Property investment strategies suitable for Super
Creative ways to get existing property into Super
by Anthony J Cordato
Note: This article has been published as Chapter 6 in Russell Medcraft’s new best seller book SUPER RICH or How to create a tax-free income for life
This article deals with
1. The advantages of property as a super investment
2. Property as a tax shelter outside and inside a self-managed super fund
3. Acquisition of property by a self-managed super fund – some creative strategies
4. Selecting suitable property for a self-managed super fund
The comments in this article are applicable to self-managed super funds.
[b]The advantages of property as a super investment[b]
Property people
Some people are property people, some people are shares people and some people are term deposit (cash) people.
Property people are people who love to invest in property, over and above owning their own home. Their joy is investment property.
Property people usually invest directly, buying in their name or in the name of a company or a trust. Some property people invest indirectly, in property syndicates or Property Trusts, to invest in commercial property. In this article we examine the advantages of property investment through a super fund.
Four reasons why property people are passionate about property
Reason 1 – Low risk
My mother favours property as an investment ‘because you can see the bricks and mortar when you drive past it’. To her, the fact that property is visible and solid is very comforting.
The risk of physical damage is low. The risk of damage to the improvements upon the property can be minimised by taking out building insurance and the risk of injury by public risk insurance.
There are financial risks. The main financial risk is rental security. Rental security is increased by proper tenancy selection processes. Residential tenancies are low risk. Housing is a basic human requirement. The low rental yields available for residential property reflect the low risk of vacancy. Factory, office and retail tenancies are a little more risky, in terms of vacancy, being aligned to the economic ‘health’ of the business sector. Longer term leases provide greater rental security. Businesses will commit to long term leases (often 3 or 5 years), while residential tenants commit to short leases (usually 6 or 12 months). Compare a commercial lease where a tenant is legally liable to pay 5 years rent of $300 per week to a residential lease where a tenant is liable to pay 1 years rent of $300 per week – total gross rent receivable of $78,000 (plus CPI increases) versus $15,600.
Title risk is practically zero in Australia. Land titles in Australia are guaranteed by the State Governments which maintain land title registries for the registration of interests in property. The title guarantee is that the registered owner is the true owner, and has full control and entitlements in the property, in terms of renting it out, mortgaging and sale.
Reason 2 – Property is a hedge against inflation
Inflation favours real assets such as property because the value of real assets rises with inflation. My mother likes to say that ‘if you put $100 into the bank, in five years time, you will still have $100, with a little interest. If you put that $100 into property, that $100 will always be worth more with inflation, and what is more, the rents will keep up with the cost of living’.
Taking the Reserve Bank of Australia’s inflation target range of 2 – 3%, then property values and rents will rise in value annually at an average of 2.5% pa simply on account of inflation. In fact, CPI inflation (headline inflation) rose 2.4% pa in 2003, rose 2.6% pa in 2004, rose 2.8% pa in 2005 and rose almost 4% pa in 2006.
Inflation detracts from the value of financial assets such as bonds/interest bearing accounts, which reduce in value according to the inflation rate. The interest received on cash investments must be viewed net of inflation. That is, if the interest is 5.5% pa, and inflation is 2.5% pa, then the ‘real return’ is 3% pa.
Inflation is only one factor underpinning increases in property values. To name a few others: wage increases, increased cost of building, reducing interest rates, easy availability of finance, rent increases, ‘booming local economies’.
As a rule of thumb, property prices double every eight to ten years. According to the Reserve Bank of Australia, ‘average capital city house prices have grown by around 175% since the mid 1990’s; prices outside the capital cities have risen by a broadly similar magnitude’ (Statement on Monetary Policy – February 2007).
This is not a smooth process for either property prices or rents. Prices and rents can remain flat in some periods, and rise strongly during other periods.
The Reserve Bank has noted that during that period since the mid 1990’s rental growth has lagged – rents have increased by only 35% to 60%. The Reserve Bank goes on to note that as a result of low investment in new property because of low yields, the national vacancy rate is low and rents will grow.
In periods such as the 1970s and 1980s, a 10% pa inflation rate underpinned unusually high increases in property prices and rents. In the 30 year period 1977 to 2007, a 1000% property price increase was experienced in many parts of Australia, half of which was due to high inflation. A propey purchased in 1977 for $42,000 would be worth $420,000 today in most places.
