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Offers of Unlisted Interests in Commercial Properties - A Review

4.71	We noted that prospective financial information does not usually span critical periods in the issuer's operating horizon where funds flows are important. For example, it usually does not cover periods where: bank facilities are due to be repaid or refinanced; leases are due to expire or be re-leased, with the associated problems of finding new tenants and increased refurbishing costs.
4.72	Where prospective financial information does not take these into account, we think that the assumptions should explicitly say so. In addition, the assumptions should spell out clearly what has been assumed in relation to these factors.
4.73	Sometimes it is not clear from the assumptions what value has been placed on the property in the prospective financial information. In most cases it is cost. Some issuers state the minimum amount that the property must sell for at the end of the investment period in order for investors to meet the stated returns. Most issuers do not. We think that such information is useful.
4.74	As most stated returns are based on the issuer meeting the prospective financial information, it is crucial that all material assumptions are clear and are comprehensively stated. The Investment Statement
4.75	The investment statement is not required to include prospective financial information. However, as noted previously (see para 3.7) the investment statement is required to include a brief description of the nature of the returns provided by the security and a brief description of the key factors that determine those returns. In addition, the investment statement is required to include a brief description of the principal risks that the subscriber will not receive the returns described in the investment statement. In essence, these "key factors" and "principal risks" will encompass many of the assumptions that have been made in the course of preparing the prospective financial information included in the prospectus.
4.76	Market participants have differing views as to where the detailed assumptions should be set out. Some respondents consider that as the investment statement is the primary offer document most prospective investors are likely to read it and refer to it for details. They consider that the investment statement should explain returns clearly and draw attention to principal assumptions and risks associated with the returns.
4.77	Others consider that the prospectus and the investment statement are complementary documents. They consider that the prospectus should include the detailed information and that the investment statement should include core information. They consider that there should be no move to duplicate disclosure in investment statements and advertisements as this could undermine the disclosure framework and render the prospectus redundant. One respondent considers that it would benefit investors if limited additional information were disclosed in investment statements and advertisements and the manner in which existing disclosures are made were improved.
4.78	Still others do not consider it appropriate for assumptions to be disclosed in investment statements. These respondents consider that principal assumptions are tied to forecast/projected financial statements and these need to be read together. The prospectus should continue to be the document in which all aspects of the investment are disclosed.
4.79	We think the law is reasonably clear. The prospectus must include any prospective financial information and set out the principal assumptions. The investment statement must set out the returns for the subscriber, the key factors determining that return or those returns and the principal risks of not meeting the described returns. This means, in our view, that the investment statement must be reasonably comprehensive where the returns from securities are complex and many factors can influence the outcome.
4.80	Other factors influencing the contents of the investment statement are the general requirement in Regulation 8 (see para 3.16) that advertisements not contain any material likely to deceive, mislead or confuse with regard to a material particular. Is a stated or projected "return" on a security misleading or deceptive without the inclusion of important assumptions that support that return? If so, then further information must be included in the investment statement. Advertisements
4.81	Most respondents agree that principal assumptions should not be included in general advertising and promotional material, particularly newspapers, other print media and television and radio advertisements. They also consider that there is a difference between these and investment statements. They consider it impractical to expect the same level of disclosure in an advertisement as in an investment statement. While respondents accept that all advertisements should be subject to the same rules, they consider that television and radio advertisements have unique qualities that make them more challenging. For instance, fine print can tend to be overlooked by viewers or, if presented more forcefully, can ruin the intended impact of the advertisements.
4.82	The reasons put forward for not disclosing assumptions in other advertisements and promotional material are: it is too cumbersome; these are primarily marketing tools, not vehicles for disclosure; assumptions are tied to forecast/projected financial statements and they need to be read together; it is repetitious and unnecessary.
4.83	However, most promoters agree that there should be a clear statement in any advertisement or promotional material cross-referencing to the assumptions in the prospectus and investment statement. Others consider that there should also be a general statement outlining the nature of the investment and the risks associated with the investment, that is, values may rise and fall and the income levels may fluctuate over time. Others support an additional warning in advertisements targeting investors who fail to properly read the investment statement and prospectus.
4.84	We think that rates of return stated in all offer documents, including advertisements, should be appropriately qualified. Where a rate of return or prospective financial information is recorded in an advertisement, we think a reference should be made to where the assumptions underlying the rates of return or prospective financial information may be found. However, if the advertisement is deceptive, misleading, or confusing without the inclusion of additional information about some of the key factors on which an indicated return is based then that additional information has to be included in the advertisement. The complexity of an offer is no reason to depart from the normal rules of law relating to advertisements and other offer documents. Disclosure of Risks Disclosures in the Investment Statement
4.85	It seems that most promoters of commercial property investments target investors who are expecting to receive an assured or fixed return. This seems to have biased the manner in which they have promoted their offers. The focus is on short-term cash distributions rather than the true nature and risks of the investment - an investment comprising of two components: a mortgage bond with possibly fixed short-term cash interest distributions but, more often, with interest distributions that are not promised but are dependent on the performance of the issuer; shares in the issuer, invariably, with no dividend payout, whether in the short-or long-term and where, in the initial years will have its net tangible asset value being less than what has been subscribed for by the investors.
