Offers of unlisted interests in commercial properties - a review [2000] NZSecCom 2 (30 March 2000)

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Offers of Unlisted Interests in Commercial Properties – A Review
SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

1.1	Private investment in commercial and residential property has been a significant feature of the New Zealand economy for many years. Traditionally, this investment has been in the form of direct ownership or ownership through private "syndicates". However, more recently what has been described as "genetically modified real estate"1 has been promoted in New Zealand. By April 1999, the Ernst & Young Real Estate Group estimated that the total size of the "syndicated" property market was approximately $1 billion compared to the listed property market at $2.6 billion 2.
1.2	In August 1999, the Commission announced that it was proposing to review the disclosure of rates of return and other related disclosures in offer documents of interests in commercial property. The Commission was concerned, on the basis of its own enquiries and on the basis of complaints, that the information contained in the marketing documents of offers of interests in commercial property was not always clear. The Commission said that it proposed to address these issues and consider whether it should propose guidelines to the industry. The Commission has completed its review. This report sets out our comments on the review.
1.3	In summary, the Commission considers that the law relating to offer documents is adequate for offers of interests in commercial property. However, we think that promoters should be more careful in applying the law. In particular, there should be clear, comprehensive, consistent and balanced disclosure of: the bases and qualifications related to the stated rates of return; the major assumptions underlying prospective financial information; and the risks associated with the investment.
	Methodology of Review
1.4	In order to cover the bulk of the market, the Commission wrote to ten promoters of interests in commercial property. We also wrote to a number of other individuals who we knew were interested in the promotion of this form of investment. The promoters were asked for copies of their current offer documents and those for securities they have promoted in the last three years. In all, we received, over a period of time, some 65 prospectuses and 39 investment statements. These were reviewed on a selective basis to ensure adequate coverage of the main promoters and with a greater level of attention paid to more recent issues.
1.5	The promoters and interested individuals were also asked to respond to a list of questions on the disclosure of returns and other related information in offer documents. The questions are set out as Appendix 1. We have incorporated the responses to the questions in the analysis in Section 4.
1.6	Our review was limited to unlisted securities for interests in commercial property. Focus has been placed on "stapled" securities made up of mortgage bonds and shares in the issuer as these appear to be the most popular structure being used to promote interests in commercial property at present. In addition, it was particularly the expression of a rate of return on the combined stapled securities under offer and the disclosure of related information that prompted the review. 1 See "Genetically Modified Real Estate - The Evolution of Real Estate and the Individual Syndicate Investor", a research paper published in November 1999 by Ernst amp; Young Real Estate Group. return 2 See "Property Syndication - Leading the Way" a research paper published in April 1999 by the Ernst & Young Real Estate Group. return 2. THE NATURE OF COMMERCIAL PROPERTY INVESTMENT 2.1 Although the structure of commercial property investment has evolved over the years, the common form in recent market issues has generally comprised the following: The issuer, a property-owning company, purchases and holds one or more commercial property or properties with a single or multiple tenants; The issuer raises funds from the public by issuing a combination of equity securities and mortgage bonds, described as "stapled" because the subscriber must purchase both equity securities and bonds in a fixed ratio, and with a minimum investment of usually $5,000; The issuer may also borrow funds on mortgage from a bank via a term loan with terms usually requiring interest payment during the term of the loan and repayment or roll-over of the principal in a lump sum within a few years (sometimes a bridging loan may also be taken out for a short-term of up to 6 months to cover shortfalls in subscriptions); The equity securities have no termination date, the bonds may have a specified maturity date some distance in the future or repayment may be dependent on the property or properties being sold; The issuer meets what are usually quite significant preliminary expenses, including costs of arranging the issue, brokerage, a fee paid to the promoter for "finding" the property and legal and valuation expenses; The issuer receives rental income from the property's or properties' tenants and this cash flow provides the source for the payment of returns to investors; The promoter, who is usually the manager of the investment, is paid regular management fees for administering the property, including collecting the rent, arranging for new or replacement tenants and arranging building maintenance; In some cases, promoters also hold promoters' shares (without the requirement to subscribe for the bonds) entitling them to a share of the net assets of the issuer when the investment is terminated; Final repayment of shares and bonds will not normally occur until the property is finally sold; In some cases investors' interests may be tradable on an unofficial market run by the promoting company. 2.2 A typical investment (not based on any particular offering) might look something like this: (a) Property cost : $10 million (b) Shares and bonds subscribed : $7.5 million ($1.5m equity, $6m bonds) (c) Bank loan : $3.5 million (to be repaid in 5 years) (d) Rental income : $1 million p.a (e) Preliminary expenses : $1 million (f) Interest on bank loan @ 7% : $245,000 p.a. (g) Expenses and fee : $115,000 p.a. (h) Interest to bondholders : $640,000 p.a. (forecast for 5 years) (i) Net deficit in first year : $1,000,000 (j) Net surplus for subsequent years : $0 (k) Sale price of property : $10 million (forecast no price increase) What is the "return" to investors in this typical case? 2.3 For the first 5 years, the investor receives $426.66 cash in hand for every $5,000 invested in shares and bonds (1,000 shares, 4,000 bonds). 2.4 In relation to the $4,000 invested in bonds, $426.66 represents an annual "return" of 10.66% in each of the first five years. This is return type A - interest rate on the bonds. 2.5 In relation to the $5,000 invested in shares and bonds, $426.66 represents an annual "return" of 8.53% in each of the first five years. This is return type B - combined rate of return on bonds and shares. 2.6 If the return is expressed as a cash distribution, the return on the investment would be described as $426.66 per $5,000 investment. This is return type C - dollar value of cash distribution. 2.7 At the beginning of the forecast period, the net tangible asset of the investor is $1.00 per share (equity of $1.5 million divided by 1.5 million shares). At the end of the first forecast period, the net tangible asset of the investor is $0.33 per share (equity of $0.5 million divided by 1.5 million shares) as the value of the issuer's equity would have declined to $0.5 million (opening equity of $1.5 million less net deficit of $1 million). Shares initially costing $1,000 would realise $333.33 at the end of the first forecast period if sold at book value. Adding back the cash payment received of $426.66, the investor's initial $5,000 investment would amount $4,760, a negative return of 4.8% for the first forecast period. This is return type D - interest on the bonds plus change in net tangible assets. 2.8 Another way of measuring the return on an investment is to calculate an "internal rate of return" (IRR). This is the rate required to equate the present value of all cash flows from an investment with the present value of all cash outlays on that investment. Using the investment period of 10 years and assuming: the property realises its cost price of $10 million at the end of 10 years; and the bank loan of $3.5 million is renewed at the end of 5 years on the same terms as the initial loan; then, the internal rate of return for this project would be about 7.5% p.a.3 This is return type E - internal rate of return. 2.9 A further measure of a property's ability to produce "returns" is that of rental yield. In this instance the property produces rental income of $1 million per annum on a property costing $10 million. This is a rental yield of 10% per annum. This is return type F - rental yield. 2.10 As illustrated above, the "rate of return" to investors that is stated in an offer document by a promoter can vary depending on the method and assumptions used to calculate the returns and whether these returns relate to the short or long-term. Risk factors and assumptions affecting returns 2.11 Some particular risk factors arise from investment in property, whether directly or indirectly, through commercial property shares and bonds. They include: Changes in property prices will affect the overall return achieved by the investor over the term of the investment; Difficulties in tenanting the property, particularly where it is a single tenant investment, can have a marked effect on the continuing cash flow for investors; If external loan finance has been used to finance part of a property purchase the need to refinance the loan could affect the cash available for investors, particularly if refinancing cannot be arranged or is renewed on less favourable terms than the original loan; Preliminary expenses, ongoing management fees and profit sharing arrangements with promoters could impact significantly on the returns available to investors; Although unlisted, many promoting companies provide an informal market for investors to trade their securities. The market for stapled property securities may be illiquid and, if investors need their funds early on in the life of an investment they may suffer significant losses if they attempt to sell their interests; There could be some corporate risk if the investment vehicle is a company. The directors of the company may have the ability to use the company's funds for investment outside the particular properties owned by the issuer. 