But what effect does inflation have on loans? Assuming the house was purchased in 1977 with a loan of $34,000, and $34,000 was still outstanding in 2007 because it has become a home equity loan, the loan has effectively shrunk, because a dollar in 1977 is worth about 10 cents today.
Is another burst of inflation around the corner? Property people will be waiting!
Reason 3 – Low price volatility
Property is stable investment in terms of price. Property does not undergo price fluctuations daily, weekly or monthly, as shares do.
Property prices can rise quickly – in a boom market, a rise of 20% in prices in a 3 month period, and 50% over a two year period, is often experienced. Property prices fall slowly - in a bust market, a fall of 20% in prices can be experienced over a 2 year period. The fall is often cushioned by inflation.
Having said that, property is a long term investment, because over time, the transaction costs are amortised, and because a full boom and bust cycle is recommended to gain full benefit.
For these reasons, it is often considered that 7 plus years is a minimum term for holding property.
Reason 4 – A favourable tax environment
Property investment has a favourable tax environment.
Reasons why tax laws advantage property
Regardless of whether a property is purchased in a personal name, in a company, a trust or a super fund, tax laws advantage property investment in these ways:
Sale of the property – capital gains
-
Property tax is deferred
until sale:
The tax on the capital gain in a property is not payable annually; as it would be if the gain were subject to income tax (which is payable on income earned annually). Tax on capital gains is paid only when the property is sold. The liability to pay tax on capital gains can therefore be deferred for many years simply by holding on to the property. As the old saying goes ‘tax deferred is tax saved’.
The low volatility of property values makes a holding strategy for capital gain a sustainable strategy.
Illustration: A property is purchased for $100,000. It is sold 8 years later for $195,000. Capital gains tax is payable on $80,000 (i.e. $95,000 gain less $15,000 expenses). The tax is $18,000 (at 22.5 cents in the $1). For the 8 years the property was held, the $18,000 that would be payable as tax on sale has been retained and used to generate income – at 5% pa the income on the ‘tax’ would be $900 pa.
-
Concessional tax rate for
capital gains:
If the property is owned for 12 months, and if the property is purchased in the name of an individual (or the individual receives a benefit from the sale under a discretionary trust), then one half of the capital gain (net of expenses) is added on to the taxpayer’s taxable income. Therefore, if when the gain is added to the individual’s income it brings the taxpayer into the top tax rate of 45 cents in the dollar, because only one half the gain is brought to tax, the effective tax rate payable will be one half, that is, 22.5 cents in the dollar.
The one half discount applies for individuals and trusts. No discount applies for companies. A one third discount on the super tax rate of 15c in the dollar applies for complying superannuation funds making the tax rate for capital gains in a super fund where the property has been held for 12 months 10c in the dollar.
-
The Family Home:
No capital gains tax is payable on the sale of the family home (the ‘main residence’), so long as the family home is purchased in the personal name of an occupier of the home and the occupier lives there. The proceeds of sale of the family home may be tax free in some circumstances after the owner leaves, for example, if disposed of within 2 years of date of death, if the property was purchased before 20 September 1985 or if a marriage breakdown rollover applies. Otherwise, tax is payable based on the increase above the market value of the property at the date the owner left.
Comment: Some commentators have suggested that homeowners should pay tax on what their homes would rent for, had they not been owner-occupied. Needless to say, such suggestions of a tax on ‘imputed rentals’ have fallen on deaf ears politically.
Rental of investment property - deductions
- Rent is taxable income. Taxable income is the net amount of the rent, which is to say, the rent after deductible expenses and depreciation, not on the gross rent received.
- The expenses that are deductible include loan interest, repairs and maintenance, council rates, water rates, strata levies, insurance, real estate management fees, gardening and rubbish removal. The most controversial of these expenses (in terms of tax deduction) is the loan interest expense, which is examined below. Also examined is the depreciation deduction, which is commonly touted in the sale of new property.
Property as a tax shelter
outside and inside a
self-managed Super Fund
Property (real estate) is many
things to many people. It
satisfies the basic human need
of providing shelter. After all,
“we all have to live somewhere”.
But property serves not only as
a physical shelter, property
serves also as a first class tax
shelter!
Gearing as a wealth creation
strategy
Gearing is a shorthand term for
borrowing against a property.
Super funds are not permitted to
gear (borrow money). But super
funds can invest in some
property trusts, where the
trustee gears the property
investment. It is therefore
important to understand the way
that gearing works.
