There have been a number of people who have lost thousands of dollars through failed investment schemes such as Westpoint, Fincorp and ACR. Unfortunately, there may still be some more schemes of this type that collapse in the not-too-distant future.
These investment schemes are basically involved in developing property. The directors want to raise money to purchase land, build property and then lease or sell it to make a profit. They need money to start these schemes and they’ll borrow most of it from the banks. Banks understand that property development is a risky venture, and therefore they lend a lower percentage of the total funds compared to when you go to a bank and ask for money to buy and hold a residential rental property.
Traditionally, the directors of the scheme will have to put in some of their own money, either as cash or equity. This is often 10%. Banks will typically lend up to 60% of the total money for the scheme, which leaves the directors to raise the remaining 30%. This percentage comes from investors like you.
In financial terms, you’re providing ‘mezzanine finance’. Mezzanine means ‘in between’. At one end of the financing spectrum, the directors have come up with 10% of the funds; at the other end, the bank has provided 60% – and you’re left with providing the 30% in the middle.
This all sounds harmless until you realise that your money is generally unsecured. This means that if things go bad, you could lose all of your money.
The bank will get its money back first, then if there’s money left over the owners will get theirs, and if there’s still some money left over by this stage (there usually isn’t), you’ll get your money back.
However, invariably what happens is there’s hardly any money left over from the ‘fire sale’ of partly built properties that not even the bank gets all of its money back, let alone unsecured investors like you.
So how can you avoid these schemes and eliminate the chance of losing
your hard-earned money? Read on to find out.
1 If it sounds too good to be true it probably is
Marketing and sales hype about high returns is just that – hype. There’s no substance behind these claims. Such schemes will often advertise the high returns you could make, but there’s not much of a mention of the accompanying high risk and the resulting loss of all or at least some of your money if everything doesn’t go to plan.
2 High returns are accompanied by high risk
Investing money usually carries some risk. One of the lowest risk assets is cash in the bank, where in the current market you could earn 6.5% in interest. A moderate risk accompanied by a moderate strategy would be to purchase a house as a rental property. It will provide you with approximately 4% rental return and 7–10% capital growth, giving you a total return of 11–14%.
In regards to residential property, one of the highest risk strategies is property development. A return of 20% is the norm. Investment schemes promise returns of around 9.5%. Why would you place your money in a risky investment scheme when you could earn more by buying and holding your own rental property? If you’re attracted by high returns and don’t mind the risk, you could make much more if you went it alone, assuming you knew what you were doing.
3 Does this investment fit in with your goals and risk profile?
There’s no point considering these schemes if you’re the type of person who doesn’t like to take big risks and/or your goal is to create long-term wealth. In the main, these schemes are hoping to make some quick money. Unfortunately, however, many of them lose money.
4 What is your security? Is it real property?
As mentioned earlier, the reason ‘mum and dad’ investors are the last to receive any money is because they’re unsecured. The bank has security as it has a mortgage on the property. If anything goes wrong, it can sell the property and recoup its funds. The directors have security because they own some real estate as they provided this to the bank as security. However, as an unsecured investor, you have nothing to fall back on.
Ask the salesperson if your money is secured against some form of real estate. If they ‘um and ah’ and hesitate in answering, walk away. If they say no, walk away. Investing in real estate is a great asset, but only if you have some form of ownership or legal interest.
5 Check the PDS or Prospectus
These sorts of investment schemes are required to provide potential investors with a product disclosure statement (PDS) and in some cases a prospectus. Take the time to read this document as it should provide a wide variety of information, including a blueprint for what the scheme hopes to achieve. If you’re thinking of spending tens of thousands of dollars, spend an hour or two reading the information provided. If you’re unsure of what it means, ask your financial planner or accountant for assistance.
6 Are the managers experienced? Do they have qualifications?
The PDS or prospectus will provide you with some detail of the directors and other entities that are involved in the scheme. Read the information to ascertain the following:
· Have these people had any experience in the past with this sort of investment scheme?
· Are there any accountants amongst the group? These people should understand the numbers.
· Does anyone have a property or finance qualification? Not a real estate sales qualification, but rather a university qualification which should provide a thorough understanding of property, finance, the market and its cycles.
7 Check with the Australian Investment Securities Commission (ASIC)
ASIC is the regulatory body for most investment schemes, providing that the scheme meets certain criteria. Directors who wish to avoid the regulations of ASIC can set up schemes where they don’t fall under the ASIC umbrella – therefore they face neither regulation nor penalties from ASIC when things go wrong.
Go to the ASIC website or call ASIC to see what you can find out about the scheme. At the very least, do a search on the internet to see what others have said about the scheme. Check out these relevant websites:
8 What is your worst case scenario?
The glossy brochures and marketing will emphasise the most probable or best case scenario. That is, they’ll talk to you about what should happen and what your returns will be if everything goes well.
Ask them where you stand if everything doesn’t go well. What are you left with then? In the worst case scenario, you’ll be left with nothing as you don’t have a claim on the real estate; you’re providing money with no security and are hoping you’ll make a profit, whereas a bank is happy to provide money but it first requires security, generally in the form of a mortgage on real estate.
9 What is your exit strategy?
If you wish to get out of the scheme before the development is completed, are you able to? The scheme should have some cash set aside for people who wish to pull out before the project is completed and there should also be a mechanism for people to be able to sell their share in the scheme.
10 Stick to real estate
Investing in real property provides real returns. When you invest in schemes, you’re investing in the activity of property development. You don’t have a share of the property, only the profit or loss.
Aren’t you better off being in control of your own future and investing in real property yourself? At the very least, you have something to sell if things go bad. If you’re not sure how to invest in real property, read books, magazines such as Your Investment Property and Your Mortgage, and complete a property investment course.
Peter Koulizos can be contacted at Peter.Koulizos@unisa.edu.au or phone
(08) 8207 8388.