Property – aspiration to fulfilment

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Property is one of the world’s oldest asset classes and has historically been viewed as a principal sign of wealth. In Australia, from the late 19th century into the mid-20th century, property ownership flourished and then the two world war generations, followed by the baby boomers, carried ‘the great Australian dream’ as their pennant in life; a principal financial objective to achieve at all cost, and it remains a significant ambition for many.

Home ownership in Australia has remained stable for close to fifty years according to Australian Bureau of Statistics data. In 1971 it was at 69% and in 2006 it was at 70% clearly indicating that property ownership in the form of a home remains a key objective for the majority.

Compared to home property ownership, approximately 8% of the population have an investment property and for 70% of those it is geared. By comparison, about 34% of the population directly participates in the Australian sharemarket. So in essence twice as many people think it is a good idea to own a property to live in but only a quarter of the number of people who invest in shares think property is a good investment. This seems incongruous unless we consider acquisition costs.

Fractions

The sharemarket is fractionalised investing making it possible to buy portions of companies for very small amounts whereas, until the advent of managed property unit trusts, property had been a very high value, all or nothing, proposition.

One conclusion we can draw is that if property could be bought in the same way as shares – i.e. fractionally – then more people would perhaps be inclined to invest in it. Arguably Australians’ confidence in property is high given the high level of home ownership.

However, as with any investment there are advantages and disadvantages with property;

Advantages

  • Low volatility – property prices do not fluctuate daily
  • Taxation – deductions if negatively leveraged, lower Capital Gains Tax if held for 12 months or beyond
  • Capital growth – if held for a longer term
  • Demand – housing almost always in shortage somewhere
  • Sector influences – e.g. mining can dramatically increase capital value, but may not be a long term proposition
  • Rent increases – provided they are reasonable they can be negotiated annually or at expiration of lease

Disadvantages

  • Valuation – usually annually but difficult to gauge in advance
  • Establishment costs – initial cash deposit, loan applications, legal fees, stamp duty
  • Liquidity – slow to sell, no guarantee, cost to sell can be high
  • Tenancy risk – particularly relevant if geared
  • Ongoing costs – rates, taxes, agent fees, insurance and maintenance
  • Position risk – location, location, location – need to do research, buy on value not on emotion
  • Concentration risk – all or nothing proposition – would you put all your equities allocation to one company?
  • Gearing – increasing interest rates can affect holding and eventual outcome
  • Partial withdrawals not possible

Generations

The baby boomer demographic created enormous wealth in the property market from their own efforts and from subsequent inheritance from the previous, frugal, war generations. Altered tax laws gave baby boomers unprecedented advantages to buy investment property and their gain became the younger generations’ burden. This could lead to falling home ownership as prices push property out of reach for many.

So what will become of generations, X, Y, Z and Generation Alpha (not yet at school) as they strive for property ownership? Gens Y and Z could be significantly carved out of the greatest social wealth creator in history, and Gen Alpha may follow suit if nothing changes.

Recent research from Domaingroup indicates that Gen Y is getting well ahead of previous generations in property ownership and, at a much earlier age. They do not appear to be buying homes but investment properties that are being funded by rent payments, and family help. And many remain living at home with their parents.

Some 16% of Gen Ys own two or more properties compared to 17% of Baby Boomers and Gen Xers.

The average generational ages for purchasing investment property are;

  • Gen Y – 25 years
  • Gen X – 35 years
  • Baby Boomers – 45 years

Superannuation

While the younger generations have the benefit of legislated superannuation to save for retirement, presently it does not help them achieve home ownership.

A future change to superannuation legislation to help with home ownership would;

  • Allow super fund members to use their super accounts to help fund a home purchase
  • Enable super fund members to help their children by investing in a home for them

Because of the potential for abuse there needs to be a suitable structure interposed between the parties that ensures adherence to the rules, if they were changed. This could be achieved by the fractional model where a trustee holds the title, ensures rent is collected and the property is correctly maintained and regularly valued.

