Understanding the key terms associated with the performance of an unlisted property trust

With the potential to provide both income and capital return, property investment is seen by many as a key tool to achieving their financial goals.  

While many Australians gain exposure to property solely through residential real estate, unlisted property trusts provide the opportunity to invest in commercial-scale property. Investment in an unlisted property trust allows for portfolio diversification and offers the opportunity to lower an investor’s overall risk level and increase potential returns.  

Investors are often drawn to unlisted property trusts because they can offer a higher return than residential real estate. As an appealing option for those exploring long-term investment strategies, unlisted property trusts provide a way to invest in professionally managed properties within different property asset classes such as commercial office, industrial, retail, healthcare, and others. If chosen wisely, unlisted property trusts have the potential to provide a regular income and the opportunity for capital growth over the term of the investment.  

Here, we break down the key language and terminology associated with the performance of a property trust to help you better analyse a potential investment opportunity. As with any type of investment, there are risks and all property investments should be considered over a medium to long timeframe. 

 

What is an unlisted property trust?

Professionally managed, unlisted property trusts provide an alternative to direct investment in property. In an unlisted property trust, investors pool their money by buying ‘units’ in the trust, which is managed by a Responsible Entity, like Trilogy Funds.  

These types of Trusts generally aim to pay distributions at set intervals e.g., monthly or quarterly. Units in the trust are valued based on the underlying value of the assets within the trust and in accordance with a unit pricing policy. Investors are offered the opportunity to withdraw their investment at set intervals and the Responsible Entity may manage these redemptions by selling assets or obtaining new investment. The frequency of distributions and withdrawal opportunities should be outlined in the relevant Product Disclosure Statement (PDS). 

 

What kind of properties does ‘Industrial Property’ cover? 

Industrial real estate includes factories, warehouses or large buildings used as distribution, manufacturing, assembly, production and storage centres. Functionality and efficiency are key to an industrial property’s success and value. Industrial properties are commonly set on large parcels of land on the outskirts of capital cities or metropolitan centres and in close proximity to major transport links such as seaports, airports and major highways.  

The Trilogy Funds Industrial Property Trust (Industrial Trust) is designed to build a diverse portfolio of industrial properties located in established regional and metropolitan precincts. The Industrial Trust includes property assets such as warehouses and manufacturing, logistics and distribution centres, showrooms and storage facilities.  

 

Key terms associated with a property trust

Unit Price and Net Asset Value (NAV) 

The unit price is the price at which units in a trust can be purchased from time to time and is calculated based on the unit pricing policy a company will set. The unit price at the time a Trust is created is set at $1.00, and thereafter can fluctuate based predominantly on the underlying value of the assets the Trust holds.  

 

Distributions, CPU and Trust Yield 

Distributions are derived from rental income from the trust’s properties and income from other investments. These income sources are pooled, and a distribution is provided to investors at set intervals. Unlisted property trusts describe their distributions as cents per unit (CPU), trust yield, or both. The CPU distribution is the number of cents an investor will receive for each unit they hold in the trust. The trust yield is the CPU divided by the unit price and is described as a percentage. Distributions are typically described on an annualised basis, e.g., monthly distributions are multiplied by 12, and quarterly distributions are multiplied by 4 to equalise as a ‘per annum’ rate.    

 

Capital Gain

Capital gain is an increase in the value of units in the trust. Units in the trust can increase in value if the valuation of the underlying assets increase. Property valuers use several methods to determine the value of a property, the simplest of which is the capitalisation method, in which the value of a property is determined by: 

Rent: leases for assets will typically be subject to fixed annual increases, CPI or a combination of both. Market rent reviews also occur at set intervals, such as lease options. 

Divided by 

Capitalisation Rate (‘cap rate’) – this metric reflects typical market yields and is determined based on market data for comparable and recent sales. Lower cap rates reflect higher property prices and lower yields, and therefore are typically associated with properties that buyers are willing to pay more for based on the quality of the property, location, term of the lease, tenant covenant, amongst other factors.  

 

Internal Rate of Return (IRR) & Total Returns 

Internal Rate of Return (IRR) and total returns are a metrics used in financial analysis to describe the returns received by investors (distributions and capital gain) in combination. A concept real estate investor may be familiar with, essentially, the IRR is the percentage return earned on each dollar invested in a property over the measurement period.  

 

Weighted Average Lease Expiry (WALE)

In a property or property portfolio with various leases of different lengths, conveying lease duration can be complex. WALE is used to indicate the average expiry period of all the leases within a property or portfolio, weighted by either income or area. The figure enables a clearer assessment of the current and future income stream the property will provide. 

Generally, a higher WALE indicates lower risk as this means that tenants are contracted for a longer period of time, with less chance of the trust’s income being negatively affected by vacancy and lease incentives. A higher WALE is conventionally seen as better by investors, although in the current market of increasing industrial rents, this is not always the case. A shorter-term WALE can potentially provide the chance to make improvements to a property, renegotiate lease agreements and position a property within a higher rental return bracket. 