2.12 It is apparent that the assumptions made by a promoter concerning property values, ability to keep a property fully tenanted, ability to roll-over external finance and economic conditions generally will have a significant effect on any promised, forecast or projected returns from a property investment being offered to the public. 3 @7% @8% Initial outlay by investor : $7,500,000 $7,500,000 Years 1-10 interest @$640,000 pa : $4,294,400 $4,495,400 Year 10 net residual value (Sale of property less bank loan) $6,500,000 : $3,009,500 $3,302,000 return $7,303,900 $7,797,400 3. APPLICATION OF SECURITIES LAW 3.1 Offers of equity securities and bonds made by promoters of a commercial property investment company are required to comply with the provisions of the Securities Act 1978 ("the Act") and the Securities Regulations 1983 ("the Regulations"). 3.2 In general terms, this means there must be an investment statement and a registered prospectus for the offer as well as a trust deed and trustee appointed in relation to the bonds. The investment statement 3.3 The investment statement is the primary offer document - every investor must have received an investment statement before subscribing for a security (section 37A(1)(a) of the Act). The issuer must also prepare and register a prospectus in relation to any offer of securities to the public (section 37(1)). The prospectus must be provided free of charge to any prospective investor who requests it (section 54B(3)). 3.4 The contents of the investment statement are prescribed in sections 38C to 38E of the Act, and in Part 1A and Schedule 3D of the Regulations. Investment statements are also deemed to be "advertisements" for the purposes of the Act and Regulations which means they are subject to most of the constraints and requirements of the Regulations as to their content. 3.5 Section 38D states: "The purpose of an investment statement is to- Provide certain key information that is likely to assist a prudent but non-expert person to decide whether or not to subscribe for securities; and Bring to the attention of such a person the fact that other important information about the securities is available to that person in other documents." 3.6 Regulation 7A includes: "(1) In addition to the other requirements set out in the Act, every investment statement must contain, in a succinct manner, all of the information, statements, and other matters specified in Schedule 3D that are applicable to the securities to which the investment statement relates." 3.7 The requirements of Schedule 3D that are of particular relevance to our review of offer documents relating to commercial property investments include: *"What are the charges?* 7. Types of charges- (1) A statement as to which of the following types of charges are or may be payable to the issuer or a promoter, or an associated person of the issuer or promoter, or (if there is a scheme) the scheme, by a subscriber (whether directly or indirectly, including by deduction): (a) Entry charges: (b) Trustee, administration, or management charges: (c) Expenses or overhead charges: (d) Charges or expenses relating to goods or services that the subscriber is required to obtain: (e) Early termination charges: (f) Switching or sale charges (including the difference between any buying and selling prices for the securities): (g) Alteration charges: (h) Other charges. (2) A statement as to which of the types of charges specified in subclause (1) are or may be payable by the issuer or, if there is a scheme, from the scheme to a promoter or administration manager or investment manager or an associated person of the issuer or the promoter or the administration manager or the investment manager, being charges that will or may affect the amount of the returns to subscribers. (3) A brief description of any practices of the issuer or any associated person in relation to charges that will or may affect the amount of the returns to subscribers. (4) A brief description of the rights of the issuer or any other person to alter any of the charges applicable to the securities. 8. Amount of charges- (1) If a charge, or the minimum or maximum amount of a charge, referred to in clause 7(1) can, at the date of the investment statement, be expressed as a dollar amount (or as a percentage of another dollar amount), a statement of the dollar amount (or of the percentage and a description of the other dollar amount). (2) If a charge, or the minimum or maximum amount of a charge, referred to in clause 7(1) cannot, at the date of the investment statement, be expressed as a dollar amount (or as a percentage of another dollar amount), a statement describing how the charge will be calculated and what procedure is available to the subscriber to ascertain the amount at the time of, and following, the subscription." *"What returns will I get?* 9. Returns- (1) The following information about the returns to subscribers from the securities: (a) A brief description of the nature of the returns: (b) A brief description of the key factors that determine the returns: (c) A statement whether or not an amount of returns, quantifiable as at the date of the investment statement and enforceable by subscribers, has been promised and, if so, the amount or a description of how that amount can be calculated: (d) A statement as to which of the following (if any) will or is likely to affect the returns (in addition to any of the charges referred to in clause 7): (i) Taxes or duties: (ii) Reserves or retentions. (2) The dates on which, or frequency with which, the returns from the securities will be due and paid or, if there are no such dates or frequency or the dates or frequency are unknown, a statement to that effect. (3) If payment of all or any of the returns from the securities will or may be withheld until a particular date or for a particular period, a statement to that effect and a brief description of the circumstances that may produce this result. (4) The name of the person legally liable to pay the returns." *"What are my risks?* 11. Risks- (1) A brief description of the principal risks of- (a) The money paid by a subscriber not being recovered in full by the subscriber: (b) A subscriber not receiving the returns referred to in clause 9: (c) A subscriber being required to pay more money in respect of a security than that disclosed in clause 5 or clause 12. (2) If it is reasonably foreseeable that, on termination of any security at any time, a subscriber will have received, in total, less than the amount paid to the issuer or an associated person for the security, a statement to this effect and a brief description of the circumstances that may produce this result. 12. Consequences of insolvency- (1) A statement whether or not subscribers will or may be liable to pay money to any person as a result of the insolvency of the issuer (or, if there is a scheme, the scheme) and, if so, a brief description of the liability. (2) A brief description of any claims on the assets of the issuer (or, if there is a scheme, the scheme) that will or may rank ahead of claims of subscribers in the event of the issuer or scheme being put into liquidation or wound up. (3) A brief description of any claims on the assets of the issuer (or, if there is a scheme, the scheme) that will or may rank equally with the claims of subscribers in the event of the issuer or scheme being put into liquidation or wound up." 3.8 The emphasis of the investment statement is on clarity and brevity. Although the statutory prescription does not include financial information, the intention of the investment statement is to identify the key factors relating to (among other matters) the returns, risks and charges associated with the investment. 3.9 For Securities Act purposes, the investment statement is also an "advertisement". As such (Regulation 15) the investment statement cannot include prospective financial information unless that information is also included in the prospectus for the securities. 3.10 Since all commercial property investments rely on prospective financial information to support stated "returns" the prospective financial information included in the investment statement must also be stated in the prospectus. The prospectus 3.11 The securities offered in commercial property investments usually comprise equity and debt securities. As such, the prospectus is usually required to comply with the First and Second Schedules of the Regulations. 