At present real property can only be bought through an SMSF if certain rules are complied with:-

  • The property must meet the sole purpose test of solely providing retirement benefits to fund members
  • The property must not be acquired from a related party
  • The property must not be lived in by a fund member or a related party
  • The property must not be rented by a fund member or a related party

Partly

It could be that future generations may have to be content to part-own and part-rent – not an ideal outcome but better than outright renting. Instead of borrowing to buy a home, a buyer might contribute a portion of the purchase price for an equivalent ownership proportion of the property and invite investors to invest the remaining portion via their super fund. In return the investor receives a rental yield and owns a share of the capital value of the property, which over time they can either sell to other investors at the prevailing value or to the occupant so they can increase their holding.

Win-Win

From the property buyer’s (the person living in the property) perspective, paying rent to the investor will likely be far lower than mortgage rates. The investor has a tenant with equity in the property so they can expect the property will be well maintained with minimal risk of vacancy as it has a part owner in residence.

Funding

With Superannuation Guarantee (SG) contributions legislated at 9.5% of salary there is enormous growth potential to fund property investment in such a way as to provide not only an allocation to real property for investors but to also assist younger generations acquire property.

In the SMSF sector, only 14% is invested in property and of that only about 4% in residential.

Government owned housing could be fractionalised in a similar way to allow tenants to get their foot on the property ladder. Funds freed up for state governments in this way could be ploughed back into maintenance thereby saving millions in government capital expenditure and allow thousands more people the benefits of property ownership through social ownership.

Property regulation?

Unlike equities, cash, fixed interest and other asset classes, property is not regulated as a financial product by ASIC and without a regulatory framework anyone can provide property advice without qualification or experience. So it is open-slather and as a result has inherited a not too attractive reputation.

Until recent times, unless you purchased a whole property, property investment was only possible via A-REITS and unlisted unit trusts neither of which offer residential property as an investment choice. A-REITS generally track the equities market and unlisted trusts provide a manufactured return that could include cash, rental yield, capital appreciation and perhaps derivatives.

From 2006 to 2013, largely as a result of the Global Financial Crisis there was over 160 failed or frozen managed funds and 60 of those were property related trusts. A lack of liquidity and debt are likely contributors to these failures.

Another alternative to direct single property investment is a property syndicate. Long the realm of accountants, property syndicates often have restrictive covenants, long terms to expiry and generally lack any kind of liquidity, so they have limited appeal. They can also have costly establishment and legal fees.

Equity like

With some adaptation of existing legal structures and a few regulatory reliefs it is possible to introduce equity market concepts to the property sector as in the case of fractional property investing.

The fractional model has been around for centuries in the form of the stock market. It is a regulated version of a syndication with online functionality and a secondary market to enable investors to exit when they have a need to do so.

Drivers and markets

The drivers for fractional investing in property are the same as for equities – people who want exposure to the asset class with diversification and some choice around the underlying asset with either a higher or lower income yield.

The obvious market is the SMSF sector where property is very much under-weight and borrowing can be either not preferred or inadvisable.

Implementing

One key to implementing property in client portfolios is client engagement and the way to engage clients and prospects is to provide content – prepare white papers, produce informative brochures, run seminars and webinars. Reaching clients by gathering information through online surveys –for example, Survey Monkey – and more regular meetings so you can identify those clients most likely to want or need an asset allocation to real property. Engage qualified property advisers to help in the same way you might invite equities managers to provide expert input.

Looking at crowdfunding for a moment, it is another relatively new but unregulated property investment structure promising to make property investment more affordable for everyone. The problem with being unregulated is they can only accept sophisticated investors, those with high incomes, $250,000 p.a. or more, or with net assets of $2.5m or more.

At those levels most investors would probably go it alone or prefer a higher allocation to property via the fractional model where they diversify across multiple properties with a reasonably high contribution and have access to an active secondary market when they wish to liquidate.

Opportunity

As a financial planner the fractional property asset class offers a new and exciting extension to your business as there are people wanting to invest (partially and without debt) and people with property wanting to divest (equity release).

Note: Fractional equity release is a new development currently before the regulator. If approved it will open a vast demographic of senior Australians requiring access to the equity they have amassed in their property, and to other property owners who wish to do the same to avoid total divestment whilst creating some liquidity.

 

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