Peter Switzer interviews Rebekah Blake
Peter Switzer and Rebekah Blake discuss SMSF Property Capital’s no debt property development business model and how everyday investors can benefit.
Peter: Welcome to the Switzer daily webinar series. In this session, we’re looking at SMSFs and property development. I’ll be reviewing the ins and outs with Rebekah Blake from SMSF Property Capital. Rebekah, thanks for joining us.
Rebekah: Thank you very much for having us, Peter.
Peter: Okay. Now, I was real interested to hear what you guys are doing in the SMSF property space because most people have a very conventional view of investing in SMSF in property.
Peter: Why don’t you talk us through the conventional investments, and then we’ll look at yours as comparison.
Rebekah: Sure. Well, there’s a few conventional ways to invest in property in an SMSF. So a lot of your viewers would have heard of the borrowing rules, where you can borrow to purchase a residential property inside an SMSF. There’s also various trusts that you can invest in, in terms of listed and unlisted trusts. So that would be the main way, so you can invest in property inside a Self-Managed Super Fund or get exposure to that asset class. But we’ve taken it a step further in the past couple of years. We’ve looked at people that want to invest in property development. So not direct property, but actually invested at the front end, so getting those wholesale development profits.
Peter: Because I think most people think, “Okay, I want a property in my Super-Managed Super Fund. Go out and get a loan from the bank and buy an apartment in Bengali or Toorak or Paddington in Brisbane. And all of a sudden, I’ve got a bit of property in my Super-Managed Super Fund.” You guys have thought outside the square, I figure, and say, “Well, some people could actually do a development inside the Super-Managed Super Fund using borrowed funds and things like that.” But a lot of people don’t want to go all the way of developing it by themselves. So how do people participate in yours?
Rebekah: Sure, sure. So in terms of participating in our model, we’ve run under a managed investment scheme, but we’ve done it a little bit differently. So we have a scheme document, a constitution and, of course, Product Disclosure Statement Part 1, which is overarching. But then we look at segregating each individual development into different sub-trusts, if you like, so we call those the PDS Part 2. So that opens and closes, and it’s for one individual development only.
Peter: So I guess if you look at this development and you say, “This is going to a $3 million development,” you want people to collectively put $3 million in.
Rebekah: Absolutely. And we also want people to collectively assess that individual opportunity and decide, “Yes, I understand this. I understand what I’m investing in. I understand the model” and then putting their investment. And the development commences.
Peter: Okay. So how do people get to understand what the business plan is on that particular site?
Rebekah: Sure. So we have a value stream, we call it, which I think we’ll come back to later. But we have an opportunity assessment at the front end, so they put together the various opportunities that are around and that are out there. And then we have a feasibility from the development manager, that PDS Part 2 that I was talking about, that explains the area, so who’s going to buy the end stock, what the development is. Is it four houses that are built in Paddington? Is it a land subdivision? How is investors’ capital used, and how do they make their profit at the end of the day?
Peter: So in a sense, it’s like a business plan for a business, but in this case, the business is a property development.
Rebekah: Exactly right. It’s manufacturing a property at the front end.
Peter: Now, do people get a rough idea of what their return should be if all the assumptions work out?
Rebekah: Yeah, they do, Peter. So we call it a profit, not necessarily a return. Most developments run for 12 months.to 3 years or in between, 24 months, so it’s not a long time period. But that’s specified in the Product Disclosure Statement. Standard development profit is 20% to 30% on a particular development. You wouldn’t find a developer who would do a development for less. So that’s what we look to put together in the feasibility.
Peter: Okay. So if someone said to themselves, “I like the idea of this. I’ve got $100,000 to put into it.” Will they have an indicative return, provided the market holds up, the thing gets sold at the expected price? Is there an indicative return they can feel fairly confident with that?
Rebekah: Yeah, absolutely. So the return, just for an example of a real-life one, we’ve had Collins Capital engaged on a development in Paddington in Brisbane. That was the four luxury house one that we were discussing, so that’s almost finished. The capital’s been engaged for around 12 months, and that profit was initially 24-odd percent. Just because of capital growth, that’s looking to be more than that. Now, we don’t aim to have capital growth insides these funds. . .
Peter: And the market can be just nice to you.
Rebekah: Of course, or it can be bad, but that’s again the reason why we’ve got no debt inside these funds as well.
Peter: Okay. For example, the person that put the $100,000 in, if the profit ends up being 24%, what do you guys take out for doing all the work, and what does the person who put $100,000 end up with approximately?
Rebekah: So that profit figure is net of all fees, so there’s a funds manager’s fee, there’s a development manager’s fee.
Peter: So you’re saying that you gain 24% net.
Peter: Okay. So therefore the person who invested the $100,000, what would he expect to get?
Rebekah: So if he’s getting his capital back plus his profit, that’s $124,000. It does depend on each individual development.