3.12 Some of the provisions of these Schedules of particular relevance are: First Schedule: "1. Main terms of offer- (1) The name of the issuer, and address of its registered office (or, if it does not have a registered office, its address) in New Zealand. (2) A brief description of the securities being offered. (3) The maximum number or amount, and nominal value (if any), of the securities being offered. (4) The price or other consideration to be paid or provided for the securities being offered." "9 Prospects and forecasts- (1) A statement as to the trading prospects of the issuing group, together with any material information that may be relevant thereto. (2) The statement required by subclause (1) of this clause shall include a description of all special trade factors and risks that- (a) Are not mentioned elsewhere in the registered prospectus; and (b) Are not likely to be known or anticipated by the general public; and (c) Could materially affect the prospects of the issuing group. (3) Where the purpose of the offer of securities is expressed to be to provide finance for a particular capital project,- (a) A brief description of the project; and (b) An indication of the expected financial benefits of the project." "10. Provisions relating to initial flotations- (1) In the case of the first offer to the public of equity securities of the issuer,- (a) A brief description of the plans that the directors of the issuer, and the directors of any other member of the issuing group, have in respect of the issuing group during the year commencing on the specified date, including the sources of finance that will be required for the plans; and (b) A statement as to whether or not the proceeds of the offer of securities may, notwithstanding the stated directors' plans, be applied towards any undertaking that the issuer may lawfully engage in (including, in the case of an issuer that is a company, any one or more of the objects specified in the company's memorandum of association or constitution, as the case may be,); and (c) A prospective statement of cash flows of the issuing group which the directors of the issuer expect to occur in the year commencing on the specified date. (2) The prospective statement of cash flows required by subclause (1)(c) of this clause- (a) Shall show the likely receipt and proposed use of the proceeds of the offer of securities; and (b) Shall state the principal assumptions on which it is based. (3) Nothing in subclause (2) of this clause limits the information to be included in the prospective statement of cash flows required by subclause (1)(c) of this clause. (4) For the purposes of section 37(2) of the Act, the minimum amount that, in the opinion of the directors, must be raised by the issue of the securities in order to provide the sums (or, if any part thereof is to be defrayed in any other manner, the balance of the sums) required to be provided in respect of each of the following matters: (a) The purchase price of any property purchased or to be purchased which is to be defrayed in whole or in part out of the proceeds of the offer: (b) Any preliminary expenses payable by the issuer, and any commission so payable to any person in consideration of his agreeing to subscribe for, or of his procuring or agreeing to procure subscriptions for, any of the securities: (c) Working capital: (d) The repayment of any money borrowed by the issuer in respect of any of the foregoing matters." "16. Promoters' interests- (1) The full name of every promoter of the securities being offered. (2) Where any material transaction has been entered into at any time in the 5 years preceding the specified date, or is to be entered into on or after the specified date,- (a) Between the issuer or any of its subsidiaries and any promoter of the issuer, or of any subsidiary of the issuer; or (b) Between the issuer or any of its subsidiaries and (where a promoter of the issuer is a body)- (i) Any body corporate related to that promoter; or (ii) Any director or proposed director of that promoter or of any body corporate related to that promoter; or (c) Between the issuer or any of its subsidiaries and any immediate relative of- (i) Any promoter of the issuer or of any subsidiary of the issuer; or (ii) Where a promoter of the issuer is a body whether corporate or unincorporate, any director or proposed director of that promoter or of any body corporate related to that promoter; or (d) Between the issuer or any of its subsidiaries and any company more than half of whose share capital was or will be held directly or indirectly, at the date of the transaction, by- (i) Any promoter of the issuer or of any subsidiary of the issuer; or (ii) Where a promoter of the issuer is a body whether corporate or unincorporate, any director or proposed director of that promoter or of any body corporate related to that promoter- the following information: (e) A description of the property acquired, or to be acquired, under the transaction; and (f) The cost of the property acquired, or to be acquired, under the transaction to the person by whom it has been or is to be acquired; and (g) A brief description of the other terms of the acquisition of the property; and (h) The cost of the property to the person disposing of the property under the transaction; and (i) The date on which the person disposing of the property under the transaction acquired the property." "21. Other terms of offer and securities- All terms of the offer, and all terms of the securities being offered, not elsewhere set out in the registered prospectus, other than those- (a) Implied by law; or (b) Set out in a document that- (i) Is registered with a public official; and (ii) Is available for public inspection; and (ii) Is referred to in the registered prospectus." "40. Other material matters- Particulars of any material matters relating to the offer of securities (other than matters elsewhere set out in the registered prospectus or in the financial statements referred to in the registered prospectus pursuant to clause 22(2), and contracts entered into in the ordinary course of business of a member of the issuing group)." 3.13 The First Schedule includes a detailed prescription of the contents of the financial statements that are to be contained in, or that accompany, a prospectus for equity securities. 3.14 The Second Schedule includes similar requirements to the First Schedule but does not require disclosure of "prospects and forecasts" relating to the issuer or of any prospective financial information in a prospectus for debt securities. 3.15 In general terms, the expectation of the prospectus is that it will be a comprehensive and detailed document including financial information which only the more expert or knowledgeable investor may be able to fully appreciate. Advertisements 3.16 The Act and Regulations contain a number of provisions relating to advertisements for securities. While there are a number of constraints and prohibitions relating to advertisements the overriding principle is contained in Regulation 8 which states: "No advertisement shall contain any information, sound, image, or other matter that is likely to deceive, mislead, or confuse with regard to any particular that is material to the offer of securities contained or referred to in the advertisement." 3.17 Commercial property investments are frequently complex. The "returns" provided to investors have a number of elements and any promised, forecast or projected returns are heavily dependent on the assumptions made. There is thus considerable potential for advertisements relating to such investments to be misleading or confusing unless considerable care is taken with the information included in those advertisements. Returns 3.18 Regulation 2 of the Securities Regulations 1983 states: ""returns" in relation to a security, includes payments of any kind, whether in the nature of capital, income, benefits, or otherwise." 3.19 Although the definition describes what is included in returns, it does not prescribe how a "rate of return" should be calculated. Nor is it an exclusive definition. 3.20 There are particular difficulties in describing "returns" on stapled securities. These are made up of two different types of securities, debt and equity, with "returns" for each being in a different form (interest/principal repayment and dividends/capital growth) and expected to be paid out in different periods. In addition, distributions may include not only payments of "income-type" returns (interest, dividends) but also regular repayments of principal as well. 4. SURVEY RESULTS AND OUR COMMENT 4.1 We have identified matters for comment in each of the following areas: returns; assumptions; risks: and charges. Returns 4.2 Our review of offer documents shows that "returns" and "rates of return" are disclosed in a variety of ways by issuers. We note that they are sometimes disclosed in more than one way in a set of offer documents. We do not suggest a "best" method of disclosing returns. That is a matter for individual promoters to decide. However, where returns are disclosed, we would like promoters to take into account our comments in this report. 4.3 In this section, we discuss the following returns-related information: (a) return type A - interest rate on the bonds; (b) return type B - "combined" rate of return on bonds and shares; (c) return type C - dollar value of cash distributions; (d) return type D - interest on the bonds plus principal repayments; (e) return type E - interest on the bonds plus change in net tangible assets; (f) return type F - internal rate of return of the project; (g) return type G - rental yield from the properties; (h) alternative returns-related terminology; (i) qualifications to the returns. Return type A - Interest rate on the bonds 4.4 The interest payable on the bonds that is forecast, projected or promised is usually expressed as an interest rate per annum on the investment in the bonds. Usually, it is expressed as the only return for the investment as dividends are not provided for. All offer documents that we reviewed stated a percentage rate of interest payable on the bonds. 4.5 In general, most promoters consider it important that the interest rate payable on the bonds should be disclosed: they believe it allows investors in cash return investments to compare the rate of return on the amount invested in the bonds with the rate of return from alternative investments; they believe it is an appropriate benchmark for comparison as promoters have tended to emphasize this as a key feature and have marketed their investments on this basis; often, they assert, the key purpose of commercial property investments is to provide regular income and this reflects the main purpose of the investment; they believe the term "return" here better aligns with the concept of a distribution or interest payment rather than "change in asset value"; they believe cash distributions are what investors expect to physically receive. 4.6 We think that this information is useful as the interest payable on the bonds represents the rate of return on the debt component of the stapled investment. We think that it is information generally expected by the investor. However, as the security is a stapled security, we think that it is not sufficient to provide this information to investors without also providing information about the returns (if any) on the equity component of the stapled investment. Return type B - Combined rate of return on bonds and shares 4.7 In addition to the rate of interest payable on the bonds, issuers generally also state a "combined" rate of return based on the interest payable on the bonds calculated as a percentage of the total investment in bonds and shares. It is this combined rate that is usually highlighted in the offer documents as the return on the commercial property investment. The combined rate will be lower than the rate of interest on the bonds as returns are seldom, if ever, payable on the shares. 