Web Specials

DIY Syndicates

The July issue of Australian Property Investor features an article about how to start your own property syndicate.

We continue the article in this Web Special, discussing the different legal structures and requirements depending on the syndicate type; when an Australian Financial Services (AFS) licence is required; when an offer document needs to be presented; tax; the upsides; and the downsides.

Structure: unit trusts

McMahon Clarke Legal associate Brendan Ivers explains that the most common structure for a simple unregistered property fund for the purpose of undertaking a development or making a passive investment is through a unit trust. Under a unit trust arrangement a company is created, which acts as trustee of a unit trust.

The investors in the fund pay money to receive units in the trust (alternatively, investors can get units in the trust and shares in the trustee company under a 'stapled arrangement'), and the company which is acting as trustee of the trust will hold the title to the property "on trust" for the investors in the fund.

The company will also enter into all contracts related to the project, such as a development management agreement or building contracts (for developments) or leases and property management agreements (for passive investments).

Ivers explains that this structure can provide some protection for the investors in the fund and segregates their investment in the fund from their other investments and assets.

Structure: small property syndicate

If it's just a few friends and family getting together to buy a passive investment, then Ivers suggests an alternative to the unit trust is in establishing a property fund, which complies with the requirements of a 'small property syndicate'.

Under a 'small property syndicate' all of the investors are named on the title to the property as 'tenants in common' and there's a 'syndicate agreement', which sets out the rules of the game for each of the investors. There's also a management agreement entered into between the investors and a manager, and the manager (generally one of the investors) is appointed to provide the property management services for the property, such as collecting rent, arranging repairs and maintenance work.

Ivers explains that for a 'small property syndicate' the 'syndicate agreement' has prescriptive requirement inclusions but there are no particular content requirements for the management agreement.

The number of investors in these syndicates is also limited to 15 investors and the promoter (the person setting up the fund) must hold at least five per cent of the fund. These sorts of funds also have other restrictions, which need to be carefully considered from the outset.

Structure: participating property syndicate

Ivers explains that a participating property syndicate is designed to make it easier for a promoter (the person setting up the fund) of a property fund to set up a small fund. He notes that these sorts of property funds can be useful for people who are looking to get into the property funds management industry but don't yet have an AFS licence.

The major hurdle with these structures is that they require the promoter to issue a product disclosure statement (PDS) if retail investors are investing in the fund, he explains.

If the investors in the fund can fall within one of the exemptions to the requirement to provide a PDS (discussed in more detail below) then it can be structured to avoid this, but if not then Ivers warns that it can be a costly exercise to prepare and issue a PDS.

He explains that these sorts of funds are limited at 15 investors and no investor can hold less than five per cent of the total value of investments made by the fund. As with the small property syndicate there are also additional restrictions to comply with.

Structure: joint venture

Property funds are usually set up for a faster income or gain and need to comply with ASIC, explains MJS Law solicitor Mary Sealy on the difference between property funds compared to the more familiar 'joint ventures'.

She adds that funds are more 'passive' than the 'active' joint ventures. For a joint venture she refers to the common example of a renovation or new build where parties are actively involved in the decision-making, funding and technical details of a project.

Licensing

Ivers says depending on the circumstances the vehicle used to run the property fund (such as a company acting as trustee of a unit trust) may need to hold an AFS licence. An AFS licence is issued by ASIC and is difficult to obtain. Consequently, this isn't really an option for most ordinary investors.

However, there can be an exemption from the need to hold an AFS license, and Ivers explains that as a rule of thumb, if mum and dad investors are doing a once-off project with a close group of friends and family which isn't set up to be an ongoing venture, then they shouldn't need an AFS licence. But once they move onto more than one project, then it's likely an AFS licence will be required.

ASIC also provides exemptions from the need to hold an AFS licence for 'small property syndicates' and 'participating property syndicates', as explained earlier.

Offer document

If the project just involves a small number of friends and family setting up an unregistered fund, then you may not need an offer document. Ivers explains that whether an offer document is required will depend on who is investing in the project and the nature of the project.

He adds that an offer document isn't required if the offer is an 'excluded offer'. Ivers continues to explain that an 'excluded offer' is an exemption from the usual requirements to issue a regulated offer document in the following sort of circumstances:

• Where the property fund has less than 20 members and wasn't promoted by a person who is in the business of promoting managed investment schemes and there's no ASIC ruling applying to it (there are some other technical requirements around this exemption which Ivers recommends speaking to an experienced lawyer about).
• Where the only people who invest in the property fund are 'wholesale clients'. Ivers explains that whether a person is considered a 'wholesale client' depends on if the person satisfies one of the tests in the Corporations Act. He explains that the tests most commonly relied on are:
• where a person invests a minimum of $500,000 in the property fund; - where a qualified accountant certifies that the person either has net assets of $2.5 million or has had gross income for each of the past two financial years of at least $250,000 per year.
• Small-scale offerings. Small-scale offerings are where there are 20 or fewer investors in the property fund, with no more than $2 million being raised in any rolling 12-month period. Under this exemption, the 20 investors don't need to be 'wholesale clients'. This exemption is sometimes referred to as the "20/12/2 rule" and Ivers warns that a lot people trip up on this rule because while it seems simple, it can be deceptive because of the various elements involved, the interaction of those elements and ASIC's very broad aggregation and anti-avoidance powers. He also explains that all offers made under the small-scale offerings exemptions need to be "personal offers", which means you can't advertise or mass market the property fund under this exemption.
• If you're just setting up a small property syndicate, then you won't need an offer document, but Ivers recommends that if you're bringing in people from outside who aren't aware of all the details, an information memorandum or some form of disclosure about the fund is a good idea.

Tax

The larger unlisted property funds that acquire passive property investment properties are structured as unit trusts because tax benefits are derived on items like depreciation, which flow straight through the trust to the investors.

Structures set up as a company arrangement don't provide the same level of tax benefits, Ivers explains, suggesting you speak to an accountant or tax expert who has experience in this area before setting up your structure.

He also warns that stamp duty can be an issue for unit trusts which only own land, especially in Queensland, which he says has the most draconian trust duty rules of any of the states. He says if you're considering a development using a unit trust (especially in Queensland), then you should also speak to a stamp duty expert before issuing any units in the trust.

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