It is generally accepted that
borrowing is advantageous for
the purchase of a property,
where the aim is to build
wealth, as opposed to generating
income.
The fact that interest paid on
the borrowings will absorb some
or all of the rent or even
exceed the rent, and the fact
that the property may need to be
‘subsidised’ using other income
is not important, because there
is surplus income available from
other sources, and the gearing
multiplies the gain. This
strategy is very attractive for
wealth creation in a person’s
high income years of 30 to 50,
and in a super fund which is in
the asset accumulation phase. It
is attractive because it
leverages the capital gain.
Illustration: The following
illustration demonstrates how
gearing of 80% of the price will
magnify the capital gain on cash
invested compared with no
gearing at all.
Assumptions
- Price Property purchase
price $300,000
Add 5% acquisition costs $15,000
$315,000 - Funding Loan of 80% of
purchase price $240,000
Cash outlay – funds invested $75,000
$315,000 - Value of the property increases at the rate of 8% pa., which is the percentage calculated by BIS Shrapnel as the rate by which property prices increase in the long term.
- The property is cash flow neutral – no ongoing cash outlay is required.
After 5 years of 8% pa increases, the value of the property (compounded) has grown to $440,800. After deducting acquisition costs of $15,000, the net increase in value is $125,800 ($440,800 - $300,000 - $15,000).
This increase represents a 167.7% return on funds invested over a five year period (i.e. $125,800 ÷ $75,000).
Contrast the return on funds invested without gearing. The return would be 39.7% over the same five year period (i.e. $125,800 ÷ $315,000).
Negative gearing as a tax shelter
If the interest expense, when taken together with the other expenses exceeds the rent, then there is a net negative cash flow / loss on that property. The loss is known as ‘negative gearing’. The tax laws permit this loss to be applied against a taxpayer’s income from other sources, which reduces the taxpayer’s taxable income, reducing tax payable.
The negative gearing coupled with the depreciation deduction is the tax shelter.
Unfortunately, negative gearing cannot be utilised by super funds because super funds cannot borrow. Super funds must purchase for cash.
Comment: Some commentators suggest that the losses from negative gearing be confined to the property, and be available only to offset future rents or capital gains on the property. This suggestion was implemented unsuccessfully between 1985 and 1987, when it was abandoned because investors refused to invest in rental property during that time, as a consequence of which investment in property fell and property rentals rose.
Negative gearing is the ‘carrot’ for the sale of many off the plan properties to investors. In other cases, investors will borrow a high ratio of the purchase price, to purchase a higher priced property or to conserve cash.
The high attraction of negative gearing as a tax shelter must be counterbalanced by its deficiencies from an investment perspective.
From an investment perspective, negative gearing is a ‘bet’ that the value of the property will increase by more than the money outlaid to pay for the cash flow loss. If that is not the case, as is quite possible where property is purchased and sold in less than 5 years, then the negative gearing will result in an investment loss, even though the property may have increased in value, because the money outlaid (after tax savings) during the five years has exceeded the increase in value f the property.
Although high gearing will conserve cash outlaid when purchasing, over time, the cash outlaid with negative gearing will fetter a person’s ability to build cash reserves for the purchase of more investment property, and their ability to borrow further.
The recommended strategy is therefore to be cash flow neutral, or better still, cash flow positive, where the rental exceeds the interest payments and other property outgoings.
Where an existing property generates a cash flow loss, the use of vendor finance techniques may turn the property into being cash flow positive.
The building and fittings depreciation deduction
For all investment properties, tax can be reduced without a cash outlay by investing in newer properties to take advantage of the depreciation. A relatively new property can provide $5,000 a year in depreciation benefits as tax deductions, without spending a dollar!
Building depreciation and fittings and fixtures depreciation under the Income Tax Act provide a non-cash tax benefit in that these form part of the purchase cost, yet are deductible annually over many years as an ‘expense’. With a depreciation deduction, a property can be cash flow neutral but still generate a tax loss!
Every part of a building will need repair or replacement in the long term. The fact that the Income Tax Act allows depreciation to be deducted against income annually provides a useful reference of how long an item can be expected to last before it will need to be substantially repaired or replaced.
Building depreciation (applicable to buildings built after 1970), continues for 40 years. Fittings and fixtures depreciation continues for shorter periods. Depreciation is expressed as a percentage to be applied annually against the cost price. Where the cost price is not known, a building estimator can determine it. The following percentages are based on the prime cost method, where the same percentage is applied against the original cost each year, until the item is fully depreciated down to zero.