4.8 Most promoters tend to consider the combined rate of return on the total investment to be the most appropriate rate of return to disclose to investors. The reasons put forward are that: the investments tend to be promoted as cash return investments and, as such, investors are interested in the amount of cash that they will receive as a percentage of their total investment; investors tend to view returns from a total investment perspective and, as such, to relate to a combined rate that represents a return based on their total investment; property is a long-term investment and, over the term of the investment, the initial losses resulting from the write off of preliminary expenses should be recouped through increases in the value of the property. 4.9 Reason (c) is usually used to justify the use of a combined rate that does not take into account the expected performance of the issuer in the initial forecast period. Issuers usually incur operating deficits in the initial forecast period, the result of the immediate write-off of preliminary expenses. 4.10 In nearly all cases reviewed, issuers explicitly state that they do not take into account the net deficits of the issuer in calculating the combined return. Most issuers, in quoting a combined rate incorporating the interest payable on the bonds, state that the rate does not allow for any profit or loss accruing to shareholders through the trading operations of the company or any increase or decrease in the value of the properties or any preliminary or issue costs. This appears to be a standard feature in most of the offer documents, in the nature of a disclaimer. 4.11 The calculation of the combined rate is relatively straightforward and is used in a consistent manner by issuers. Our impression is that promoters assume this combined rate is generally accepted and understood by investors in these types of securities. 4.12 However, we think that where the combined rate of return which purports to show an overall return on the total investment is disclosed, the issuer should also disclose specific information about the amount of deficits that the issuer expects to incur in the forecast period. 4.13 While most issuers assume no increases or decreases in property values during the forecast periods, the effect of the immediate write off of preliminary expenses, which in most cases is unavoidable, will be that the issuer will show deficits in the initial forecast periods. If these deficits are taken into account, as some respondents suggest should be done, then the overall rate of return on the investment in the initial forecast period is likely to be lower than the combined rate and could well be negative (as illustrated in para 2.7). 4.14 We think that it may be misleading to highlight the combined rate of return on the investment in that initial forecast period without also giving information in an equally prominent manner to any deficits that the issuer expects to incur. Return type C - Dollar value of cash distributions 4.15 Some commercial property investments describe the returns in terms of the cash payments to be made to investors over a set period. There is no "rate" of return quoted. Frequently, these cash amounts comprise an interest component and a repayment of principal component. 4.16 Stapled securities tend to be promoted as cash return investments. However, few issuers show the dollar value of cash distributions (preferring to emphasise rates of return). One promoter shows the dollar value of cash distributions by way of an illustration of the returns that will be received from the investment with a description of how the "combined" returns are calculated. Another shows a schedule of cash distributions from the securities, showing the amount of interest and amount of principal repayments that are to be made by the issuer for the forecast periods. 4.17 Some respondents consider that investors are interested in the dollar amount of cash distributions, that is, the amount of cash that will be credited to their bank account from each distribution. They consider the amount of cash distribution to be useful as many investors rely on regular cash flows from the investment. They consider that sufficient information should be provided to identify the elements making up the dollar amount of cash distributions. 4.18 However, most respondents consider that the dollar amount of cash distributions should not be disclosed (as the primary indication of returns to investors). The reasons for this include: it does not immediately link the distribution to the amount invested, investors will have to determine the amount of their own distributions if the amount they have invested is different from the base; it does not allow comparisons with other investments; it is not the standard method of disclosing returns; it would require investors to determine the percentage rate of return. 4.19 One respondent considers that investors should be informed of the returns on the bonds (interest distribution) as well as total returns, including any principal repayments and returns on the shares. 4.20 We think that whether or not the dollar value of cash distributions is disclosed should be up to the individual promoter. However, there is considerable scope for confusing investors because of the mixing of "income" payments and principal repayments. For this reason, we think where cash distributions are disclosed they should clearly differentiate between interest returns, principal repayments and returns on the shares. In addition, the sum of these "mixed" cash distributions is not a proper basis for expressing a rate of return to investors and should not be used for this purpose. 4.21 We have ignored the influence of taxation in this report, both on the performance of the issuer and in relation to the payment of returns to investors. However, we note that some commercial property investments that pay "returns" on the bonds which are part interest and part principal repayment describe the principal component as "tax free" and then proceed to "gross up" the component to a "pre-tax" level, even though no tax is payable. Incorporating the principal repayment at a "pre-tax" level in calculating returns gives the appearance of a higher rate of return. 4.22 One consequence of making regular principal repayments is that as the debt component of the investment is progressively being repaid, the proportion of the investor's equity stake in the issuer increases. At the maturity of the investment, the investor's claims on the company will have changed from being substantially a debt security holder to that of an equity claimant. For this reason, the change in value of the issuer is a key factor determining the returns, particularly long-term returns, to investors. Return type D - Interest on the bonds plus change in net tangible assets 4.23 The writing off of preliminary expenses invariably means that issuers show an operating deficit in their first forecast reporting period. If the deficits incurred by the issuer, which are usually not highlighted in offer documents, are taken into account, the returns on the total investment will be lower and may even be negative (see para 2.7). In addition, the net tangible asset per share at the end of the first forecast period is usually less than the $1 issue price for the shares. 4.24 Some respondents consider that the rate of return disclosed in offer documents should take into account the performance of the issuer. They consider this can affect the calculation of the stated returns. It can also affect the issuer's ability to maintain interest payments on the bonds. It can provide investors with a more realistic expectation of the rate of return and the viability of the investment more generally. It can make investors aware of the potential for variation in future cash flows and information that actual returns are dependent on the financial performance of the issuer. The information will also show how preliminary expenses are expected to be recovered over time. 4.25 Only in one instance did a promoter show detailed forecast financial statistics in its prospectus which reflected the financial performance of the issuer. The information was shown notwithstanding that most of the statistics reflected negative figures. 4.26 Most promoters, however, do not disclose a rate of return taking into account the financial performance of the issuer. It is argued that the information may be misleading unless there is also disclosure about the long-term nature of the investment. It is thought that the initial negative impact of up-front costs on net tangible asset may inappropriately focus an investor's attention on short-term effects when in fact investors are committed to a long-term investment. It is said that focusing on such a return distorts the true nature of the investment. It is said that it will mislead investors, deter them from investing and lead them to forgo the expected benefits from investing in property. 4.27 One respondent considers that if there was a requirement to disclose this rate it may lead promoters to use other methods or adopt different assumptions to calculate rates of return. Another considers that, while the financial performance of the issuer affects the underlying value of an investor's contribution, it only becomes a "return" if the investment is wound up and gains/losses realised. The promoter considers that this issue is better dealt with under "risks" rather than by complicating the issue of "returns". 4.28 This argument assumes that "returns" in the Regulations (see para 3.18 earlier) comprise only "payments". As pointed out earlier (see para 3.19), the Regulation 2 definition of "returns" is not exclusive and does not define the meaning of the term. 4.29 We think the Regulations clearly envisage that the investor may receive several types of returns on a single investment. These could comprise returns of interest, an earning concept, returns of principal, a capital concept, and returns of services, a benefit concept. 