improving disclosure for unlisted property schemes
In September 2008, the Australian Securities & Investments Commission (ASIC) released Regulatory Guide 46 (RG46) setting out eight principles for improved disclosure to help retail Unitholders compare risks and returns across investments in the unlisted property sector. In March 2012, ASIC revised RG46 to include six benchmarks and a requirement for responsible entities to state whether an unlisted property scheme meets the benchmarks on an “if not, why not” basis.
360 Capital’s Unlisted Trust Annual Reports and Half Year Reports seek to address the requirements under RG46 for each Trust. Where appropriate, 360 Capital will continue to use its website to provide disclosure to Unitholders. Information can also be found in the original Trust prospectus or product disclosure statement (PDS), in previous half yearly and annual reviews as well as specific investor correspondence.
The RG46 disclosure requirements and benchmarks are set out below:
Disclosure Principle 1 – Gearing ratio. The gearing ratio represents the extent to which the assets are financed by debt. A higher gearing ratio means a higher reliance on external liabilities (primarily borrowings) to Trust assets, which may expose a Trust to increased costs if interest rates rise. A more highly geared Trust also has a lower asset buffer to rely upon in times when asset values fall. The gearing ratio can be used to assess the potential risks a Trust may face if interest rates rise or property values decrease, and to compare the risk associated with the Trust’s return on investment to other products.
The RG46-defined gearing ratio is calculated by dividing the Trust’s total interest bearing liabilities by gross assets, based on the last financial statements and adjusted where required.
Unitholders should note 360 Capital Trusts utilise Facility loan to value ratio (LVR) as the measure of debt finance as the Facility LVR directly refers to the Trust’s performance relative to its finance covenants as set out in its finance facility.
Alternatively, the RG46 defined gearing ratio is calculated in accordance with RG46 Disclosure Principle 1 which, depending on a Trust’s non-property assets, may or may not be similar to the Facility LVR.
The Facility LVR is calculated according to the specifics of each facility and different facilities calculate the LVR in different ways. However, in general it terms, the Facility LVR is calculated by dividing the amount of debt drawn under the Trust’s debt facility by the value of the assets that the debt is secured against (based on the audited accounts and adjusted where required).
A sustained increase in Facility LVR towards its covenant limit due to reductions in property values and/or increases in debt indicate a Trust’s declining financial health which, if covenants are breached and financiers impose restrictions, may lead to cessation of distributions, penalty interest rates and potential asset sales to reduce debt levels.
A sustained decrease in Facility LVR below its covenant limit due to increases in property values and/or decreases in debt indicate a Trust’s improving financial health which may permit the Trust to acquire additional assets to improve portfolio quality, diversification, distributions, and the potential for capital growth.
To assist Unitholders, the RG46 defined gearing ratio and the Facility LVR are shown in the Finance Facility Summary for each Trust in 360 Capital’s Unlisted Trust Annual and Half Year Reports.
Benchmark 1 – Gearing policy. The written Gearing (LVR) Policy for each 360 Capital Unlisted Trust states that the Trust will seek to maximise returns (for a given level of risk) by borrowing up to its LVR limit if forecast market conditions are favourable.
All 360 Capital-managed Unlisted Trusts comply with their Gearing (LVR) Policies.
Disclosure Principle 2 – Interest cover ratio. Unitholders can use an interest cover ratio (ICR) to assess a Trust’s ability to meet ongoing interest expense.
The RG46 defined ICR is calculated by using the latest financial statements to determine earnings before interest, tax, depreciation and amortisation (EBITDA), subtracting unrealised gains (if any) and adding unrealised losses (if any). This figure is then divided by the current interest expense (also known as the finance cost) of the Trust.
Unitholders should note 360 Capital Unlisted Trusts utilise Facility ICR as the measure of interest cover as Facility ICR directly references the Trust’s performance relative to its finance covenants.
Alternatively, the RG46 defined ICR is calculated in accordance with RG46 Disclosure Principle 2 which, depending on a Trust’s covenants, may or may not be similar to the Facility ICR as some facilities adjust for rental arrears, or substitute net income for earnings before interest, tax, depreciation and amortisation (EBITDA), etc.
The Facility ICR is calculated using the latest consolidated financial statements according to the specifics of each facility and different facilities calculate the ICR in different ways. However, in general it terms, the Facility ICR is calculated by determining earnings before interest, tax, depreciation and amortisation (EBITDA), subtracting unrealised gains (if any) and adding unrealised losses (if any). This figure is then divided by the current interest expense (also known as the finance cost) of the Trust.
