AWA: Academic Writing at Auckland

Question 1:

The firm the guest lecturer represents is Oyster property group, who specialise in commercial property transactions in particular office, retail and industrial. Oyster manage and syndicate commercial property and are focused on delivering returns for their clients. In addition to property syndication, Oyster also offer property and funds management services. The strategy that Oyster uses is property syndication. Property syndicates are used for small scale investors, where funds are pooled in order to purchase larger commercial property, which they otherwise may be unable to afford[1]. These property syndicates also include institutional investors which are bigger firms such as CBRE, Cromwell and AMP, large corporate firms that specialise in property.   

These syndicates are structured as proportionate ownership, so investors buy an interest in the property. The property is purchased through 50% bank funding and 50% investor funding. The properties are matched in relation to the investors and their strategy, for example retail investors are concerned about their monthly cash flows and prefer stable low risk assets. Whereas institutional investors are willing to invest more and develop/reposition an asset for example as shopping centre and expect bigger returns. This also helps Oyster diversify their risk and portfolio.

All loans are non-recourse loans, which are investors are not personally liable in the event of a default[2].  A nominee will carry out the purchase and hold the title as a bare trustee, who holds the property for the benefit of the beneficiary[3]. Once property acquisition is complete, the property is then managed by Oyster’s property management team that deal with the day to day management.

 There is a set life for each fund and Oyster is mostly low risk, they offer  package deal for various investors,  and are highly geared for institutional, oyster makes their revenue through fees and any overage they get off returns.

Question 2:  The overall constraints Oyster face in achieving their strategy is a loss of tenant due to lease expiries can affect monthly income paid to investors, certain tenants like Cardinal logistics who tenanted the presented property also pose as the have typically low margins and rely on their cash flow which is affected by the market.  interest rate increases can affect the distribution income paid out to investors. The liquidity is also highly dependent on the market. Another constraint is capex requirements which may be large and can affect the investment returns and the target return for the fund. The value of the property may also decrease depending on the market. Investor confidence and the overall performance of the fund may performance poorly because of the market which can result in investors losing their money and a loss of fees for Oyster. Other investments rate of returns in the market may also be attractive to investor compared to Oyster.

Returns can also be lower accepted can also be lower depending on the market as interest and gearing condense returns and investors may not accept lower returns.

Question 3: The properties presented was an industrial property in 71 Westney Road Mangere, Auckland. This fits into Oyster’s investment strategy as it was a retail investor opportunity. This property is well positioned in a good location with close proximity to the airport and motorway which aligns with Oyster’s decision making strategy for properties which requires property to be well located in main urban centres and have proximity to main arterial routes. The LVR of the property is 49.50% which is ideal for retail investors as they expect an LVR between 40- 50%, the cash yield return was 8.1% was acceptable for investors as returns are typically between 8% -10% depending on the location of the asset. To mitigate the effects of liquidity, liquidity event was factored in year 5 which meant if 75% of investors agreed then the asset would be sold.

Question 4: The rate of return was determined by the different investors for retail investors who have as strong focus on pre-tax cash flows, cash on cash return, they want to know return based on equity put in. The returns range from 8-10% depending on the location of the property in New Zealand. The rate of return for institutional investors are based on what strategy they decide. A core and core plus strategy is lower risk and has longer holding period where as value add and opportunistic strategies have a higher rate of return as there is higher risk. Investors are also investing more equity as properties with these strategies tend to be developments, therefore they require a higher return.

Question 5:

1. Rents: Rents can be higher or lower depending on the asset, for example the industrial property presented was rented at 9.5% over rented based on the valuation as Oyster wanted to maximise the value and income derived from this asset. Rental income can also be affected by lease expires. Valuations help establish market rental levels and provide rental evidence. With the example property fixed annual rental growth of 1.4% with reviews every three years to the greater of market or 1.4%. These Rental growth periods and rent reviews in the market, rents are in line with the market and the rent generating potential of the property is maximised.

2. Vacancy Risk: Vacancy risk is relatively low and can be caused because of lease expires. Oyster looks at all tenants and assesses on whether they are financially stable, their core activities and what their long term benefits are and whether the space will be able to be tenanted long after the potential tenant has vacated .To resolve vacancy in the example property an 18 month bank guarantee and personal guarantee was obtained from the company director.

3. Possible non-recoverable outgoings: The possible non recoverable outgoings can be attributed to their due diligence process which can include legal fees, engineering fees , council rates advice and fees for obtaining documents such as the LIM , etc. Other fees may include the financial modelling and costs of to do with oyster’s investment reports such as editing/proofreading costs, printing costs (hard copies for directors) and storage costs of internal documentation such as filing cabinets, data servers.

