The Financial Markets Authority (FMA) is the country’s government agency responsible for ensuring financial services and markets adhere to the law.
Their vision is to promote and facilitate the development of fair, efficient and transparent financial markets.
It is no real surprise then, that in their 2021/22 annual corporate plan, they have highlighted a problem area worthy of attention. Investors search for yield in this low interest rate environment. More specifically, they are concerned with products and services that do not act as expected, disclosures that are not clear and are misleading. They are worried that providers are over emphasising potential returns in promotions, advertising, social media, and other informal means of disclosure.
How do they hope to focus on this problem area? By reviewing the wholesale offers available and the wholesale investor classification. In fact, warnings have already been issued.
There are obviously many companies offering wholesale products to investors that have been flagged as misleading to customers for this to become a key focus of this year’s annual plan. The most obvious of which, due to all the ads I am sure you have all seen, are the likes of mortgage funds offered by property developers who offer 10% fixed returns.
Before we continue, we should explain what a wholesale investor is. By definition it is someone with at least $750,000 available to invest in the product offering OR someone who is eligible. Eligibility is based on an Accountant, Lawyer or Financial adviser deeming you competent enough to invest in the particular wholesale investment.
A couple of problems with this, which is why the FMA are looking at redefining the definition of a wholesale investor.
1/. Someone can get lucky with a windfall through no smarts of their own. Such as a large windfall or sale of property that has experienced significant capital gains. If the amount is greater than $750,000 then you are considered eligible for investing in wholesale investments, even though you may not understand the product being sold or the risks involved. Products out of the mainstream can be very convoluted and difficult to grasp. Just because you have a lot of money, it shouldn’t mean you are automatically a sophisticated investor.
2/. Some professional accountants, lawyers or financial advisers will sign certificates for investors with less than $750,000 who may not be competent enough to fully understand the product being sold to them.
Wholesale products are not bound to the same regulations as typical retail products such as mutual funds. Wholesale product providers do not even have to be in a dispute resolution scheme like others in the retail industry such as financial advisers. They are not required to meet a determined level of disclosure. Heck, they aren’t even required to put the clients needs first.
More companies emerge promoting unregulated (wholesale) property investments with eye popping returns. This environment of low returns, has seen a real search for yield. Companies that are offering the high returns for ‘no risk’ are all coming out of the woodwork and taking advantage of the wholesale investor clause.
One company has recently removed the word guaranteed returns from their website which is good to see. Maybe the FMA focus on this segment of the financial services industry is working. Because there is no such thing as a guaranteed 10% return in a low interest rate environment..
Risk free and high returns don’t work together.
This can be seen by the many property development funds that have gone bankrupt over the years. The promise typically being for high returns with little risk, luring many mum and dad investors into losing their life savings.
Here is a list of just some of the failed property development companies over the last 20 years:
Takapuna Village Ltd
Taradale properties
Chelsea View Estate Trust
Kitchener Group
Bridgecorp
Starline Group
Blue Chip
Melview Group
Hanover finance
Strategic finance
Marlin property consultants
Perron Group
Melview developments
Kensington properties
Dominion Finance
Sarvee Group
Pounamu Prime Ltd
Castlereagh Properties
Nathan’s finance
Cornerstone Group
Sanctuary developments no 8
LDC properties
GRA Developments
TBA Developments
Just to name a few! Quite a list isn’t it?
That is over one a year. That we know of too. Some will slink into insolvency much more quietly.
They all have a lot of common with today’s mortgage offerings:
Highly leveraged. Relying on other people’s money to make gains
Highly risky. Otherwise, the banks would lend more to them. There would be no need for them to go public if they were such a sure thing.
Started out small and getting more and more ambitious as the market booms.
The scary thing about a lot of these businesses is that after their companies have folded, leaving thousands of people guttered of their savings and millions of dollars lost, not to be repaid, they reopen a new business and start the cycle all over again.
With the housing market doing so well, leverage works great. But as the list of the failed property companies above show, things don’t always work well. In fact, they often don’t.
These developers all rely on significant capital gains. Your money is backed by the price of the assets and the land. But if people don’t value the land or the properties as much as was paid for them, then where does that leave you?
There could be many reasons for these funds failing to deliver:
No capital gains for a decade
Significant increases in cost of building
Significant increases in cost of lending
Building a dud building with issues such as leaky or non-compliance
A pandemic worse than Covid
Falling rents
An economic recession
Lack of buyers for property
Lack of tenants
The building contractor going out of business
Project delays
These risks are exacerbated by the fact that many property developers love taking risk with other people’s money. Too much leverage is at the root of all failed property developments. That is why banks know better than to lend too much to these companies.
The property development companies promise large, fixed returns. As they receive money, that money must be deployed into projects. This often means having to sell all the units/houses they spent the last 2-3 years developing. Then they have to start the process all over again.
But property can turn sour very quickly. As many large new builds take up to 3 years or longer, that is a lot of time for things to go wrong with a development.
When downturns happen, leverage works in the opposite direction where any losses are amplified. That is why so many of these developers go bankrupt. They can’t keep up with their financial commitments. As results go well, they double up and get excited with the great returns and large doses of self-belief, borrowing and spending more and more money. Taking on bigger developments.
It is easy to be a risk taker when you are using other people’s money and have no legal obligations to pay them back if you are unable to. Paper guarantees mean nothing. If the company goes bankrupt, they can’t pay you. Simple as that.
So not only may you not get your 10% returns, but you may also lose your capital.
Everything is good until it isn’t.
As always, do your due diligence out there. This a highly unregulated industry with very little downside to failure for the companies involved. Very rarely are they imprisoned. More often than not they declare bankruptcy, open a new business, and start again, leaving trails of destruction behind them. Hopefully the FMA does tighten up the requirements of wholesale product providers before the next wave of investors get really hurt.
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The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here