A sustained increase in Facility ICR above its covenant limit due to increases in rental income, decreasing unrealised gains, increasing unrealised losses and/or decreasing interest expense indicate a Trust’s improving financial health. A high ICR provides a buffer if interest rates or other expenses of the Trust increase.
A sustained reduction in Facility ICR towards its covenant limit due to reductions in rental income, increasing unrealised gains, decreasing unrealised losses and/or increasing interest expense would place pressure on the Trust to reduce its interest expense (via reducing debt or refinancing its facilities) or improve its property rental income performance.
The lower the Facility ICR, the higher the risk the Trust will not be able to meet its interest payments. A Trust with a low Facility ICR only needs a small reduction in earnings (or a small increase in interest rates or other expenses) to be unable to meet interest payments.
To assist Unitholders, the RG46 defined ICR and the Facility ICR are shown in the Finance Facility Summary for each Fund or Trust in 360 Capital’s Unlisted Trust Annual and Half Year Reports.
Benchmark 2 – Interest Cover policy. The written ICR Policy for each 360 Capital Unlisted Trust states that the Trust will seek to maximise returns (for a given level of risk) by maximising its ICR if forecast market conditions are favourable.
All 360 Capital-managed Unlisted Trusts comply with their ICR Policies.
Benchmark 3 – Interest Capitalisation. Interest capitalisation involves adding the interest costs under the Trust’s finance facility to the overall loan amount and has the effect that the Trust is not required to make interest payments until an agreed point in time. It may apply in the context of a development asset that does not generate any income during development to meet any interest obligations under finance facilities. If in the situation the property cannot be sold for a price greater than the amount borrowed plus capitalised interest, the Unitholder is unlikely receive any return as a result of the sale of the property.
No 360 Capital-managed Unlisted Trusts capitalised interest at 30 June 2015. Please see the individual Trust web pages.
Disclosure Principle 3 – Trust borrowing provides information on the Trust’s borrowings, including maturity (or duration) and any associated risks including breaches of loan covenants.
Unitholder interests in the Trust generally rank behind lenders and other creditors, meaning if the Trust were to be wound up, then lenders and other creditors would be repaid first, before any capital or outstanding distributions were paid to Unitholders.
If a Trust has a significant proportion of its borrowings maturing within a short timeframe, it will need to refinance and there is a risk that the refinancing will be on less favourable terms than the existing facility or is not available at all. If a Trust cannot refinance, it may need to sell assets (on a forced sale basis with the risk that it may realise a capital loss) in order to reduce debt.
A breach of a loan covenant may result in a lender being able to impose a penalty such as higher interest rates or even require immediate repayment of the loan, in which case a Trust may be forced to arrange alternative financing or sell assets. In general, the two most common finance facility covenants relate to the LVR and ICR.
Details on Trust borrowings (including duration, loan type, LVR, ICR, interest rate, hedging, security, and “covenant headroom” (the amount (as a percentage) by which either the operating cash flow or the value of the asset(s) used as security for the facility must fall before the scheme may be non-compliant with any covenants in its finance facility) are shown in the Finance Facility Summary for each Trust in 360 Capital’s Unlisted Trust Annual and Half Year Reports.
The terms of a Trust’s finance facility usually allow the financier to call an Event of Default if Unitholders in a Trust exercise their rights under the Trust’s constitution to replace the Responsible Entity.
Disclosure Principle 4 – portfolio diversification. Each Trust’s investment strategy seeks to maximise the level of return for an acceptable level of risk. In general, the greater the degree of diversification within a portfolio, the lower the risk.
The level of diversification is illustrated though property information such as geographic location, sector, valuations (date, external or internal valuation, capitalisation rate), weighted average lease expiry, lease expiry profile, occupancy, top five tenants and the value of any development assets (if any, as a percentage of total assets).
The 360 Capital’s website and the 360 Capital’s Unlisted Trust Annual and Half Year Reports set out the metrics described above for each Trust as well as the various investment strategies, in particular as they relate to any investment in other Trusts and whether a Trust’s current assets conform to the investment strategy.
Benchmark 4 – Valuations. 360 Capital’s valuation policy for its Trusts underscores the reliability and quality of property valuations in ever changing property and financial markets. Each Trust complies with this valuation policy and a copy of 360 Capital’s valuation policy can be found in the Corporate Governance section of the 360 Capital website. In summary, the valuation policy states the following:
External valuations of direct property investments are obtained at least once in a two year period or if the internal valuation in relation to a property produces an indicative valuation which differs materially from the current carrying value. Properties that are part of a portfolio of assets may be staggered throughout the two year period so as long as each property is externally valued once.
