PORTFOLIO POINT: An innovative combination of property and superannuation might suit investors who are disenchanted with the sharemarket.
This week I was in Canberra when Wayne Swan announced his mini budget. Buried in all the measures was a nasty action that provides a clear signal to many Australian savers; new long-term strategies may be required.
The purpose of my visit was to talk to clients of Dixon Advisory. Another speaker was Chris Duffield, head of Dixon Advisory Property, whose presentation, combined with the mini budget, caused me to consider a strategic course I had not thought about before. Let me share with you my early thinking and I would be interested in your comments because these are new concepts.
What’s more I’m sure many of you have been following the recent debate between property correspondent Monique Wakelin (see Building a case for bricks and mortar) and our investment strategist (and property sceptic) Michael Feller (see Property pales before bond rivals). Both have a strong point of view on the merits or failings of the residential property market but what I will outline today is a tax structure that blends our superannuation system with some of the obvious appeals of long-term property holding.
During my life I was able to pay off my house and then begin seriously saving via superannuation. I was able to defer super savings because the limits were much higher than they are now so I could accumulate large sums later in life (and the sharemarket helped as well!) But step by step that option is being taken away and in the mini budget Swan further tightened the superannuation entitlement squeeze by once again not allowing indexation of the concessional amount.
Accordingly, middle aged and older savers are only allowed to contribute $25,000 to superannuation and gain a tax deduction, partly offset by 15% tax rate. (You can contribute $150,000 a year from tax-paid funds that carry no tax deduction)
That means every year of your working life you have a superannuation entitlement. If you don’t take it up it will never emerge again and that entitlement is falling every year because it is not indexed. That means that today’s younger people are simply not going to be able to accumulate the wealth that people of my vintage were able to achieve through superannuation in later life.
A couple who marry in their 30s and buy a house are immediately saddled with a huge mortgage; paying it off often means having to forgo part of their superannuation contribution entitlements.
So now let me introduce you to a radical strategy.
In decades gone by people have often suggested it was far better to rent a residence than buy, but in my view that strategy has not worked out well. From time to time (usually about every seven to 10 years) there is a surge in the price of residential real estate. Those who are renting simply miss out and are forced to pay much higher rents.
By the time retirement comes they are at a significant disadvantage. But in the past two years the government has allowed superannuation funds to leverage residential real estate – an option that was not available to me.
There are a number of restrictive rules in this plan. The first is that the residential property must be purchased from a third party and rented to a third party. If some way the superannuation beneficiary is linked to the purchase or rent there are nasty penalties. Second, there are also restrictions on what you can do on the property but there are no restrictions on normal maintenance. So, provided the rules are followed, it is possible to borrow up to 80% of the purchase price.
While there are very strict provisions on the property to be purchased, there are few restrictions on what happens when a person reaches the age of 60. For example, there are no restrictions on who buys the property and of course when a person is aged over 60 they can virtually pay the property out as a lump sum (that process will require careful monitoring by a retirement expert because it is not straightforward).
And so we have a fascinating alternative strategy where a couple rents a dwelling for their personal use and pays off their investment property via tax-deductible contribution to superannuation plus rent. They get access to the “superannuation dwelling” when they are 60 and even if that is not the way it works out their asset base is protected if there is a sharp rise in residential values.
This strategy is not for everyone because a lot of people want to own their own home and have the security of a residence. But there are also a large number of people who have become disenchanted by the sharemarket and are seeking a different form of equity investment: one they can see and touch.
There are all sorts of calculations measuring shares versus residential real estate. But in essence, except for very highly priced residential real estate and houses in outer suburbs, there is a great deal of stability in the major capital cities’ residential market, which as I mentioned before, is punctuated by sharp rises every seven to 10 years. However, population must keep rising to maintain this pattern.
Nevertheless, if you are going to go into the residential market via superannuation, then to make the residential sums work well it is best to combine two tax-deductible contributions so as to get a gross contribution after superannuation tax of $42,500. That enables the debt to be paid down relatively quickly. For single-income families, this is the sort of investment that can be undertaken with a friend in a combined self-managed fund that simply owns the dwelling.
Others with large amounts already in their superannuation fund may consider residential real estate as part of their asset allocation.
Of course, the residential real estate options via superannuation must be matched against negative gearing of salary and leaving superannuation to other assets.
Today I have canvassed a number of options but those options are a simply those I have conceived. There will be many other alternatives that Eureka Report readers will develop. But the fact that it is now possible to buy a $400,000 dwelling in a superannuation fund with borrowings of $320,000 and pay off those borrowings over about seven years using tax-deductible contributions from two people (I extracted these sums from the Duffield presentation).
We are currently enjoying a rally of the sharemarket and that rally might go further than the bears expect, but I am very wary. It is unlikely to convert to a full bull market, particularly as globally many people are becoming disenchanted with equities. Today’s commentary is about opening Eureka Report readers’ eyes to residential property as an alternative to shares as an equity investment.