interest to its existing members, things can turn sour very quickly.

“It’s not uncommon, particularly when you need to get land rezoned, for the property development process to get blown out,” said Mr Silvia. “As the project takes longer, it costs more money to develop, ultimately at the expense of profits.”

This sentiment is shared by Property Planning director Mark Armstrong.

“In the accounting industry, there’s a term called slippery slope syndrome, and that’s what happened to most of the recently collapsed property investment schemes,” says Mr Armstrong. “As any delay in construction or marketing goes on, costs associated with holding the property, as well as the amount of interest owed to members, continues to go up.”

“The more new investors it gets to help fund existing debt, the more it has to pay in future interest, and this is when the venture starts eating into itself.”

The second common property investment vehicle is called a managed investment scheme. Here, investors buy an interest in one specific property development, and share in the returns. Again, rates of return offered to investors are usually a high 8 to 10 per cent, and, like property finance schemes, the company can collapse if delays are experienced building and turning over a project.

While delays in a development’s timing are often blamed on rezoning or construction, another problem in Melbourne over the last few years has been the stagnant residential market.

“The residential market in Melbourne is performing strongly this year, but it wasn’t long ago that it came to a grinding halt,” said Mr Armstrong.

He said that in many cases once permits were approved, and projects were built – developers were then faced with the problem of selling them at a sluggish time in the market.

Mr Armstrong said that while many property scheme-led developments started construction of new projects, major residential developers such as Mirvac or MAB, were putting their apartment projects on hold until the market improved.

“Property finance companies such as ACR weren’t conspiring to lose money, they just got their timing wrong,” said Mr Armstrong.

How to avoid investing in a bad property investment scheme.

One common theme that emerged after the collapse of Fincorp, ACR and Bridgecorp earlier this year, was that investors were unaware of the financial risks they faced by investing into a property investment vehicle.

“Many investors realised their investments were unsecured (and therefore not obliged to be repaid in the event of a collapse) only after the property scheme went sour,” said Mr Armstrong.

Australian Capital Reserve, Fincorp and Bridgecorp are amongst the biggest property finance companies to collapse this year, affecting some 16,000 people who are owed more than $550 million.

Westpoint collapsed in December 2005, affecting 4000 people who were owed around $300 million.

While Westpoint used its own spruikers to sell its investments, Fincorp and ACR promoted its products through sophisticated television, radio and newspaper advertisements. Combined with swank offices, the businesses appeared professional, successful outfits.

However they were much higher risk than investors would have realised.

After the collapse of three property schemes in quick succession since March this year, many in the industry are now pointing the finger at industry watchdog ASIC to do more.

KordaMentha partner Mark Korda said after a Fincorp Group creditors meeting that the government and ASIC should tighten the rules for property investment vehicle advertising – and do more to protect unsophisticated investors being swindled.

Mr Armstrong agrees.

“I also feel there is a lack of transparency in the advice people are given when they buy these products,” he said. “The onus is on ASIC now to inform people about the risks of investing in any investment.”

“Financial services is one of the only professions where an adviser can make their money not from their client (the investor) but from someone behind the scenes (like a property investment vehicle),” said Mr Armstrong.

“The advice is tainted because the vested interest doesn’t lie with the person receiving the advice, but the person selling the advice.
Some argue even more should be done.

Mr Silvia of receiver Ferrier Hodsgon is calling for credential guidelines to be introduced, which would limit a property scheme’s ability to borrow money, against assets it already owns. This would prevent some schemes seeking more money, when the writing is on the wall that it will collapse.

To its credit, ASIC did put a stop order on Bridgecorp last year, preventing it from raising $238 million to fund debt. Similarly, it placed three interim orders stopping ACR from raising funds before its demise in May.

But there are questions about how far ASIC should go. The current volatile property investment vehicle situation puts the government watchdog in a bind.

On the one hand it is obliged to protect investors from continuing to invest in floundering companies – but on the other hand, raising an alarm may cause investors to stampede out of the $29 billion property finance sector – which means far more could be lost.

For the moment, ASIC seems to have bought itself some more time to come up with a solution. The federal government recently blocked Labor’s proposal for a full and comprehensive enquiry into the collapse of property investment schemes. The opposition wants ASIC to identify regulatory weaknesses and recommend change in order to minimise such collapse occurring in the future.

Recently appointed ASIC Chairman Tony D’Aloiso recognises ASIC has a lot to do.

He said one of ASIC’s priorities this year is to set up a special team to examine the risks of the sector. The group aims to educate consumers via ASIC’s website, about the risk and reward of property schemes. It will also try to crack down on how complex property related products are advertised.

Mr Armstrong says research and education by investors can take a lot of the guesswork out of investing in property investment vehicles.

“Unfortunately, you can’t believe everything you read in a prospectus,” he says. “I encourage investors to have a clear understanding of what they are investing in; look at what happens when things go badly; and know where you sit as a creditor, if projections don’t come to fruition.”

Finally, Mr Armstrong says understanding where a property asset will sit in the real estate cycle is essential.

“Investing in large-scale multi-storey residential unit developments in 2003 to 2005 was a higher risk because of where we were in the market cycle,” said Mr Armstrong. “We could clearly see that people were abandoning property investing.”

Mr Armstrong said diversifying investments into a range of available options, is an important strategy of all successful investors.

 

Case study: Graham Macaulay, President of the Westpoint Victims Action Group

Three weeks ago, Graham Macaulay received a letter from receivers PricewaterhouseCoopers saying he won’t get a cent back from his investment into failed property developer Westpoint.

Mr Macaulay and his wife had invested $300,000 into three Westpoint residential projects. It was the couple’s first time investing in a property investment scheme, and they were promised a 12 per cent annual return.

“Everyone of these Westpoint, ACR and Fincorp products were sold by ASIC controlled licensed financial planners at some stage,” said Mr Macaulay. “Under the guise of them being safe products, these trusted groups were selling high risk products.”

Westpoint also received a clean bill of health from its auditor less than twelve months before collapsing, as did ACR.

“I knew there was a certain element of risk for that kind of high return, but I didn’t realise exactly what the risk was. I have since learned,” said Mr Macaulay. “I thought as a worst case scenario that even if Westpoint didn’t come good, I’d recover 60 – 70 per cent of my money back.”

“I never saw Westpoint as a risk of capital.”

Like many people in the property industry, Mr Macaulay thinks ASIC could have done more to prevent investors falling victim to high risk property schemes.

He believes that, following the $4 billion demise of HIH, $600 million collapse of One-Tel, and more than $800 million in failed property investment schemes – a Royal Commission should be obtained into ASIC’s recent performance.

“When you’re in my position and you’ve tried to do everything right, you can’t help but feel confused as to why both sides of politics aren’t doing anything overtly about the problem,” said Mr Macaulay. “I now think there are two answers to that question.”

“The first is neither party wants to pick up the tab and compensate investors for the losses because of ASIC’s mistakes,” he said. “The second is if they publicly admit the situation, it will immediately cause the companies to crash with its negative impact on the investment marketplace.”

Mr Macaulay says he hopes his story will prevent other people becoming victims of the high-risk, low monitored sector.

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Marc Pallisco

A former property analyst and journalist, Marc is the publisher of realestatesource.com.au.

Marc Pallisco

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