4.30 The main argument put forward for not disclosing a rate of return taking into account the performance of the issuer seems to be that promoters are reluctant to direct attention to the performance of the issuer in the initial periods. This is notwithstanding that issuers are free to explain the reasons for the short-term deficits. 4.31 Promoters tend to argue that the investment should be considered as medium to long-term and that to disclose a rate of return taking into account the initial loss-making position of the issuer is potentially misleading. Whatever merit this argument has, it is our impression that promoters for the most part adopt the apparently inconsistent practice of focusing on the short-term cash returns of the investment, excluding information about the medium to long-term nature of the investment. This is worrying. OFFERS OF UNLISTED INTERESTS IN COMMERCIAL PROPERTIES - A REVIEW 4.32 We think that the expected financial performance of the issuer is a key factor in determining the rate of return to investors in commercial property investments. We think that equal prominence should be given to such information, whether or not the loss-making position of the company is taken into account in calculating the return. 4.33 Related to the concept of an overall return to investors, a majority of respondents consider that the issuer's anticipated net tangible asset backing per unit of securities should be disclosed. It is considered that preliminary and acquisition expenses have an effect on net tangible assets in the absence of capital growth and/or accumulation of retained surpluses and that this should be disclosed. Others, in supporting the disclosure, consider that it is important information, especially in cases where initial losses will reduce the net tangible asset for each share. The information is considered necessary to enable a potential investor to make an informed assessment of the investment. 4.34 Clause 8(5) of the First Schedule and clause 6(5) of the Third Schedule to the Regulations require the net tangible asset of the securities to be stated assuming that the securities have been allotted. However, this applies only where the actual previous financial statements of the issuer are included in the prospectus. There is no requirement to disclose this information where the issuer has no previous trading record. Notwithstanding this, we think that prospective net tangible asset information would be useful to investors in commercial property investments, particularly as a means of balancing any information that is disclosed about the combined rate of return. Return type E - Internal rate of return of the project 4.35 A limited number of issuers show internal rates of return (IRR) in addition to the interest rate of return on the bonds and the combined return on the shares and bonds. Where disclosed, the IRR and its principal assumptions are usually stated in the prospectus rather than in the investment statement. 4.36 An IRR is calculated by determining the discount rate that equates total discounted cash inflows with total discounted cash outflows for a project. On the basis of our review we note that IRR is usually shown for ten years. This is unrelated to the stated maximum period of the investment period of 20 years or to the forecast "return on total investment" often stated for only one or two years. 4.37 It seems that little comparison can be made between the IRR and the interest rate of return on the bonds or the combined rate of return as the bases of calculation are different and the periods covered are different. The differences are not highlighted in the offer documents and issuers seem to assume that investors understand the concept of an IRR. 4.38 Some respondents consider that it is useful to disclose an IRR for the total expected period of the investment. This enables investors to assess the impact which up-front costs, unrealised movements in property values and retained earnings have on cash return over the life of the investment. It is considered by these respondents that the disclosure of the IRR and the cash return rate allows investors to compare returns offered not only with other property investments but also with, say, fixed interest rate alternatives. It is considered that the commercial property investments are, by nature, medium to long-term and the effects of the passage of time are fundamental to understanding real returns. 4.39 One promoter considers it desirable to disclose IRR forecast, projected or promised at the end of each prospective financial period, that is, assuming realisation of the investments at those dates. Another considers that as property funds are marketed as long-term, IRR should be calculated over the lesser of the expected period of investment or the first 10 years of its life. 4.40 However, while it was considered by some that an IRR may provide the best measure for comparing the investment performance of different schemes as the calculation takes into account the timing and amount of all cash flows, it is rare within the industry to disclose IRR. The reasons put forward are: most investors would not understand the method or technique used to derive IRR; assumptions are difficult to make and authenticate - as the investments do not have a fixed life span, it may be difficult to make assumptions about the terminal value of assets at the beginning of the investment; assumptions have a significant effect on the calculation of IRR and most investors and their advisors, even if provided with a full set of assumptions, would find the calculation confusing and may be misled about the return they could expect from the investment; as actual IRR cannot be determined until the investment is terminated, it may be difficult to make performance comparisons during the term of investment and there is likely to be significant variation between actual and projected IRR. 4.41 We think an IRR is useful as a means of showing the overall return of a particular project, particularly over the maximum period of the investment rather than for some other arbitrary time period. We think that where an IRR is disclosed, the rate and its basis of calculation must be clearly identified and differentiated from other types of returns to investors. Assumptions used should be clearly stated, in particular, the period, the significant cash flows and the terminal value of the investment. Return type F - Rental yield from the properties 4.42 One issuer states a rental yield from the properties under offer. This yield was unrelated to the interest rate payable on the bonds or other distributions that were payable. 4.43 In the particular offer, the rental yield of over 12% per annum was prominently stated in its advertisement. This included a statement that the yield was calculated on the purchase price of the properties and that the yield on investment properties was different from the forecast pre-tax return on investment moneys. Investors were referred to the investment statement for further details. The advertisement used the rental yield as a headline rate. There was no other reference to the interest to be paid on the debenture, repayment of capital or other promised dividend returns. 4.44 The investment statement showed the interest rate payable on the debentures at under 5% per annum calculated on the balance of the principal outstanding with the principal being returned over 183 instalments. 4.45 One respondent considers that it is "unacceptable" for rental yields to be used in an advertisement. If the rental yield is advertised without the rate of return to investors also being clearly disclosed, our respondent considered investors may be misled into thinking that the rental yield is the return payable to investors. 4.46 Rental yields can provide investors with useful information about the properties under offer. They are a factor in determining returns to investors. However, the manner in which the rental yield is disclosed is important as it has the potential to mislead investors, particularly where the rate of return to investors is not clearly stated. 4.47 We think that, where disclosed, rental yields should be clearly identified and differentiated from the returns to investors. In addition, we think it is inappropriate to use rental yields as headline rates, given that it is not a generally accepted practice in such offers to express and highlight such yields. Where disclosed, we consider that rental yields should be accompanied by the disclosure of returns to investors. Alternative returns-related terminology 4.48 Apart from the different types of stated returns, issuers also sometimes use different terminology to describe the returns to investors. 4.49 There is unanimous agreement from respondents that there should be guidance on the terminology used in offer documents to describe and explain forecast, projected or promised returns. It is considered that guidance would contribute to consistency and would benefit investors when comparing alternative offerings. Others consider it helpful if industry standards are established, as this will help all parties involved in the industry - promoters, issuers, investors, their advisers and monitoring agencies. One respondent considers that all technical terminology should be explained or defined in offer documents (perhaps by including a glossary of terms). 4.50 Some terms that are commonly used by promoters are "cash distribution", "per annum cash return", "interest rate", "per annum interest return", "per annum forecast return", "income return", "projected revenue returns", "yield", "forecast yield", "pre-tax equivalent yield" and "forecast per annum yield". 4.51 We endorse the industry's concerns. However, we do not prescribe the terminology that promoters should use in describing returns because schemes may differ in structure. Even so, we think that the use of certain words, particularly "yield", "income return", "revenue return" and "earn", to describe a combined return which relates to only one component of the stapled security, the debt component, may be confusing. If used, such words should be explained. We think that it is up to promoters to ensure that whatever terms are used, they are properly applied in the context and are understandable. 