Peter: Some have enormous upsides, some have okay upsides.
Rebekah: Exactly. And of course, time is the biggest risk here. That person that invested $100,000 still may get $124,000 at the end of the day. But it depends if it takes 12 months or if it takes 18 months.
Peter: Yeah. We’ve all seen grand designs. Homes can take longer, and it can often be cancelled or weather or anything.
Rebekah: Of course, or people making changes or variations. But as part of our value stream, we’ve got a builder that we use and rely on in that development delivery side of things, after the capital’s been raised. So fixed price contracts are a good way to mitigate any of those risks or changes.
Peter: So how long has the company been going for?
Rebekah: About three years.
Peter: Because it’s a very innovative approach. I don’t know of many companies who have actually done this before. They may have done in a small group, but they haven’t offered them to the public, I would have thought.
Rebekah: Look, we’re of the same view. We can’t find anyone that does what we do. But what’s really important to us is making these investments accessible, so they’re not necessarily for wholesale or sophisticated investors only. We do it under that PDS structure, so they’re for retail investors.
Peter: What’s the minimum investment?
Rebekah: Five thousand dollars. A unit price is $1, but $5,000 is the minimum. . .
Peter: Is the minimum amount. You’ve made a suggestion before that there’s not a debt issue. Why isn’t there a debt issue?
Rebekah: Sure. We get that question more often than not actually because, as you know, debt in the past has provided great leverage for developers. In these particular developments, you could make a lot more than 20% or 30% if you include debt in there. But there’s also a risk for that. You pay a price for that. And we see debt as a conflict to the development happening quickly. So we have a saying that “Risk is placed where risk is best managed.” We don’t think risk is best managed with the bank, who does not necessarily have the best interests of getting that building built to the standard that investors want it to be built by.
Peter: Yeah, they’re best interests is the shareholders.
Rebekah: Of course, which is rightly so.
Peter: In your case, your shareholders are more [inaudible 00:09:01].
Rebekah: Essentially, exactly right.
Peter: I’m sure a lot of people, when they’re thinking about this, they think, “Well, what could go wrong here?”
Rebekah: There’s always challenges and problems in property development, so I think that’s generally what people ask about. Time is the biggest risk, so at the end of the day, the development could take longer. And it could take longer to achieve that minimum asset sale price of the end stock of that individual development than we think.
Peter: I guess high interest rates could get in the way . . .
Rebekah: Of course.
Peter: . . . and hurt the market, a recession.
Rebekah: That’s right. No one’s got a crystal ball. But at the end of the day, the individual investor assesses that opportunity at the beginning. They look at what’s being produced, what’s being manufactured at the end. “What block am I going to own, and will that sell in the time period that that specifies?”
Peter: And a sensible investor would, if for example let’s take the case of Paddington in Brisbane. You talk to the real estate agents in the area. You get an idea of the benchmark price is going to be in the future. You look at the capital gain that’s typically in the area. And is the market doing well? And all those sort of things.
Peter: And you just hope that things don’t go wrong, just like in the stock market. You can buy BHP.
Rebekah: Of course, yeah.
Peter: And commodity prices can fall, and the share price goes down. So that’s much obvious. I think it’s also important to understand something you’ve mentioned a couple of times already, and that’s the value stream. Let’s understand that.
Rebekah: Okay, great. So in our business, we have a value stream. Now, that is made up of four components to the particular property development model that we run. So number one is the opportunity assessment team. So those guys are out there all the time, looking at sites in most of Australia, potential development sites, looking for things that have a development approval already, and looking at the things that will meet the appetite of our investors. So once they find one, they’ve then got to negotiate with the vendor or the owner of that particular property to put an option it to purchase. Then they create the PDS, and then it comes to the capital raising section of the value stream, where we put that to investors and investors decide if they’re going to fill that particular fund. So then once that’s full, it’s on to the development delivery team. They’re the ones that monitor the development, that look at the builders and sub-contractors and build it to the specifications that are required. And then it’s on to the fourth section, which is the asset sales team. So it’s their jobs to sell that end property or end block or widget, if you like, to the market. And then funds manager gets the capital back to investors.
Peter: So Rebekah, give us an example. You’ve talked about the value stream. Give an example so I can understand it better.
Rebekah: Sure. So an example is for the opportunity assessment side of things, the front end, the people that look for the sites. So they’re looking at a site currently in Brisbane, a five townhouse site, but they’re working with the vendor in this case. So the vendor’s got the development approval. The vendor doesn’t want to, though, develop the property themselves. So they’re looking to put their land in to this particular fund and then will raise the remainder of the capital to complete the development. Now, that particular vendor would go in as an investor in the fund, so they’d own whatever their land is worth.
Peter: So if the land is worth a third of it, they have two thirds using other people want to contribute, not borrow. You know how it is.