Illustration: Building depreciation 2.5% pa
Bathroom fittings 5% pa
Kitchen cook tops, ovens 10% pa
Carpets, linoleum, vinyl 10% pa
Dishwasher, range hood 12% pa
hot water system 12% pa
Refer: http://www.ato.gov.au / Legal database / TR 2006/15
Super funds are able to use building depreciation and fittings and fixtures depreciation as a tax deduction, in the same way as individuals, companies and trusts are able to use it.
Note that on sale, any building depreciation claimed is deducted from the cost base before capital gains tax is calculated.
Superannuation as a tax shelter
Superannuation is the latest tax shelter for property. It is attractive for both wealth accumulation and for maximising income during a person’s retirement years from their 60’s, during the pension phase of the super fund.
-
Concessional tax rates and
capital gains tax discount:
Rental income and capital gains in a super fund are sheltered from full rates of taxation. Income in a super fund is taxed at a concessional rate of tax, 15 cents in the dollar, rather than the individual’s marginal tax rate, which could be as high as 45 cents in the dollar (+ 1.5 cents Medicare levy). Capital gains in a super fund are taxed at 10 cents in the dollar, if the property is owned for more than 12 months (if less than 12 months, the rate is 15 cents in the dollar), as against a possible tax rate of 22.5 cents in the dollar for the individual and 30 cents in the dollar for a company.
-
Property tax deferral
applies:
Super funds are not taxed annually on the increases in value of their assets. Therefore an increase in a property’s value will not be taxable until the property is sold.
-
Property expenses and
depreciation apply:
The normal property deductions are available, being for expenses such as repairs and maintenance, council rates, water rates, strata levies, insurance, real estate management fees, gardening and rubbish removal. Building and fittings depreciation also applies to be offset against rental income. There is no interest deduction, as there are no loans.
-
Super funds cannot include
the family home as an asset:
The family home should not be purchased in or transferred to a super fund. As the law stands at present, the transfer of the family home to the super fund or the purchase of a residence for a beneficiary of a super fund is not permitted. If a property ceases to be a family home, and is rented as an investment property, it may be able to be transferred. But rarely are stand-alone residences suitable for property investment property, on account of repairs and maintenance and high rates and taxes (see below).
Acquisition of property by a
Self-Managed Super Fund = Some
creative Strategies
Property is a ‘lumpy’ asset, in
terms of the fact that it is a
high value item, and the super
fund may not have sufficient
cash reserves to fund the
purchase the property.
If an individual, company or
trust has insufficient cash to
purchase a property, they will
borrow the balance required.
Super funds cannot borrow.
There are a number of creative
strategies that can be used for
a super fund to acquire a
property without breaching the
superannuation laws which
prohibit borrowing by a super
fund.
But first, it is useful to note
that there is both a ‘purpose’
requirement and a funding
requirement to be satisfied for
the acquisition of property,
namely:
- The acquisition of the property must be for the sole purpose of paying benefits to members of the fund when they retire or meet the prescribed age or die. A super fund cannot for example acquire a holiday apartment for use by members of the fund before retirement. Refer www.ato.gov.au / Superannuation Professionals / Fact Sheets
- The acquisition of the property is to be funded entirely from the resources of the superannuation fund, usually cash resources. This is a legal requirement. A super fund cannot borrow funds to acquire a property, or having acquired it, borrow against the property.
In this section, the focus is
upon creative strategies to
overcome the funding requirement
in acquiring a property.
Acquiring a property with no
external finance
Acquiring a property with no
external finance (no borrowings)
is a strategy employed for
property acquired to derive
income for a super fund to
during the pension phase.
If an individual does not wish
to borrow, they choose a partner
to buy the property with. Super
funds can do likewise – by
investing with others jointly in
a property.
These strategies can be used for
property purchases with no
external finance.
[list]* Tenants in common
purchase:
A property may be purchased in
two or more names jointly. Joint
purchases may take two forms.
- Joint tenants When the family home is purchased, the relationship between the two spouses or partners is designated as ‘joint tenants’. This designation means that on the death of one of them, their interest passes automatically to the other, regardless of the provisions of a will.
- Tenants in common When an investment property is purchased, the relationship between the two investors is designated as ‘tenants in common’. This designation means that their interest remains separate, unaffected by death, of if they are corporate, unaffected by liquidation. Also, when purchasing as tenants in common, it is possible to specify unequal shares, so that for example, one purchaser may acquire a one-third share and a co-purchaser a two-thirds share.