4.52 The term "projection" is also sometimes used interchangeably with the term "forecast", notwithstanding that in the prospectus (and sometimes in the investment statement) forecasts, not projections, are set out. In one instance, while the prospective financial information in the prospectus was labeled a "projection", the assumptions used were best estimate assumptions and the prospective financial information would have better been referred to as a "forecast". 4.53 A forecast is prepared based on best estimate assumptions about future events associated with actions that management expects to take. A projection is prepared based on one or more hypothetical but realistic "what-if" assumptions that reflect possible courses of action. Prospective financial information prepared as a forecast may be significantly different from prospective financial information prepared as a projection. 4.54 Some respondents argue that the legal, financial reporting and disclosure requirements in advertisements, investment statements and prospectuses are too technical and precise. This is seen to undermine the purpose of disclosure as investors struggle to understand what is presented. It is considered that more emphasis should be given to plain language disclosure even if this decreases technical accuracy. 4.55 While many promoters are reluctant to use technical language, it appears that the language currently used in offer documents is also unclear. We think that the appropriate use of technical language is useful where the terminology is already established and generally understood. There is a danger that it will be more difficult, in cases of doubt, to determine what a promoter or issuer intended to state where alternative words are used in place of generally accepted technical terms. 4.56 It should also be noted that the Financial Reporting Standards Board of the Institute of Chartered Accountants has, on issue, FRS-29 "Prospective Financial Information". The FRS sets out guidance for the preparation and presentation of prospective financial information. The guidance and terminology used is generally accepted and understood and serves as a common basis for preparing, presenting and understanding the information. 4.57 We think that confusion arises where offer documents do not comply with the Standard. We think that the guidance in FRS-29 is sufficient and should be applied in respect of all prospective financial information that is included in offer documents. We do not think that it is useful to further prescribe terminology or guidance for the preparation of prospective financial information. Instead, we think that promoters should exercise greater care in choosing words to describe returns and ensuring that these are used consistently throughout the offer documents. 4.58 Where prospective financial information is included in a prospectus, the law requires the prospectus to contain a report on the information by the issuer's auditors. We think the onus is on issuers and promoters and their auditors to ensure that all prospective financial information included in offer documents, including the terminology where appropriate, complies with FRS-29. Qualifications to the stated returns 4.59 Most offer documents include a qualification relating to the stated combined rate of return to the effect that the returns are based on the interest payment on the mortgage bonds only and do not take into account the deficits and surpluses of the issuer. However, some issuers do not include such qualifications, especially where the rates are used as headline rates on the covers of offer documents and in advertisements. 4.60 It is not always obvious from a stated rate of return whether it has been promised, forecast or projected. Sometimes, while the interest on the bonds may have been stated to be "promised" for the first forecast period by some issuers, the use of words like "intends to pay" and "based on the forecast" makes it unclear if the return will be paid if, for instance, one of the forecast assumptions was not met. In other cases, interest rates on the bonds are stated to be "forecast" rates. Yet, the wording in relation to the return in parts of the offer documents uses words like "will be paid". We find such inconsistencies to be potentially confusing. 4.61 We have already recorded (see para 3.7) that clause 9(1)(c) of Schedule 3D requires an investment statement to include a statement of whether an amount of returns, quantifiable as at the date of the investment statement and enforceable by the subscriber, has been promised and, if so, the amount or a description of how the amount can be calculated. 4.62 Issuers should ensure that there is a clear statement in the investment statement whether or not there are returns that have been promised which is in accordance with clause 9(1)(c). Issuers should also ensure that the wording in other parts of the offer documents clearly and consistently reflects the nature of the returns as stated under clause 9(1)(c). 4.63 We think that, where returns are stated, it should be immediately clear to an investor from looking at the stated returns whether they are promised, forecast or projected returns. 4.64 It is also not immediately obvious from some offer documents that any promised returns are for a limited time period only, usually for the first forecast period, and not for the length of the investment period. This is unsatisfactory. 4.65 The period for which the returns are payable is considered by respondents to be information useful to investors in making an informed investment decision. It is considered that this information should accompany any returns that are disclosed in an offer document. One respondent considers this information an absolute necessity. We agree. 4.66 One respondent thinks that there may be a danger in associating returns with time periods as investors may wrongly assume that their investments would mature on the stated dates and see the investments as substitutes for fixed term investments. We disagree. We think that there is a greater danger, given that property investments are normally associated with being medium to long-term, if forecast periods are not stated. This may imply that the stated returns apply to the term of the investment. 4.67 We think that all rates but, in particular, headline rates should be appropriately and clearly qualified. The qualifications should, as a minimum, state: what the rate relates to (interest rate of return on the bonds, dividend rate etc); whether the rate is promised, forecast or projected; the period for which the rate applies; and where the major assumptions on which the rate is calculated can be found in the offer documents. Assumptions 4.68 Most offer documents for interests in commercial property investments include some information about future returns derived from forecast or projected financial information about the issuer or the scheme that is included in the prospectus. The Prospectus 4.69 As previously noted (see para 3.12) a prospectus for a first issue of equity securities is required to include a prospective statement of cash flows for the issuing group for the first year after the prospectus is issued. In addition, an advertisement (including an investment statement) cannot include prospective financial information unless that information is also included in the prospectus (Regulation 15). When prospective financial information is included in a prospectus the principal assumptions on which the forecast is based must be stated in the prospectus (Regulation 5(4)). 4.70 We found, in most offer documents, including both prospectuses and investment statements, that the major assumptions used in calculating disclosed returns were not always clear or comprehensive, notwithstanding that the law and FRS-29 both require the disclosure of major assumptions underlying prospective financial information. 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.

4.32	We think that the expected financial performance of the issuer is a key factor in determining the rate of return to investors in commercial property investments. We think that equal prominence should be given to such information, whether or not the loss-making position of the company is taken into account in calculating the return.
4.33	Related to the concept of an overall return to investors, a majority of respondents consider that the issuer's anticipated net tangible asset backing per unit of securities should be disclosed. It is considered that preliminary and acquisition expenses have an effect on net tangible assets in the absence of capital growth and/or accumulation of retained surpluses and that this should be disclosed. Others, in supporting the disclosure, consider that it is important information, especially in cases where initial losses will reduce the net tangible asset for each share. The information is considered necessary to enable a potential investor to make an informed assessment of the investment.
4.34	Clause 8(5) of the First Schedule and clause 6(5) of the Third Schedule to the Regulations require the net tangible asset of the securities to be stated assuming that the securities have been allotted. However, this applies only where the actual previous financial statements of the issuer are included in the prospectus. There is no requirement to disclose this information where the issuer has no previous trading record. Notwithstanding this, we think that prospective net tangible asset information would be useful to investors in commercial property investments, particularly as a means of balancing any information that is disclosed about the combined rate of return.
Return type E - Internal rate of return of the project
4.35	A limited number of issuers show internal rates of return (IRR) in addition to the interest rate of return on the bonds and the combined return on the shares and bonds. Where disclosed, the IRR and its principal assumptions are usually stated in the prospectus rather than in the investment statement.
4.36	An IRR is calculated by determining the discount rate that equates total discounted cash inflows with total discounted cash outflows for a project. On the basis of our review we note that IRR is usually shown for ten years. This is unrelated to the stated maximum period of the investment period of 20 years or to the forecast "return on total investment" often stated for only one or two years.