Rebekah: That’s it. Well-picked up. Yeah.
Peter: You know how they put their money in to make up the balance.
Rebekah: Exactly right. So he’s been a property developer previously, but he doesn’t want to do that anymore, and he didn’t want to use debt. So this property model works really well.
Peter: And I guess another issue that people might be concerned about would be, well, at the end of the day, what happens if your company has troubles? Banks have troubles. Big organizations have troubles. That’s another variable they have to consider.
Rebekah: Absolutely. The assets are held by a custodian, though, so that’s really important to know. It’s not an individual that’s holding those assets, and that’s Australian executor trustees. Then there’s a funds manager in place as well, guardian security. So they look after the scheme and the compliance around that, which is very important to us.
Peter: Yeah, that’s good. Minimum asset sale. Tell us about that.
Rebekah: So the minimum asset sale price is what we look to put together in the Product Disclosure Statement Part 2 for individual development. So if I can use Pennington as an example, that was between $1.25 million and $1.35 million for each of those four houses.
Peter: And these were simply minimums?
Rebekah: Exactly right. That’s minimum.
Peter: So if you didn’t make the minimum, the deal wasn’t going to be, in a sense, pulled off.
Rebekah: Well, that was the minimum asset sale price. So investors assessed the opportunity, they looked at the area, and they said, “Yes, we think that that’s achievable.” And then they delivered their capital, and then the developments progressed. So the end asset will never be sold for less than the minimum asset sale price. That’s the development manager’s mandate. The investors, of course, could decide differently at a meeting that an investor may call, and they could vote on that.
Peter: So the unit holders, as a group, do have the capacity to say to the developer, “Now, we think you should liquefy the asset, even though it’s below the minimum sale price.”
Rebekah: Absolutely. And they would say that to the funds manager, and the development manager would be there to give their opinion. But yeah, they’d say, ultimately, the investors’ decision. It’s an investment collective.
Peter: It would probably be worthwhile going through the arm’s length connections between the fund manager and the developer and the unit holders.
Rebekah: Sure. So the funds manager has a standard AFSL license for managing investment schemes. SMSF Property Capital is an authorized representative of the funds manager, so we give general advice only about this individual product. We don’t give personal advice to Self-Managed Super Funds or individuals or any investor. So we have our own company and hold the appropriate education for that. The builder, development delivery, are separate, as well, and then the opportunity assessment team and the overall arching board SMSF Property Australia is separate too. But we do work in the same office, and that’s really important because there’s lot of conflict that occurs in development. And the reason why we can give those profit margins, which is standard development profit to investors, even though we’ve got this layer of fees around it — We’ve got the compliance fees, etc. — is because we’re eliminating those conflicts. The conflicts between the architect and the builder, so when the builder’s onsite trying to look at plans, that the architect’s drawn this Whiz bang grand design plans.
Peter: Nice pictures, but it doesn’t work.
Rebekah: Doesn’t work, or it’s maybe too expensive. Or maybe the builder doesn’t have the plan reading skills to understand that. That’s where we’ve eliminated that conflict. So the problems that you find with two parties that are at either end and not necessarily speaking through the actual process, we’ve brought them closer together. So the communication on those issues for investors is much more powerful. And it saves money, it saves time. It saves money.
Peter: Here we go. I want you to put yourself in the position of being a daughter and your father says to you, “Okay, it all sounds very good, Rebekah. So in a nutshell, is there anything I haven’t asked you so far that you think I should know before I make a decision to go into something like this.”
Rebekah: The important thing is that you’ve got to understand what you’re investing in. And I’d say that to my own father because that’s one of the reasons why I’m close to this business in terms of looking at all the other investments out there. It’s something that I understand, and it’s something that I feel comfortable with. And it’s something that’s affordable for everyday people to invest in, in terms of the amount, and that’s the reason we chose to make it available to retail investors, not just for wholesale investors.
Peter: But what if he said to you, “Well, how would you compare this kind of investment to, say, a term deposit?”
Rebekah: Look, I couldn’t compare it. Term deposits, you leave your cash in the bank. You’re in whatever you’re in.
Peter: It’s 4% nowadays.
Rebekah: Yeah. Is it 4%?
Peter: If you’re lucky.
Rebekah: If you’re lucky, yeah. I’d say this to my parents, “Consider your investment portfolio.”
Peter: Your risk appetite.
Rebekah: Yeah, your risk appetite, exactly. But I can remember a few years ago having an interesting conversation with my parents, where I said, “You’ve got to do something.” And this is not related to this business, but just what they’re investing in. Time is your friend, I think, when it comes to investing. And property was something they understood, and they chose to invest in property. So I think, when you’re talking about this particular business model, the documentation’s there. You’ve just got to read it at the end of the day and understand it. And if you don’t understand it, don’t invest.