A property may be purchased
by a super fund, as tenants in
common with an individual,
company or trust. Each makes a
cash contribution to purchase
their share in the property.
Illustration: A property is
purchased for $300,000. The
super fund contributes $100,000
towards the price, while the
individual or their entity
contributes $200,000. The
individual uses their own funds,
which may for instance be drawn
from a home equity loan on their
family home. The ownership of
the property is designated as:
the super fund as a tenant in
common as to a one-third share
and the individual/entity as a
tenant in common as to a
two-thirds share.
The property purchased cannot be
mortgaged or used as security
for a loan. This applies both to
the share of the super fund and
the share of the individual.
* Units held in a unit trust:
A property can be purchased in
the name of a company as the
trustee of a unit trust. The
super fund can invest in the
property through the purchase of
units in the unit trust. The
units in a unit trust give an
entitlement to a fixed share of
the profits and assets of the
trust.
The investment by the super fund
in the property is indirect,
that is, the super fund pays for
an allotment and issue of the
units in the trust, and the
trust in turn purchases and owns
the property.
If the property purchased in the
unit trust is not geared, then
it is perfectly acceptable for a
super fund to make this kind of
investment.
Illustration: A company (as
trustee of a unit trust)
proposes to purchase a property
for $300,000. The super fund
pays the company $100,000 and is
allotted and issued 10 units in
the trust. The individual pays
the company $200,000 and is
allotted and issued 20 units in
the trust. The property is
purchased using these funds. The
super fund and the individual by
virtue of their unit holdings
indirectly own the property in
the proportions of one-third to
two-thirds. The property
purchased is not mortgaged or
used as security for a loan.
These comments apply equally to
investment in shares in a
company for the purchase of
property. Refer ATO
Superannuation Circular No.
2003/Draft for further comments.
Acquiring a property with
external finance
If the super fund is in ‘wealth
accumulation mode’, which is to
say, is building assets for
payment of retirement benefits
at a future time, the super fund
will often be looking for a
gearing strategy to leverage the
capital gain.
Because of the prohibition upon
borrowing, super funds can only
make a geared investment
indirectly, where they do not
exercise control over the
investment and where the lender
has no recourse against the
assets of the super fund.
These strategies can be used for
property purchases with external
finance.
[list]*
Unit
holders in a geared unit trust
created up to 1998:
Investments made by a super fund
up to 1998 in a geared unit
trust are ‘grandfathered’.
Up until around 1998, the
commonly accepted means of
purchasing a property for a
super fund, with gearing, was
for the fund to set up a unit
trust, with a corporate trustee,
and invest in the unit trust by
taking an allotment and issue of
units. As the super fund
received cash contributions, the
super fund would pay the cash
into the trust and be issued
more units. The trustee of the
fund would then use the cash to
pay down the loan.
Illustration: A property is
to be purchased for $300,000 in
the name of a unit trust. The
super fund subscribes $100,000
and is allotted 10 units with
entitlements to income. The unit
trust borrows the balance price
of $200,000 and the acquisition
costs of $15,000. The property
is cash flow neutral. After a
year, contributions have flowed
into the super fund, so that it
has $20,000 to outlay for the
issue of another unit. The funds
are paid into the trust and
$20,000 of the debt is retired.
The super fund now has 11 units.
And so it goes on until the debt
is retired and the super fund
holds 30 units.
* Unit
holders in a geared unit trust
created since 1998:
Since 1998, the super fund can
make the investment in a unit
trust used for the purchase of a
geared property only if it meets
the (lack of) control test.
The ‘control test’, as applied
by the Australian Tax Office
(the ‘ATO”),, is that the
beneficiaries of the super fund
cannot also control the unit
trust which owns a geared
property. And so, the unit trust
must be at arms length.
The control test is satisfied
for investment in a publicly
listed unit. , The control test
is significant when the unit
trust is private. The definition
of ‘control’ for these purposes
is technical, and its
examination is outside the scope
of this article, suffice to say
that the beneficiaries of the
super fund should not constitute
50% or more of the directors of
the trustee company and the
super fund should not hold 50%
or more of the units in the unit
trust.
This restriction will exclude a
super fund from investing
through a unit trust which is
related, in a geared property. A
trustee of a super fund is
therefore restricted to
investment in publicly listed
property trusts and private
property trusts over which it
has no control.
