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News Bulletin : ADA News Bulletin August 2010
34 AUGUST 2010 business perspectives • Under the first scenario, Peter purchases a surgery for $600,000 in his SMSF and his practice rents it off the SMSF for an annual rental of $48,000 (8% yield). The capital growth rate is projected to be 2% above inflation -- so 4.5%. The dentist had $300,000 of cash in super and will buy the surgery in his SMSF with cash and borrowings. • Under the second scenario, Peter leases the surgery, pays the landlord $48,000 per annum and instead invests his super in direct residential property with borrowings (residential property will return 8% capital growth and 3.5% rental yield -- in line with long-term returns). Table 1 compares net asset value of each dentist's SMSF in today's dollars. You'll notice that investing in blue-chip residential property is much better from an overall asset perspective. Table 1. Net asset value of SMSF (today's dollars) 10 years 20 years 30 years Commercial dental surgery 401,000 614,000 845,000 Cash 399,000 1,023,000 1,960,000 Buy Scenario Total 800,000 1,638,000 2,805,000 Residential property 749,000 1,646,000 3,074,000 Cash 151,000 528,000 1,247,000 Lease Scenario Total 900,000 2,174,000 4,321,000 'Lease' superior to 'buy' by: 12.5% 32.7% 54.0% However, as you'll notice from the above table, the 'buy' scenario allows you to get more cash into super (you'll note that the cash holdings are higher). This is important given the current Government's reduction in the concessional contribution cap (i.e., limiting the amount you can tax-effectively contribute into super). Therefore, if you can invest this cash wisely, you might be able to make this strategy work for you. Let's assume that under each scenario, Peter's SMSF invested any surplus cash holdings in excess of $50,000 in the Fund into direct blue-chip shares with a franking level of 70% (dividend franking is very valuable to SMSFs because of super's low tax rate of 15%). Table 2 demonstrates the net asset value in today's dollars, assuming the surplus cash is invested. Table 2. Net asset value of SMSF (today's dollars) 10 years 20 years 30 years Commercial dental surgery 401,000 614,000 845,000 Shares 457,000 1,700,000 4,572,000 Cash 40,000 31,000 24,000 Buy Scenario Total 898,000 2,345,000 5,441,000 Residential property 749,000 1,646,000 3,074,000 Shares 129,000 740,000 2,374,000 Cash 40,000 31,000 24,000 Lease Scenario Total 918,000 2,417,000 5,472,000 'Lease' superior to 'buy' by: 2.2% 3.1% 0.6% As you can see, investing the cash wisely starts to make up for the lack of capital growth in respect to the surgery. The main benefit of owning a surgery is to get more money inside super (from renting the property). But you must invest wisely once it's in there to get any benefit. The analysis does teach us a valuable lesson in that the surgery you buy cannot be a complete dud. The scenario I used included an overall return (rental plus capital growth) of 12.5%, which is pretty good. If the overall return is less than this (and I've seen plenty of examples of this), you'd be much better off renting. By the same token, if you're able to buy an investment-grade surgery, then you'll have the best of both worlds and it's a sensational personal and business solution. Therefore, when selecting a surgery premises, you would be well-rewarded for selecting an asset that is likely to enjoy sustained buyer demand over the long-term (and therefore strong capital growth). In this regard, you should consider seeking advice from an investment property specialist (specifically someone with commercial experience) to advise you (or at least provide a second opinion) on the investment quality of a prospective surgery purchase. THE RELATIVE RISK This comparison and analysis has been completed without regard to the relative risks associated with commercial versus residential property investments. It is widely held that commercial property investments are higher risk investments (compared to residential). The reason for this is mostly due to the fact that demand can be more elastic for commercial properties. That is, demand for commercial property is a function of Australia's economic health, the local economy, business sentiment and so on. Demand for residential property can be more stable because, to some extent, housing is essential. Everyone needs somewhere to live. It is a consistent level of demand that propels the price of assets forward and rewards investors. In this regard, commercial property can be more volatile (the 2008 and 2009 years are good examples of this volatility). IN CONCLUSION Taking into account the relevant investment risks, on balance, I believe that not buying your dental surgery and instead investing your super in a blue-chip investment often results in a superior, lower-risk solution. There are only two occasions I would depart from this approach. Firstly, a situation where we could be sure that owning a surgery premises would also make an astute investment in its own right (i.e., supported by an independent appraisal of the property's growth prospects by a property advisor). In this circumstance, owning your surgery is sure to result is an excellent solution. Secondly, if you couldn't negotiate adequate lease terms (i.e., with plenty of options to extend the lease) and the dentist had spent (or needed to spend) a lot of a fit-out, then owning might be a better solution (or find a different landlord). The key lesson here is, do not automatically assume buying your surgery is a smart move. If the surgery's capital growth prospects are limited, make sure that you are an astute enough investor to make the most of your money in super -- or appoint someone to do it for you. Buying a surgery and ignoring the rest is a recipe for disaster. Stuart Wemyss is a qualified Chartered Accountant, financial planner and mortgage broker. Stuart founded financial advisory firm ProSolution Private Clients which helps dentists maximize their net worth through proactive and strategic asset and liability management. Contact: email@example.com
ADA News Bulletin September 2010