The Property-Related Risks in Denison LMWI Property Trust - Case Study Example

A report on Denison LMWI Property Trust # 1 Denison LMWI Property Trust #1 is a predetermined term, unlisted entity trust that is registered with Australian Securities and Investments Commission (ASIC) as a managed investment scheme. It has been specifically established to acquire a commercial office building which is located in North Sydney-165 Walker Street. No more additional property investments are expected to be made in the future (Denison LMWI 2009, P.12). The anticipated investment period of the trust is five to seven years. Having completed five investment years and just prior to the seventh year, the liable entity will request to vend the property and bring to an end the trust. If the market environment will be favorable, the responsible entity may decide to put up for sale the property at any time during the term of the Trust. This is in support of its’ guiding philosophy which focuses on creating income from dynamic management, exploiting inadequacies and identifying strong developing markets. To achieve its guiding philosophy, the trust has set a number of objectives which include: to grant constant, tax effective profits returns with precariousness from a distinct real estate asset, disburse quarterly distributions and create investment growth through planned property selection in addition to dynamic asset management, value-add opportunities and a flexible way out strategy (Denison LMWI 2009, P.4). The trust will be managed by directors and a senior management team of Denison LMWI Collectively who have a wealth of experience in most aspects of commercial real estate including funds management, asset management as well as valuation, sales and leasing, property management and advisory. In addition to establishing and managing property funds, the executive team has applied its expertise to all phases of property transactions: sourcing, selection, securing loan funding, acquisition, re-development or refurbishment, management, marketing, leasing and ultimately disposal. Both teams shall use their skills and expertise to actively handle the property, to augment the return rate and minimize risks. They will also be expected to put into operation certain growth tactics and suggest the sale of the property at an appropriate time to make the most of value for investors. Active and skilled property and asset management will be put into place to ensure that property assets maintain or increase their appeal to both tenants and investors. In depth research has been carried out both in-house and through independent experts to identify crucial determinants within the broader market. The trust is eligible for significant tax deductions based on building allowances, plant and equipment depreciation, and the amortization of the costs of borrowing. Further deductions are available for the amortized costs of the offer. It is expected that the total amount of deductions claimed for depreciation and building allowances on the property, will reduce the cost base of the units. According to Denison LWMI (2009, P.), the trust is expected to generate income from a range of tenants including not-for-profit organizations, professional partnerships and developed small to middle businesses. The investors will benefit from the strategic physical location of the property, as well as from the actively managed lease profiles and associated capacity for income generation which are fundamental to the philosophy of the manager and the skills and experience of its executive teams. The responsible entity seeks to raise $14,800,000 through the issue of 14,800,000 fully paid Units at $ 1.00 per unit. It may also accept an additional $ 250,000 in oversubscriptions. This additional equity will be applied towards the purchase of the property which will mean less debt will be required. The borrowings will be limited to a single debt facility to partially fund the purchase of the property, and an undrawn amount to be used over the term of the facility to fund required capital expenditure. A leading Australian bank has already made an offer for provision of a cash advance facility summing up to $13,250,000. The facility is expected to mature after three years from the settlement date. If the debt facility does not mature within the given period of time (3 years), the responsible entity will continually monitor the Trust’s debt requirements and may seek to refinance the borrowings when the conditions are favorable. In any event, the Responsible Entity will begin discussions with the financier well before the maturity date with a view to rolling over the debt funding. However, it can not always guarantee that the debt funding for the finance will be available at the time. The offer from the bank provides that 50% of the $12,050,000 debt facility used to fund the acquisition of the property will have a fixed interest rate of 6.75% for every year. The remaining 50% will be borrowed at a variable interest rate, expected to be 5.25% per annum at the settlement date. The balance of the total debt facility that is available to be drawn down to fund capital expenditure over the term of the facility will be borrowed at variable rates. All debt facilities arranged for the Trust will limit the security of a financier to the assets of the Trust. Therefore, the financier will have no recourse against other assets of any investor. The Capital will be applied to purchase price, stamp duty, due diligence expenses, acquisition fee, contribution fee, capital raising costs, borrowing costs, prepaid interest, and cash at bank summing up to $26,850,000. The gearing ratio for the Trust at the settlement Date is forecast to be 49% based on the gearing ratio calculation. The ratio will be used by investors as a guide to the level of Trust liabilities versus Trust assets at a point in time. The property is strategically located at the gateway to North Sydney’s CBD, with frontages to Walker Street, Berry Street and Little Walker Street and highly visible from the Warringah Freeway. It is a brief walk to wide-ranging lifestyle facilities including the Greenwood Plaza Shopping Centre, Berry square and the Tower Square retail precinct. The close by North Sydney station/bus crossing point benefits from exceptional transport links to the entire Sydney Metropolitan area. The building has a net rentable area of 5,279M2, over six upper office levels which enjoy Sydney Harbor and District views and 44 parking bays. The Property is characterized by unique and key characteristics which include: North Sydney Central Business District location with views from the upper levels, natural light to three sides with flexible tenancy options, 96% leased, with staggered lease expiry profile, ample secure car parking, well presented, upgraded