4.86	A number of respondents share our concern about the way commercial property investments are being marketed. In the current low interest rate environment, investors seek a better return and are attracted by the high headline rates that are advertised. There is a concern that investors may not fully appreciate from the manner in which the investments are marketed that they are investing in property-based, not fixed-interest, investments. It does not help that most of the commercial property investments are structured as stapled investments. The ability to advertise returns to investors is more complicated because of the mixture of securities offered.
4.87	The intention of the investment statement is to describe the key features of the offer to the public. It is important to keep in mind the "prudent, non-expert investor". It is important to have clear unambiguous information. It is important to have a clear but comprehensive statement of the risks associated with the investment, primarily under "What are my risks?" but also in other parts of an investment statement.
4.88	We agree with a respondent, who is not a promoter, who considers that potential investors need to know the terms of the investment before they can understand any prospective financial information on investment returns. Investors need to understand that they are investing in the collective ownership of a commercial property or collectively investing in an entity that itself owns a commercial property. They are sharing in the risks and rewards associated with the ownership of commercial property. In this regard, not only is the rate of return on the bonds and the rate of return from the equity portion of the investment important, but also the risks that these rates of return will not be achieved.
4.89	The focus on the short-term de-emphasizes important information relating to the medium to long-term aspects of the investment. The latter are usually not taken into account in drawing up the prospective financial information in the offer documents that we have reviewed. For instance, how any third party loan will be paid off and the consequences of the maturity of any initial loan are usually not taken into account in the prospective financial information. Questions like: will the issuer be able to refinance with another term loan? if so, is it expected that the rate of interest will be the same? if not, what alternatives and consequences are there? are important factors to the investment and are relevant to the risk factors.
4.90	Sometimes, the fact that there is funding from a term loan or a bridging facility is not stated in the investment statement. Most investment statements contain a general statement under "What are my risks" to the effect that in the event of the issuer being wound up, "any creditors that rank in priority to the bonds will be paid first". We think that such a general statement is inadequate.
4.91	Clause 12 of Schedule 3D requires a brief description of any claims on the assets of the issuer that rank ahead or equally with the claims of subscribers in the event that the issuer is liquidated or wound up. We think there should be a statement about the claims of any lender/bank that ranks ahead of investors and a brief description of the claims, particularly, where information about the associated funding is not disclosed elsewhere in the investment statement.
4.92	The effect of refurbishment and the expiry of leases are not always stated or provided for in the prospective financial information. We think that the risks of not finding a tenant or leasing at a lower rental should always be stated. These may be very material to the investment, particularly in a single tenant investment.
4.93	The investment statement is required to disclose the interests of promoters and other related parties in relation to the charges that are payable by an issuer to them. In most commercial property investments, promoters and other related parties hold promoters' shares which entitle them to certain residual interests in the issuer on termination of the investment. Some issuers state this in their investment statements but a majority do not. In a number of cases, this information can only be obtained from the material contracts and summary of trust deed provisions sections in the prospectus. The presentation of the information is usually not user-friendly. We think that these could be considered as factors affecting the returns to investors and investors should be informed of them.
4.94	Under generally accepted accounting practice preliminary expenses must be written off in the first period of the investment. It is not always clear from the investment statement, particularly in the "What are my risks" section that, on termination of the investment in the short-term, investors may receive back less than they paid for the securities because of these write-offs.
4.95	Only a small number of investment statements refer to the write-off of preliminary expenses or mention that these expenses are not expected to be recovered in the forecast periods. Some refer indirectly to a need to recover the "charges and fees set out in the "What are the Charges" section". However, the information under that question only covers charges that are or may be payable by the subscriber to the issuer or a promoter, or an associated person of the issuer or promoter, or by the issuer to a promoter or administration manager or investment manager. It does not necessarily cover all preliminary expenses.
4.96	We think that the consequences of writing off preliminary expenses in the initial forecast period on the investment by investors should be clearly described in the investment statement. Disclosure of Charges
4.97	We note from our review of offer documents that preliminary expenses are not always clearly disclosed in investment statements.
4.98	The law requires the amount of the preliminary and issue expenses to be disclosed in a prospectus. Clause 7 of Schedule 3D requires certain types of charges to be disclosed, either in the form of a dollar amount or a percentage figure, in the investment statement. Invariably, this has resulted in the same preliminary or issue expenses being expressed as a dollar amount in the prospectus and as a percentage figure in the investment statement. Reconciliation of the information between these two offer documents is not always straightforward. It is sometimes difficult to determine from the percentages expressed in the investment statement how certain charges are derived. Where figures are capable of being expressed as a dollar amount in the prospectus, we think that it is useful for these to be also disclosed in the investment statement whether or not in addition to any percentage figures that are disclosed.
4.99	Finally, we observe that promoters need to be careful about balancing the prominence of any information disclosed. The potential to mislead or confuse arises when one piece of information is highlighted, usually the positive aspect for marketing purposes, to the detriment of other, usually negative aspects. This applies not only to matters of detail but to the broad structure of the offer document, to a balance between the potential risks and the potential returns of an investment.