* A
participant in a property
syndicate:
Property syndicates are property
partnerships created for the
purchase of particular property.
Instead of the property purchase
being made in the name of the
syndicate members, the purchase
is made in the name of a nominee
company.
Even though the nominee company
finances the purchase of the
property with external finance,
and the guarantees of the
syndicate members are not
required by the financier, the
sole recourse for the financier
being against the property.
Provided that the super fund
satisfies the ‘control test’ as
defined above, it can
participate in the property
syndicate.
Acquiring the property with
vendor finance - transfers
between related parties
Vendor finance, in terms of the
vendor permitting the purchaser
to pay the purchase price of the
property over time, is thought
of as ‘finance’ in the broad
sense of the word, but does not
necessarily constitute a loan.
If interest is not payable, then
it is merely the payment of the
price by agreed instalments.
It is therefore available as a
technique to transfer property,
particularly between related
parties.
Illustration: A property is
sold for $300,000. Assume that
the vendor agrees that the price
is be paid over 5 years, by 60
monthly instalments of $5,000
each. The instalments do not
carry interest, because the
vendor is selling the property
at a premium of $60,000, with
the current market value
$240,000. The premium of $60,000
could be viewed as capitalised
interest. It is equally feasible
not to add in a premium, so long
as the sale price is at market
value.
By this means, a super fund
could purchase a property,
subject to a market valuation to
support the price. Provided that
the instalments add up to the
price and no interest is
charged, then a transfer by this
means appears not to breach the
prohibition on borrowings by a
super fund. Refer www.ato.gov.au
/ Superannuation Circular 2003/1
– valuation of assets, for
comments on market valuations.
Restriction on in-house
transfers
There are restrictions in super
funds purchasing from related
parties. Section 66(1) of the
Superannuation Industry
(Supervision) Act 1993
prohibits regulated
superannuation funds from
intentionally acquiring assets
from related parties of the
fund, with some exceptions, one
of which is business real
property. The prohibition
extends to leasing properties
owned by a super fund to related
parties, unless it is business
real property.
Residential property will
generally not satisfy the
business use exception – renting
out one or two residential
properties is not considered the
carrying on of a business, but
renting out a number of
properties may be.
Refer further
ATO
Superannuation Circular No.
2003/Draft for comment –
business real property at
http://www.ato.gov.au /
Superannuation Circular No.
2003/ Draft.
Some
aspects of terms finance
The form of vendor finance
described is a sale by
instalments, which is also known
as terms finance. In sales by
instalments, the title to the
property is not transferred
until completion, that is, until
the final instalment is paid.
The documentation is a Contract
for the sale of land. The
Contract specifies that the
price is payable by instalments.
Because there is no transfer of
tile until the price is paid in
full, there is no mortgage or
external finance required by the
purchaser. On the other hand,
the vendor can retain their
existing mortgage over the
property until the final
instalment is paid and the title
to the property is to be
transferred.
The vendor, if it is a related
party, should obtain appropriate
tax advice to defer payment of
capital gains tax until the
price instalments are received.
Refer: www.ato.gov.au /Legal
database / ID 2004/407.
The vendor may allow the
purchaser to take the benefit of
possession, on the entry of the
Contract. If the property is
rented out, this would mean that
the super fund would be entitled
to the rentals and could apply
rentals from the property
towards payment of the price
instalments.
Further illustration: In
the illustration above the
monthly instalments were $5,000.
If the property rents for $2,000
per month, then the rent plus
cash contributed to the fund of
$3,000 per month could fund the
instalment payments.
Transfers of property into a
super fund are fully liable for
Transfer Duty (Stamp Duty)
calculated on the value of the
property transferred.
In South Australia, legislation
applies to limit the number of
instalments to 4. In Queensland,
legislation applies to require
the title of the property to be
transferred once one third of
the price has been paid. The
other states have no such
limitations.
Suitable property for a Super
Fund
The property must be suitable
for the super fund to acquire as
an investment. This is a
subjective, rather than a legal
requirement.
The property must be suitable in
terms of a high capital growth
or rental return, and have low
outgoings and maintenance, so
that it can provide the capital
gain or the income stream
desired.
The following are criteria for
suitability:
[list]*
Maximising income – land
content:
When considering whether a
property is suitable for
purchase in a super fund, the
emphasis should be upon
maximising income, rather than
maximising capital gains.