common areas and services , Weighted average lease expiry of 3.4 years as at 30 June 2009 and a total income which is substantially derived via a lease expiring in September 2013 to Meat and Livestock Australia Limited, who occupy 60% of the building. With its harbor views, good natural light and generous car parking ratios, the Property has confirmed to be extremely attractive to potential tenants. Its general appeal and appearance helps the building to be viable within North Sydney Central Business District mutually to part floor and entire floor tenants. Its elevated tenancy rate testifies to these eye-catching features. The property is currently 96% leased to a variety of tenants with a staggered lease expiry profile. The tenancy profile in the building is well positioned for ongoing rental growth opportunities with a healthy mix of medium and long term lease expiries coupled with annual fixed rental reviews. The top five tenants of the property are: Meat & Livestock Australia (MLA); occupies 3,171 M2. Majorly provides R&D and marketing services to 43,500 livestock producer members and the broader red meat industry to help them meet community and consumer expectations. It has been a long term occupant of the building and its occupancy has expanded to approximately 60% of the net to let area and they have recently committed to a further lease expiring in September 2013, with an option for a further five years. Network Limited (oOh!Media); occupies 788m2, it is a specialist digital advertising agency providing highly effective digital advertising and marketing solutions for business. The advertisers are provided with premium digital space on large format plasma and LCD screens in high traffic public locations around Australia. AMA Finance Corporations property Ltd; occupies 452m2. It is a specialist provider of high quality, consumer finance services to a global network of customers. The group has largely focused on various niches, including direct sales, Retail sales and small to medium personal loans Clearswift Asia Pacific; occupies 29m2. It basically helps companies of all sizes to conduct their businesses safely over the internet. Century Software (Censoft Investments); occupies 260m2. It is a worldwide organization that builds up and installs technology based trade answer to corporate, government and retail industry. The chart below shows the leased area. Figure 1: Leased area adapted from Denison LWMI (2009, P. 19) There are a number of risk factors which could impact an investor’s investment and have an effect on projected income, the tax effectiveness of any distributions, and the return of capital or capital growth. An investment of this nature carries a certain level of risk, and the performance of the trust may be affected by a number of factors, many of which are outside the control of the Responsible Entity and manager. The risks have been classified into two groups: Property-Related Risks and General Risks. To start with, the property-related risks include: investment in a real property which by its nature involves a risk and an investment in the Trust is no different. The Trust is not guaranteed a capital gain on the sale of the property, lack of property value drop and an occurrence of distributions. The trust may not be adequately compensated by an insurance company incase of a particular loss or the specific provisions of the insurance policy may preclude a claim being accepted by the insurer. Major capital works and refurbishment of the property involving constructions may trigger cost increases since they are not normally budgeted for. The trust’s performance is reliant on the financial strength of its tenants. This may pose a risk if the tenants default under their leases since the manager will be required to re-let the affected space, which may result to an increase of expenses (Denison LMWI 2009, P 21). The responsible entity will use debt to partly fund the acquisition of the property which has a potential to magnify gains as well as losses. The use of debt funding is a risk factor, particularly where short term borrowings are used to fund assets intended to be held long term. Violation of a loan agreement may result in penalties being executed or the lend becoming repayable instantly. This means that the trust may need to refinance on less favorable terms or sell the property. Termination of critical financing could also mean that the Trust is no longer viable. The Trust will be exposed to interest rate movements on any viable rate borrowings that it has. Increases in interest rates could have the effect of reducing the availability or increasing the cost of finance for the Trust. The general risks which relate to the overall risk of a broad range of investments have been categorized into economic factors, regulation and taxation, compliance risk, capital raising risks and forecast risks. On the economic risks the returns on investments are affected by various economic factors including changes in interest rates, exchange rates, inflation, government policy and the general state of the domestic and international economies which may impact the business of the building tenants or other participants in the property market. Changes in State government policy or legislation, including in relation to taxation (including stamp duty) may adversely affect the Trust or investors. The effects of tax may vary depending on the status of investors, but may affect the accessibility of income, the deductibility of expenses, and the treatment of Trust income or impose additional expenses on the Trust. If the responsible entity does anything to jeopardize its’ AFS license then ASIC may take action which could adversely impact the Trust. This is due to the fact that it is subject to strict regulatory and compliance arrangements under the corporations Act and ASIC policy. If the responsible entity does not raise all the equity required within a maximum period of four months, then the offer may not proceed and Investor’s application money will be refunded without interest. The distributable income of the Trust will be adversely affected by any failure to receive the forecast income from the property. There is a risk that the models may not accurately predict future distributions available from the Trust because the assumptions prove to be wrong. This would therefore be a good investment for both the old and young people since a 9% return rate is expected per annum. In addition, the Trust is structured as a unit trust, allowing for participation by all types of investors, including superannuation funds. It also means gearing benefits apply and, under current tax laws, the returns are generally untaxed before one receives them. Reference Denison LMWI Property Trust # 1, 23 June 2009 Product Disclosure Statement ARSN 137 361 785 Read More