4. Obsolescence / Depreciation: Oyster attempts to limit the effect of depreciation and obsolescence through their pre purchasing process by assessing the building condition and it’s services, including the NBS %. Obsolescence and depreciation is cured by the maintenance plans provided the quantity surveyors. Deprecation remediation costs are factored into the financial modelling process by oyster in order to see how obsolescence and depreciation affect returns of the asset, from then Oyster will make the decision of whether they want to invest in this asset or not.

5. Going-in and Going-out Capitalisation Rates: The going and going out cap rates reflect, current market conditions and performance of asset. Going out cap rates would be higher because some assets can be redeveloped depending upon strategies of institutional investors, in which case the would expect a higher reversion value as they have spent a significant amount of equity and going in cap rates can fluctuate due to economic conditions, so they can be lower of higher.  

6. Capital Expenditure: Cap ex is forecast in 10-year maintenance plans provided by technical property experts such as quantity surveyors, on issues identified which outline what costs will be for maintenance and remediation of items. These costs are then factored in to financial modelling by Oyster which provides an understanding of what returns will be once capex is factored in. In the example property a lot of the Capex can be financed by the tenant in the case of a net lease. Valuations also help estimate the amount of capex required for an asset. Capex in relation to the structural stability of an asset is important as to Oyster and it’s investors as result of the Christchurch earthquake. Investors are also concerned about the cost of structural upgrades as some upgrades can be very costly and NBS % can affect the value of a building and create a risky unsafe asset.

7. Debt / Gearing: The debt/gearing depends on the investor; retail investors have lower gearing with an LVR of 40% which gives these investors comfort as less money is owed to the bank. Institutional investors are geared highly especially with value add and opportunistic strategies, which have an LVR of 75-80%. These investors invest more of their equity into the asset and expect higher returns. Differs depending on the asset as there may be an extended LVR position from the bank for,3 months, this helps improve returns for short period. Refurbishments are done of the property and then more equity is put in which decreases the LVR. Investors determine debt to equity level and this is based on return the more you borrow the higher the return. With institutional investors value add and opportunistic strategy 65%, of banks debt finance the property and increase returns.

Question 6: Cash flows are separated out for both investors depending on whether they are institutional or retail investors. Retail investor’s focus on pre-tax cash flows and cash on cash return where as institutional investors focus purely on capital growth and tend to look at the total return of an asset.

Question 7: The presentation incorporated lease structures, in this case the weighted average lease term (WALT) as an overarching driver of the cash flow analysis. The WALT is important as it affects the values of property and determines the stability of income streams. It is a measure of a property’s risk of going vacant[4].

Investors generally prefer a longer WALT as it is less risky and income streams are guaranteed for a longer time period. Despite a shorter WALT being risker due to vacancy risk which affects distribution income for investors. Shorter WALT’s can also be attributable to higher management costs due to a higher turnover of tenants and leasing costs because of vacancies. However, there may be opportunities to increase rents, repositioning and development   The WALT can also be used to help investors and valuers understand different sale price and yields that are achieved in similar properties as result of the WALT[5].

Oyster also assess the quality and financially stability of the tenant in order to determine the structure and length of the lease, for the example property presented Oyster was able to negotiate the lease so it was favourable to them and their investors through a net lease and annual rent increases with a hard ratchet.

Leases are structured depending upon the risk investors are willing to take, retail investors are generally low risk and are looking for their income stream to protected so having long term leases in place means their returns are secure. Lease expires create risk as the tenant may not choose to renew their lease which can affect the income/return earned by retail investors. For institutional investors the weighted average lease term (WALT) drives the yield they are willing to pay, for example an asset with 2 year WALT an investor will not willing to fund that asset as the income is only guaranteed for 2 years.

[1] Interest.co.nz, Property syndicates are proving popular but investors need to understand how they work and what the risks are, July 30, 2014 , http://www.interest.co.nz/property/71168/property-syndicates-are-proving-popular-investors-need-understand-how-they-work-and

[2] Colliers International, how does property syndication work?16^th October 2016, http://www.colliers.co.nz/services/syndication/how%20does%20it%20work/

[3] Duhaime's Law Dictionary, Bare Trustee Definition, 16^th October 2016, http://www.duhaime.org/LegalDictionary/B/BareTrustee.aspx

[4] Reits 101, Weighted Average Lease Expiry (WALE), May 20, 2013, http://www.reitsweek.com/2013/05/weighted-average-lease-to-expiry-wale.html