Is there a rule of thumb
criterion that could be applied?
Yes. The simple rule of thumb is
land content.
Income will be maximised when
the land content is low relative
to the value of the
improvements, while income will
be minimised when the land
content is high and the value of
the improvements is low.
Examples of low land content
relative to improvements include
home units, villas, terrace
houses, shops and offices.
Examples of high land content
include detached houses, vacant
land and hobby farms.
Illustration: Assume that a
two bedroom dwelling will rent
for $250 per week, and a two
bedroom unit for $220 per week,
next door to each other.
For the two bedroom house, the
value of the house improvements
might be $200,000 and the land
value might be $150,000, being a
total of $350,000. The gross
rental return will be 3.7% (i.e.
$250 x 52 = $13,000 ÷ $350,000).
For the two bedroom home unit,
the value of the unit
improvements might be $175,000
and the land value might be
$75,000. The gross rental return
will be 4.6% (i.e. $220 x 52 =
$11,440 ÷ $250,000).
The differential in net rental
returns will be greater in that
outgoings such as council rates
and water rates, and repairs and
maintenance will be higher for a
two bedroom house, than a two
bedroom unit, because they are
based on land value.
*
Maximising income – more than
one rental source:
It may be possible to derive
more than one rental from a
property, by separately renting
out parts. The classic example
is a shop, with a residence
upstairs. Each is separately
rented. Perhaps there is a
garage at the rear which is also
separately rented. Another
example is a split level house,
where the flat underneath is
separately rented. My personal
favourite is to build a
studio/garage, which consists of
a garage underneath, and a
studio above, which can be
rented out as a whole,
separately from the house /
terrace at the street front of
the land.
*
Minimising maintenance - low
maintenance buildings:
Experienced investors will
purchase property which does not
have large or difficult to
maintain exteriors. Investors
will purchase a block of flats,
home units, a row of villas or
terraces where there are common
walls or where it is all ‘under
the same roof’.
My father always pointed out
that if you buy a house you have
four external walls and one
roof; if you buy a block of
flats you have four walls and
one roof; BUT you have 4, 6 or
more rentals from a block of
flats, compared with 1 rental
from a house, and almost the
same external repair
requirements in both.
Experienced investors will
purchase property where the
building, the fit out and the
appliances are in good condition
and where their useful life can
be extended by repair, rather
than by replacement.
Buildings which are built with
low maintenance materials should
be favoured. Examples are:
- Exposed brick is always lower maintenance than painted cement render. Most exposed brick is found externally. Sometimes the exposed brick is internal; where it matters less if it is painted as it is not exposed to the weather.
- Tiled roofs maintain their appearance long after colorbond, or worse still, galvanised iron or alcenite roofs deteriorate. Skylights are more long lasting if they are glass rather than a polymer.
- Aluminium powder coated external windows, door frames and screens require less maintenance than wooden widows and frames in terms of painting.
- Tiled floors in kitchens and dining areas are easier to maintain and last longer than linoleum.
- Wall tiling floor to ceiling in bathrooms takes away the need to repaint walls.
- Polished floorboards are
usually more durable than
carpet, particularly if the
floorboards are polished
professionally or the carpet
is low quality.
-
Minimising maintenance - low
maintenance locations:
Experienced investors will avoid purchasing property in high maintenance locations. They avoid seaside locations where the salt spray and the salt air will accelerate the deterioration of the exteriors – particularly windows. They will also avoid locations near heavy industry or mining where ‘acid rain’ will accelerate the deterioration of roofing and guttering.
-
Low maintenance landscaping:
Tenants do not look after large gardens or properties. They do not mow large areas of lawn, do not keep plants and bushes trimmed, do not keep fences in good repair. At the end of the tenancy, the cost of bringing the grounds up to an acceptable state will often fall upon the landlord, as it is difficult to satisfactorily cover the care and maintenance of the grounds in a lease. The solution is small yards, easy to maintain garden areas, and extensive paved areas, which can easily be cleaned up at the end of the tenancy.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Disclaimer: The information and
advice contained in this article
is: (a) general in nature; (b)
intended to draw attention to
certain items to be discussed
with a professional adviser; (c)
not intended to provide specific
advice; (d) takes no account of
particular facts and
circumstances; and (e) is not to
be relied upon for any purpose.
The author and publisher
disclaim all liability and
responsibility to the fullest
extent available at law.
Liability limited by a scheme
approved under Professional
Standards Legislation