At each reporting period an internal valuation (Manager’s valuation) will be performed. To the extent that an external valuation has been undertaken, reliance can be placed on that valuation, however Management must consider all inputs into that valuation and confirm whether they are still appropriate and valid. A property purchased within the most current financial year can be valued either externally or via a Manager’s valuation.
A panel of approved external valuers is to be confirmed at least every 24 months with each valuation firm and nominated individuals to meet pre-determined criteria of the Corporations Act, Trust financiers, and surety of business.
All external valuations must be undertaken by valuers who are authorised to practice under the relevant legislation of where the asset is located, hold a recognised and relevant professional qualification, have experience in valuing the type or nature of the property and have no pecuniary or conflict of interest or any potential conflict of interest with the valuation of the property.
External valuation firms may not value the property more than three consecutive times. An internal valuation being undertaken in one reporting period does not negate the above. The selected valuation firm/valuer is to undertake the valuation providing the Manager with draft report for review of accuracy regarding assumptions. The valuation method undertaken may include (but not limited to) a discounted cashflows, capitalisation of income and comparable recent sale transactions.
An internal valuation may be undertaken by the Manager. Internal valuations may be taken up in the financial statements however they may also trigger an external valuation where there is a material movement in the carrying value of the asset (as disclosed in the balance sheet) or where the movement may materially affect the relevant Trust’s NTA. Internal valuations are prepared by using appropriate valuation methodologies. Once approved by the Manager, the valuation will be accepted and reflected in the financial accounts.
On an individual property basis, an external valuation is to be obtained
a. before the property is purchased
i. for a development property, on an “as is” and “as if complete” basis; and
ii. for all other property, on an “as is” basis; and
b. within two months after the directors form a view that there is a likelihood that there has been a material change in the value of the property.
Disclosure Principle 5 – Related Party Transactions. In the normal course of conducting its business of managing Trusts, 360 Capital expects to transact with entities either directly owned or associated with the 360 Capital Group which may potentially lead to conflicts of interest.
Examples of these transactions include investments, loans, fee agreements or guarantees with other 360 Capital entities. The related party provisions of the Corporations Act are set out in Chapter 2E (and are applied to schemes by virtue of section 601LA).
In essence, these provisions provide that Trusts must not give a financial benefit to a related party without the approval of the Unitholders of a Trust unless the giving of that benefit is on terms that would be reasonable if the parties were dealing “at arm’s length” meaning transactions are conducted as if the parties were not related.
Any related party transactions are outlined in 360 Capital’s Unlisted Trust Annual and Half Year Reports, describing the value of the financial benefit, the nature of the relationship, whether the arrangement is on arm’s length terms, whether Unitholder approval was sought and any associated risks.
Benchmark 5 – Related Party Transactions. 360 Capital’s Related Party Transactions Policy states that each Trust aims to ensure that all transactions that might involve related parties are dealt with on a fair, reasonable and consistent basis. All 360 Capital-managed Unlisted Trusts comply with the Related Party Transaction Policy.
The Board of the Responsible Entity of 360 Capital's Unlisted Trusts utilise a number of processes to enable them to give full consideration to transactions with a related party. These processes cover the initial assessment and approval of related party transactions, as well as ongoing monitoring. The processes include Board Review, Due Diligence Committees, and Investment Committee consent to proceed with either a proposed sale or acquisition that is considered to be “arm’s length”. If a related party transaction is considered not to be on “arm’s length” terms, then the transaction should be referred to the Board to ensure that, if proceeded with, the transaction is carried out in accordance with 360 Capital policy, the Corporations Act and the Constitution and Compliance Plan of the relevant Trust. More information can be found on this 360 Capital website or in the Annual and Half Year financial reports for each Trust.
Disclosure Principle 6 –Distribution Practices. The source and sustainability of a Trust’s distribution have the potential to influence a Unitholders perception of that investment. In order of decreasing sustainability, distributions can be made solely from realised income, from retained earnings from a prior financial year, or from a combination of realised income and a return of capital funded by borrowings.
360 Capital’s focus is to increase Trust distributions to Unitholders where permitted by the current and forecast financial position of the Trust, in a sustainable manner.
360 Capital’s distribution methodology is that distributions are to be paid in accordance with the Trust Constitution and associated disclosure documents and generally not be supplemented with a return of capital component funded by cash reserves or new debt funding. Distributions are therefore based upon a number of inputs, including, where relevant:
- accounting net income, including unrealised earnings and retained earnings;
- capital expenditure requirements;
- debt management issues; and
- forecast future earnings, taking into account the need to meet financial covenants, discussions with financiers and the requirement to strengthen Trust balance sheets in order to provide future flexibility to respond to market events.