4.37	It seems that little comparison can be made between the IRR and the interest rate of return on the bonds or the combined rate of return as the bases of calculation are different and the periods covered are different. The differences are not highlighted in the offer documents and issuers seem to assume that investors understand the concept of an IRR.
4.38	Some respondents consider that it is useful to disclose an IRR for the total expected period of the investment. This enables investors to assess the impact which up-front costs, unrealised movements in property values and retained earnings have on cash return over the life of the investment. It is considered by these respondents that the disclosure of the IRR and the cash return rate allows investors to compare returns offered not only with other property investments but also with, say, fixed interest rate alternatives. It is considered that the commercial property investments are, by nature, medium to long-term and the effects of the passage of time are fundamental to understanding real returns.
4.39	One promoter considers it desirable to disclose IRR forecast, projected or promised at the end of each prospective financial period, that is, assuming realisation of the investments at those dates. Another considers that as property funds are marketed as long-term, IRR should be calculated over the lesser of the expected period of investment or the first 10 years of its life.
4.40	However, while it was considered by some that an IRR may provide the best measure for comparing the investment performance of different schemes as the calculation takes into account the timing and amount of all cash flows, it is rare within the industry to disclose IRR. The reasons put forward are: most investors would not understand the method or technique used to derive IRR; assumptions are difficult to make and authenticate - as the investments do not have a fixed life span, it may be difficult to make assumptions about the terminal value of assets at the beginning of the investment; assumptions have a significant effect on the calculation of IRR and most investors and their advisors, even if provided with a full set of assumptions, would find the calculation confusing and may be misled about the return they could expect from the investment; as actual IRR cannot be determined until the investment is terminated, it may be difficult to make performance comparisons during the term of investment and there is likely to be significant variation between actual and projected IRR.
4.41	We think an IRR is useful as a means of showing the overall return of a particular project, particularly over the maximum period of the investment rather than for some other arbitrary time period. We think that where an IRR is disclosed, the rate and its basis of calculation must be clearly identified and differentiated from other types of returns to investors. Assumptions used should be clearly stated, in particular, the period, the significant cash flows and the terminal value of the investment.
Return type F - Rental yield from the properties
4.42	One issuer states a rental yield from the properties under offer. This yield was unrelated to the interest rate payable on the bonds or other distributions that were payable.
4.43	In the particular offer, the rental yield of over 12% per annum was prominently stated in its advertisement. This included a statement that the yield was calculated on the purchase price of the properties and that the yield on investment properties was different from the forecast pre-tax return on investment moneys. Investors were referred to the investment statement for further details. The advertisement used the rental yield as a headline rate. There was no other reference to the interest to be paid on the debenture, repayment of capital or other promised dividend returns.
4.44	The investment statement showed the interest rate payable on the debentures at under 5% per annum calculated on the balance of the principal outstanding with the principal being returned over 183 instalments.
4.45	One respondent considers that it is "unacceptable" for rental yields to be used in an advertisement. If the rental yield is advertised without the rate of return to investors also being clearly disclosed, our respondent considered investors may be misled into thinking that the rental yield is the return payable to investors.
4.46	Rental yields can provide investors with useful information about the properties under offer. They are a factor in determining returns to investors. However, the manner in which the rental yield is disclosed is important as it has the potential to mislead investors, particularly where the rate of return to investors is not clearly stated.
4.47	We think that, where disclosed, rental yields should be clearly identified and differentiated from the returns to investors. In addition, we think it is inappropriate to use rental yields as headline rates, given that it is not a generally accepted practice in such offers to express and highlight such yields. Where disclosed, we consider that rental yields should be accompanied by the disclosure of returns to investors.
Alternative returns-related terminology

4.48	Apart from the different types of stated returns, issuers also sometimes use different terminology to describe the returns to investors.
4.49	There is unanimous agreement from respondents that there should be guidance on the terminology used in offer documents to describe and explain forecast, projected or promised returns. It is considered that guidance would contribute to consistency and would benefit investors when comparing alternative offerings. Others consider it helpful if industry standards are established, as this will help all parties involved in the industry - promoters, issuers, investors, their advisers and monitoring agencies. One respondent considers that all technical terminology should be explained or defined in offer documents (perhaps by including a glossary of terms).
4.50	Some terms that are commonly used by promoters are "cash distribution", "per annum cash return", "interest rate", "per annum interest return", "per annum forecast return", "income return", "projected revenue returns", "yield", "forecast yield", "pre-tax equivalent yield" and "forecast per annum yield".
4.51	We endorse the industry's concerns. However, we do not prescribe the terminology that promoters should use in describing returns because schemes may differ in structure. Even so, we think that the use of certain words, particularly "yield", "income return", "revenue return" and "earn", to describe a combined return which relates to only one component of the stapled security, the debt component, may be confusing. If used, such words should be explained. We think that it is up to promoters to ensure that whatever terms are used, they are properly applied in the context and are understandable.
4.52	The term "projection" is also sometimes used interchangeably with the term "forecast", notwithstanding that in the prospectus (and sometimes in the investment statement) forecasts, not projections, are set out. In one instance, while the prospective financial information in the prospectus was labeled a "projection", the assumptions used were best estimate assumptions and the prospective financial information would have better been referred to as a "forecast".
4.53	A forecast is prepared based on best estimate assumptions about future events associated with actions that management expects to take. A projection is prepared based on one or more hypothetical but realistic "what-if" assumptions that reflect possible courses of action. Prospective financial information prepared as a forecast may be significantly different from prospective financial information prepared as a projection.
4.54	Some respondents argue that the legal, financial reporting and disclosure requirements in advertisements, investment statements and prospectuses are too technical and precise. This is seen to undermine the purpose of disclosure as investors struggle to understand what is presented. It is considered that more emphasis should be given to plain language disclosure even if this decreases technical accuracy.
4.55	While many promoters are reluctant to use technical language, it appears that the language currently used in offer documents is also unclear. We think that the appropriate use of technical language is useful where the terminology is already established and generally understood. There is a danger that it will be more difficult, in cases of doubt, to determine what a promoter or issuer intended to state where alternative words are used in place of generally accepted technical terms.
4.56	It should also be noted that the Financial Reporting Standards Board of the Institute of Chartered Accountants has, on issue, FRS-29 "Prospective Financial Information". The FRS sets out guidance for the preparation and presentation of prospective financial information. The guidance and terminology used is generally accepted and understood and serves as a common basis for preparing, presenting and understanding the information.
4.57	We think that confusion arises where offer documents do not comply with the Standard. We think that the guidance in FRS-29 is sufficient and should be applied in respect of all prospective financial information that is included in offer documents. We do not think that it is useful to further prescribe terminology or guidance for the preparation of prospective financial information. Instead, we think that promoters should exercise greater care in choosing words to describe returns and ensuring that these are used consistently throughout the offer documents.
4.58	Where prospective financial information is included in a prospectus, the law requires the prospectus to contain a report on the information by the issuer's auditors. We think the onus is on issuers and promoters and their auditors to ensure that all prospective financial information included in offer documents, including the terminology where appropriate, complies with FRS-29.
Qualifications to the stated returns
4.59	Most offer documents include a qualification relating to the stated combined rate of return to the effect that the returns are based on the interest payment on the mortgage bonds only and do not take into account the deficits and surpluses of the issuer. However, some issuers do not include such qualifications, especially where the rates are used as headline rates on the covers of offer documents and in advertisements.