Peter: Exactly. And also when you get better returns, better returns always mean they’re going to be more risky than a safe held term deposit. But ultimately your assets should be a mixture of very safe, very reliable, and a few that will give you some extra return.
Rebekah: That’s it. But when we are talking about risk, too, it’s important, I think, just on that point, to remember the risk that debt gives to property development and also the risk that time gives. So if you’re comfortable with those risks, having a time risk but eliminating your debt risk, then you just need to make your decision.
Peter: Okay, great. Well, we’ve got some questions here, and these are questions that historically have been asked by lots of people. So let’s go through them and see what the answers are. What do you say is the biggest risk in investing in property development in this way?
Rebekah: If I can use the same answer that we’ve used before: time.
Peter: Yeah. Time.
Rebekah: Time, I think’s the biggest risk.
Peter: How do you deal with the builder risks of time delays or cost blowouts?
Rebekah: Sure. So I think when you touched before that there’s a fixed price building contract. . . Now, whether or not that’s civil’s contract or building contract, whatever the individual development is, that is fixed. So the builder has a margin for that, but at the end of the day, they know what they’re building. They know the amount that they have available to spend, and that’s their job contractually to build in between that amount.
Peter: Okay. This is a real good question. Can the buyer sell units in the fund?
Rebekah: They can, but it’s an illiquid fund. So it’s not like equities or stocks that you can trade, so you’ve got to be prepared to go into that development for the time that those estimated. But if you know a buyer or you can find a buyer and you can agree on a price, then, yes, the fund’s manageable.
Peter: Yeah, so basically you might have a family member who might say, “Well, you’re holding $100,000. You want $20,000. I’ll buy $20,000 of that off you.”
Rebekah: Yeah, absolutely. We’ve had that before.
Peter: Who owns the assets during the development? What is the mechanism that protects the investors? There’s always a two-part question, isn’t it?
Rebekah: Sure. So owning the assets during the development is the investors, but it’s held on trust by the custodian for the investors. So that’s Australian executive trustees. So there’s a special purpose, vehicle, company, if we can get technical, which is all in the Product Disclosure Statement, that owns the land. So investors own land first and then cash at bank. And then those weightings shift, so as the cash at bank goes down, the land value improve land until you’ve got no cash at bank left and you’ve got the end product or widget left. And then it’s sold, and the cash and capital goes back to investors.
Peter: Okay. If the market is not strong at the completion of the development, do investors have the choice of holding their property until the market is stronger? And how do they do that?
Rebekah: Sure. They’re able to hold the particular development, like we say time is the risk. And we touched on the minimum asset sales price, so that’s out for how long that PDS is open for. We’re working with the funds manager currently to make the PDSs open for three years, as a minimum, even if the development time period is 12 months, for example. That’s the estimated time the development manager thinks it’ll take to build and get the money back. Just for that reason, at the end of the day, if the market does crash or something happens, there’s that time period available.
Peter: And the supposition is that within two years, the market would start to recover if it was a bad time. But even then, it could be longer.
Rebekah: Yeah, exactly right. So the investors would make that decision at an investor meeting and they could rent the things out. There’s a number of options the fund manager could talk through with them.
Peter: Okay. Here’s another question that may well be, granted, that we’ve covered before, but let’s just reinforce it because it is a question that has been sent in. Bank leverage is the core of why so many developers have done so well in the past. Not having a bank debt reduces potential profit but puts a greater burden on investors. So why not use them?
Rebekah: Sure. We have touched on this before, but we can never touch on it too much. At the end of the day, when you’re looking at someone’s that in a development that doesn’t have their interests aligned with the investors, that’s where we get the conflict. So the bank, rightly for the shareholders, wants their money back plus their interest — that’s the business that they’re in — the developer, well, the investor, if we’re talking about this model, wants to get their capital back plus their profit and, often, the most profit that they can make. So they don’t want to get 80 cents on the dollar back. They don’t want to get 50 cents on the dollar back. They want 100% of their capital back plus their profit. So in using bank debt or in using banks, you can have fantastic leverage. You can go, “Yes, we got that one. We did that particular development. We’ve made 80% profit.” Then you can have some dramatic downside as well. So it evens out that risk.
Peter: So that’s what you’ve tried to eliminate from the [inaudible 00:24:55].
Peter: Okay, Rebekah. Well, thanks for joining us on the program. I think it’s very informative and very educational. And I guess I should you this — could people who watch this might be thinking — What’s the website they should go to if they want to know more about . . .
Rebekah: Sure. Thank you, Peter. So the website’s smsfproperty.net.au, and you can leave your details there. You can give us a call. We do different developments all the time, so jump on, have a look at our development updates, and educate yourself.
Peter: Thanks very much.
Rebekah: Thank you, Peter.