In some instances, in order to manage a short-term position rather than on a sustained basis, this methodology may require that the distribution be supplemented by distributions out of capital in the following circumstances:
- operating cashflow is greater than Trust net accounting income;
- taxable income is greater than Trust net accounting income;
- the Responsible Entity resolves it is appropriate to distribute a portion of any unrealised gain; or
- the Responsible Entity resolves to normalise distribution income for short-term fluctuations in Trust net accounting income.
Also, in the current economic conditions, 360 Capital considers it appropriate for some Trusts:
- to continue to suspend distributions;
- reinstate distributions; or
- increase distributions.
The decisions to continue to suspend distributions are generally made in order to apply the retained cash to reduce Trust debt and to help reduce any future financial stress in relation to debt covenants.
Benchmark 6 – Distribution Practices. No 360 Capital-managed Unlisted Trusts drew down debt in order to fund FY15 distributions. While 360 Capital expects that each Trust will have sufficient income with which to meet the forecast, the actual level of distribution paid will reflect economic, property market and other factors that are outside 360 Capital’s direct control which may impact the actual distribution paid. The Responsible Entity only forecasts a distribution if, at the time the forecast was made, it considers the rate of distribution is sustainable.
Disclosure Principle 7 – Withdrawal Arrangements. The constitution of each Trust set out whether Unitholders in a Trust have the potential to withdraw their investment. Typically Unitholders in unlisted closed-ended Trusts have no rights to withdraw from the Trust prior to the scheduled Trust expiry date (other than through off market transfers).
The Constitutions of the following Trusts do not allow withdrawal arrangements to Unitholders:
- 360 Capital Subiaco Square Shopping Centre Property Trust
- 360 Capital 441 Murray Street Property Trust
- 360 Capital Havelock House Property Trust
- 360 Capital 111 St George’s Terrace Property Trust
These Trusts are fixed-term for which there is no current redemption or withdrawal facility available to Unitholders. Due to the nature of the Trusts and their underlying assets, the Trusts are considered “illiquid” based on the definition in the Corporations Act. Accordingly, 360 Capital does not propose to offer redemption facilities to Unitholders in these Trusts, although it may introduce liquidity facilities via changes to the Constitutions where it is judged in the best interests of Unitholders to do so. These Trusts should be considered as medium to long term investments, with the ability to withdraw only upon the termination of the Trust.
At a Unitholder meeting on 8 September 2014, 360 Capital Diversified Property Fund Unitholders voted to accept an offer from 360 Capital Group to acquire all Units in the Fund it did not already own as detailed in the Notice of Meeting and Explanatory Memorandum with the consideration paid on 19 September 2014 providing full liquidity.
The option of liquidity was provided to unitholders in the 360 Capital Industrial Fund and the 360 Capital Office Fund via their listings on the ASX in December 2012 and April 2014 (respectively); to unitholders in the 360 Capital Developments Income Fund as part of the recapitalisation, restructure and ASX listing of the 360 Capital Office Fund; and to unitholders in the 360 Capital Retail Fund via a scheme of consideration in February 2014.
Disclosure Principle 8 – Net Tangible Assets (NTA). NTA per Unit is used as the measure of an investment’s value as it takes into account the value of the Trust’s underlying assets and other liabilities.
NTA per Unit is calculated by dividing net tangible assets as per the latest audited or reviewed Financial Statements by total Units on issue, except where the Responsible Entity is aware of material changes since those statements were issued.
An increase in NTA per Unit as a result of increases in asset values, reductions in liabilities (e.g. debt) and/or a reduction in the number of Units on issue indicates a Unitholder’s investment is growing in value and should permit the Trust to attract new equity or debt capital in order to acquire additional assets to improve portfolio quality, diversification, distributions, and the potential for growth in overall NTA.
A decrease in NTA per Unit as a result of decreases in asset value, increases in liabilities and/or an increase in the number of Units on issue indicates a reduction in the value of a Unitholder’s investment and may restrict the ability of the Trust to attract new equity or debt capital. In some instances the Responsible Entity may determine that a short term reduction in NTA per Unit may be necessary and in all Unitholders’ best interests. An example may be the issuance of new equity in order to recapitalise the Trust so to avoid the Trust breaching its financial covenants and thereby avoid being wound-up and impacting Unitholder value, or to reposition the Trust in terms of quality, diversification and scale in order that the Trust’s prospects of providing distribution and capital growth are improved.