4.60	It is not always obvious from a stated rate of return whether it has been promised, forecast or projected. Sometimes, while the interest on the bonds may have been stated to be "promised" for the first forecast period by some issuers, the use of words like "intends to pay" and "based on the forecast" makes it unclear if the return will be paid if, for instance, one of the forecast assumptions was not met. In other cases, interest rates on the bonds are stated to be "forecast" rates. Yet, the wording in relation to the return in parts of the offer documents uses words like "will be paid". We find such inconsistencies to be potentially confusing.
4.61	We have already recorded (see para 3.7) that clause 9(1)(c) of Schedule 3D requires an investment statement to include a statement of whether an amount of returns, quantifiable as at the date of the investment statement and enforceable by the subscriber, has been promised and, if so, the amount or a description of how the amount can be calculated.
4.62	Issuers should ensure that there is a clear statement in the investment statement whether or not there are returns that have been promised which is in accordance with clause 9(1)(c). Issuers should also ensure that the wording in other parts of the offer documents clearly and consistently reflects the nature of the returns as stated under clause 9(1)(c).
4.63	We think that, where returns are stated, it should be immediately clear to an investor from looking at the stated returns whether they are promised, forecast or projected returns.
4.64	It is also not immediately obvious from some offer documents that any promised returns are for a limited time period only, usually for the first forecast period, and not for the length of the investment period. This is unsatisfactory.
4.65	The period for which the returns are payable is considered by respondents to be information useful to investors in making an informed investment decision. It is considered that this information should accompany any returns that are disclosed in an offer document. One respondent considers this information an absolute necessity. We agree.
4.66	One respondent thinks that there may be a danger in associating returns with time periods as investors may wrongly assume that their investments would mature on the stated dates and see the investments as substitutes for fixed term investments. We disagree. We think that there is a greater danger, given that property investments are normally associated with being medium to long-term, if forecast periods are not stated. This may imply that the stated returns apply to the term of the investment.
4.67	We think that all rates but, in particular, headline rates should be appropriately and clearly qualified. The qualifications should, as a minimum, state: what the rate relates to (interest rate of return on the bonds, dividend rate etc); whether the rate is promised, forecast or projected; the period for which the rate applies; and where the major assumptions on which the rate is calculated can be found in the offer documents. Assumptions
4.68	Most offer documents for interests in commercial property investments include some information about future returns derived from forecast or projected financial information about the issuer or the scheme that is included in the prospectus. The Prospectus
4.69	As previously noted (see para 3.12) a prospectus for a first issue of equity securities is required to include a prospective statement of cash flows for the issuing group for the first year after the prospectus is issued. In addition, an advertisement (including an investment statement) cannot include prospective financial information unless that information is also included in the prospectus (Regulation 15). When prospective financial information is included in a prospectus the principal assumptions on which the forecast is based must be stated in the prospectus (Regulation 5(4)).
4.70	We found, in most offer documents, including both prospectuses and investment statements, that the major assumptions used in calculating disclosed returns were not always clear or comprehensive, notwithstanding that the law and FRS-29 both require the disclosure of major assumptions underlying prospective financial information.

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.

APPENDIX 1 REVIEW OF DISCLOSURES IN OFFER DOCUMENTS OF INTERESTS IN COMMERCIAL PROPERTY - QUESTIONS ON POSSIBLE RATES OF RETURN AND RELATED INFORMATION

We are conducting a review into the disclosures made in offer documents intended for the general public by promoters/issuers of interests in commercial property. In the course of this review, we are taking a particular interest in the manner in which forecast/projected/promised returns, assumptions and related information are derived and are expressed in the offer documents. We hope to issue a discussion paper on the subject and offer guidelines to the industry.

We have written to a number of promoters and other individuals posing the following questions. We would welcome your responses to the questions, in each case stating the reason(s) for your response.

We would welcome any other comment or general observation you may wish to make to us about industry practice in relation to forecast/projected/promised returns and related information that you think would be helpful in addressing the issues at hand.

5.1	The preceding discussion sets out the Commission's comments from our review of the offer documents of selected promoters of interests in commercial property.
5.2	We think that the law relating to offer documents is adequate for offers of interests in commercial property. The problems lie, we think, with the way the law is being applied in practice.
5.3	In our view promoters should exercise more care in applying the law. In particular, there should be clear, comprehensive, consistent and balanced disclosure of: the bases and qualifications related to the stated rates of return; the major assumptions underlying prospective financial information; and the risks associated with the investment.
5.4	While disclosures in the prospectus should be comprehensive, we believe the investment statement may also need to contain some detail because of the complex nature of the securities under offer.
5.5	We do not suggest a single best method for disclosing returns in offer documents. That is a matter for individual promoters to decide. However, we believe a key factor in any description of a property investment is the balance struck between risks and returns to investors for the period of the investment.
5.6	It is worrying that some promoters of commercial property investments: tend to highlight the combined rate of return on the investment in the initial forecast period without also giving equal prominence to any deficits that the issuer expects to incur in the period; tend, while contending that the investment should be considered a medium to long-term investment, to focus on the short-term cash returns of the investment, excluding information about the medium to long-term nature of the investment; use unclear and inconsistent language in offer documents, particularly in relation to returns and prospective financial information; do not always make it clear from a stated rate of return whether it has been promised, forecast or projected; do not always make it clear that the stated rate of return relates to a limited period of time and not to the whole investment period; do not always clearly state the qualifications relating to a stated rate of return; do not always state all material assumptions underlying the prospective financial information in a clear and comprehensive manner or indicate where they can be found in the offer documents; and tend to highlight the positive aspects of the investment without giving equal prominence to the risks associated with the investment.
5.7	It is up to the individual promoter to decide the manner in which risks and returns are disclosed in an offer document. However, whenever prospective rates of return are disclosed, the offer document should also contain information about the expected financial performance of the issuer, the method of calculation, material assumptions and qualifications. These should be clearly stated.
5.8	Promoters should ensure that the wording of offer documents is clear and consistent when describing the risks and the returns. All rates, but in particular headline rates, should be appropriately and clearly qualified. The qualifications should, as a minimum, state: what the rate relates to (interest rate of return on the bonds, dividend rate etc); whether the rate is promised, forecast or projected; the period for which the rate applies; and where the major assumptions on which the rate is calculated can be found in the offer documents.
5.9	We do not think that it is necessary to further prescribe terminology or guidance for the preparation of prospective financial information. We think that the guidance in FRS-29 is sufficient and should be applied in respect of all prospective financial information that is included in offer documents. Promoters should exercise greater care in choosing the words that are used to describe returns and to ensure that these are used consistently throughout the offer documents. We think that the appropriate use of technical language in offer documents is useful where the terminology is already established and generally understood.
5.10	We think 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 exclusion of other, usually negative aspects. Where factors are not taken into account in the prospective financial information, we think that they should be clearly included as part of the risks associated with the investment.
5.11	Promoters should ensure the offer documents are not likely, as a whole, to deceive, mislead or confuse the prospective investor.
5.12	The Commission encourages promoters to give serious consideration to the comments set out in this paper in drawing up future offer documents.
5.13	nvestment in the commercial property sector through "genetically modified" corporate structures has grown rapidly in recent years. It is important that promoters follow high standards of disclosure in offering investment opportunities to the public. On the evidence so far there is considerable room for improvement.
5.14	The funding of the Commission has been increased in the present financial year. We expect to be able to allocate greater resources to the surveillance of investment market activity. We expect the Commission to be much more active than in the past in drawing attention to offer documents which it considers are likely to deceive, mislead or confuse investors, and in taking action in appropriate cases.

New Zealand Securities Commission

Offers of unlisted interests in commercial properties - a review [2000] NZSecCom 2 (30 March 2000)