Question Mark

I must take issue with Shane Oliver’s highly pessimistic outlook for Australia’s residential property market.

In Eureka Report on Monday, in an article headed Housing Takes a Break, the AMP chief economist says activity is likely to remain subdued because residential rental yields are extremely low. The current average rental yield is 3.2% for houses and 4.1% for units, compared with about 6.5% for commercial property and 5% for shares (on the basis of dividend yields).

I agree residential rental yields are low compared to some other asset classes, but I wonder whether the comparison is relevant in the first place.

On the demand side, the commercial property and share markets are driven purely by investors and the desire for income and/or profit.

Demand in the residential property market, on the other hand, is largely driven by home buyers, whose purchasing decisions are based primarily on lifestyle considerations.

According to the Australian Bureau of Statistics (ABS), about 70% of Australian residential property is owner-occupied. Although people are entering home ownership at a later age than in decades past, the 70/30 owner/tenant split has remained virtually unchanged since the early 1960s, reflecting the importance Australians place on having somewhere to call their own.

It’s difficult to see this changing anytime soon; particularly when federal and state governments are actively encouraging home ownership through grants schemes.

Rental yields are irrelevant to 70% of property buyers, so I don’t share Shane’s view that low yields will be a major factor in keeping the property market at bay.

Shane also says “any whiff of a return to boom-time conditions '¦ would most likely be met by the Reserve Bank lifting interest rates”, and, by extension, keeping a lid on any market recovery.

I believe we need to draw a distinction between the market “finding its feet” and going through an outright “boom”. Like many commentators, I believe an outright boom in residential property is some years off. It won’t happen until:

• Investors return to the housing market after the sharemarket peaks; and
• Demand from these investors adds to the existing demand from home buyers, so that both forces are operating in the market at the same time.

In this column two weeks ago (click here) I said that the recent increase in median house values, along with an increase in loan commitments among investors and home buyers, are early signs that the residential market is finding its feet.

I stand by this assertion. The recovery may be slow, but it will also be sustainable '” a pretty good state of affairs in anyone’s book.

BORROWING LIMITS

My partner and I have just purchased a property from people who were very keen to sell. We believe we’ve achieved a good price: we paid $310,000 yet the owner provided a sworn valuation showing the property was worth $350,000 in 2005.

We are looking to borrow as much as we can (95% plus mortgage insurance capitalised up to 97%). However, we will also need to borrow money from my partner’s parents to be able to complete settlement.

As you can imagine, we would prefer not to have to do this. We are also looking at doing some work on the property ourselves, which should add some value. If the lender’s independent valuation comes in for a higher amount than the purchase price, will we be able to borrow more from the lender, and '” fingers crossed '” not have to borrow from my partner’s parents?

If you are borrowing more than 80% of the property’s value, the lender’s mortgage insurer will want to reduce their risk by using the lower figure of the valuation or purchase price.

This means that even if the property’s sworn valuation is $350,000, 80% of this amount is $280,000. You would need to borrow more money from your partner’s parents, which is the opposite of what you want to do.

Some lenders will lend 100–106% of value of a property’s value. However, these loans have very stringent criteria. Interest rates, establishment fees and exit fees also tend to be substantially higher than conventional loans.

I suggest that your best bet would be to bite the bullet and borrow up to 97% of the property’s purchase price, even if this means borrowing from your partner’s parents initially.

You can then undertake the proposed improvements on the property and get it re-valued in several months’ time. If the true value is already about $350,000, these capital improvements should help you borrow enough money to repay your partner’s parents and ensure that you are no longer indebted to them.

GEARING UP

I have a property portfolio worth more than $5 million spread among five unlisted trusts: Cromwell diversified, SAITeysMcMahon diversified, Becton Industrial, PFA Diversified and APN Property for Income Fund.

I have been building up these funds over the past five years after selling out of a residential portfolio accumulated over 17 years. I don’t need any of the income for living expenses, so I reinvest the income to help the funds grow faster. There is no debt and all the trusts have a liquidity option.

How much do you think I need in these holdings (in dollar value terms) to make it worthwhile selling the trusts and investing in property directly? My preference would be commercial property. The reason I’m considering direct property is so that I can use gearing (say 30–40%) to increase the value of my portfolio more quickly.

It sounds to me as if you already have an investment strategy that’s working well for you. My first inclination is to say that “if it ain’t broke, don’t fix it”.

When you sell part or all of your portfolio, you will “crystallize” any profits and as a result be liable for capital gains tax. If your investment strategy wasn’t working for you and you wanted to change tack completely, I wouldn’t have a problem with you incurring CGT liability.

However, in this case, you would simply be going from a well diversified commercial property portfolio into a direct commercial property portfolio. I would prefer to see you stay in a well diversified portfolio that will continue to spread your risk, rather than buy one or two commercial properties directly and concentrate your risk in a small number of assets.

There’s no need to sell your portfolio to take advantage of gearing. You can continue to hold your interests in these funds and use a specialised product such as a margin loan to borrow against the value of your portfolio. This way, you can achieve your objective of growing your portfolio grow more quickly while spreading your risk and minimising your tax bill.

STAMP DUTY

I’m a regular reader of your column and was interested in your recent response to a reader’s question: “Because you and your wife run a DIY super fund, you are both the trustees as well as the beneficiaries. Under Section 36 of Victoria’s Duties Act, transfer of land from a trustee of a superannuation fund to a beneficiary of that trust (where the beneficiary isn’t a trustee of another trust) is exempt from stamp duty.”

Is the reverse also true? Does the same exemption from stamp duty in Victoria apply when:

• A “business real property” is bought outright, at a sworn valuation price, by a DIY super fund from a couple (my wife and I, who are the only beneficiaries of the fund).
• The proceeds are used to pay off the outstanding mortgage.
• The remaining cash is retained outside the fund?

The act does not appear to provide for an exemption in your case. I suggest this is because a trust provides benefits such as asset protection and the ability to distribute income and capital gains. When you transfer an asset into a trust, the taxman considers it a change of “beneficial owners”. This means you will have to pay stamp duty if you transfer an asset from a personal name in to a trust.

Trust law is a very complex area of property investment. I suggest you speak to a property law specialist to review your own position.

VENDOR BIDS

I have a query about the auction process. If there is no opening bid in an auction, the auctioneer has to submit an opening bid to start the process. I believe that NSW law only allows one vendor bid per auction. If the auctioneer has to submit the opening bid, is it counted as a vendor bid?

In NSW, auctioneers are required to do two things in relation to vendor bids. First, they must reserve the right to use a vendor bid during the auction. As they go through the auction preamble, they must say “I, as the auctioneer, reserve the right to make a bid on behalf of the vendor” or words to that effect.

Second, when NSW auctioneers submit a bid on behalf of the vendor, they must clearly announce that they are doing so. Once they’ve submitted this bid, they cannot submit any more for the remainder of the auction.

Agents can be fined as much as $22,000 for contravening the single vendor bid requirement.

Mark Armstrong is Director of Property Planning Australia www.propertyplanning.com.au, an integrated property advisory and mortgage sourcing service. He also writes for Australian Property Investor magazine www.apimagazine.com.au.

You can email any questions regarding property to Mark Armstrong right here, by clicking questionmark@eurekareport.com.au