 

Occupancy Rate

The occupancy rate is the ratio of used or rented space to the total amount of space within an asset or portfolio. This rate helps analysts understand changes in real estate markets and provides investors with an indication of anticipated cash flows.  

A higher occupancy rate means more locations are tenanted and the maximum amount of rent can be paid. When there is a relatively low occupancy rate, managers may have to spend time and money to find additional tenants and risk not filling the spaces while still potentially facing maintenance costs and property taxes levied on them. 

 

Tenant Covenant 

A tenant’s covenant strength refers to their ability to comply with and observe the obligations outlined in their lease, not just today but also in the future. The most important of these obligations is of course their ability to pay rent. Essentially, a tenant’s covenant describes how secure the income is coming from a lease. A strong tenant reduces the risk of lease default and improves the prospect of a good return for investors.  

 

Loan to Value Ratio (LVR)  

The LVR is a financial term used by lenders to express the ratio of a loan to the value of an asset to be used as mortgage security. Many lenders will apply a maximum LVR of 60-70% for commercial property purposes, however the Trilogy Industrial Property trust targets a LVR of 50% or lower.  

Typically, borrowers with a high LVR are considered higher risk and therefore the loan generally costs the borrower more via higher interest rates. If a borrower has a low LVR, the lender risk is lower and a lower interest rate can often be achieved. 

 

Gearing Ratio  

The gearing ratio (also known as the ‘Debt Asset Ratio’) measures the extent to which the trust has used borrowings to acquire assets.  

The gearing ratio is calculated by dividing the total interest-bearing liabilities by the total assets. If the ratio is less than 0.5, then the majority of a scheme’s assets are financed using investor’s equity. If the ratio is greater than 0.5, the majority of a scheme’s assets are financed using debt. It gives an indication of the potential risks a scheme faces in terms of its level of debt. 

 

Net Tangible Assets (NTA) 

NTA is a common valuation metric used by investment trusts and represents the value of all physical (tangible) assets minus liabilities. Essentially, the NTA is the total assets minus intangible assets and total liabilities. 

Sometimes referred to as the balance sheet or book value of the underlying properties held within the trust, NTA forms a good reference point for what an investor could expect to obtain from the sale of one of the trust’s properties. NTA can also be useful when analysing risk levels.  

 

Diversification 

As with any type of investment, commercial property investment carries risks, with the possibility of unforeseen circumstances such as tenants defaulting on a lease or going out of business. Diversification is an important way to reduce risk in an investment portfolio.  

Generally speaking, the broader the diversity, the greater the ability to spread risk, meaning investors are less exposed to market fluctuations. When the property assets of a trust are diverse, there will likely be a lower potential impact on the specific returns and value of one property on the overall trust. Investors should consider diversification by location, tenant sector, asset type and lease expiry dates (WALE). Diversification is seen as one of the biggest benefits of investing in a trust, as capital is often spread across multiple assets and industries.  

 

Closed/open Ended Trusts 

Closed-ended trusts have a specific duration – the investment manager will typically sell the assets within the trust at the end of the trust term to facilitate the return of capital to investors. Open-ended trusts do not have a specific duration – typically the investment manager will continuously raise capital and issue units in the trust. Redemptions in an open-ended trust will be facilitated either by raising additional capital, adjusting leverage, or selling assets within the trust. 

 

Redemptions and Withdrawal Offers 

Investors are able to redeem their units in a trust at the intervals set out by the investment manager in the offer documents. For closed-ended trusts, there is typically only one withdrawal opportunity at the end of the investment term, whereas open-ended trusts will tend to make withdrawal offers on a more regular basis. Some investment managers will also offer limited withdrawal opportunities, whereby a smaller allocation of capital is made available for some investors to redeem units, subject to availability of capital.   

 

Interest Cover Ratio (ICR) 

The ICR of a trust represents the ability of a trust to pay interest on its debts. For example, an ICR of 5.00 would indicate that the operating profits of the trust would be sufficient to pay the interest of the trust 5 times over. Hence, a higher ICR is generally indicative of a lower level of financial risk.  

 

The Trilogy Industrial Property Trust (Industrial Trust) 

The Industrial Trust is an Australian unlisted property trust with a portfolio that currently comprises 15 properties across Queensland, New South Wales, Victoria and South Australia. With a minimum investment of $50,000, the Industrial Trust intends to pay monthly distributions and make withdrawal offers once every four years. It paid investors an average of 7.50 CPU p.a.* annualised for the 12 months to 30 September 2022. 

The Industrial Trust’s primary objective is to maximise potential investor returns diversified by both geographical location and the industries in which the tenants operate. With a strategy to build a portfolio of properties located in key Australian regional and metropolitan industrial precincts, the Industrial Trust includes a mix of tenants in different sectors such as mining, cold storage and manufacturing. The Industrial Trust seeks to target industrial properties that have the potential to provide long-term cashflows to investors and could offer the opportunity of value-add.