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News Bulletin : ADA News Bulletin December 2010
29 DECEMBER 2010 strategy -- particularly for younger dentists with limited equity/ deposit. Maybe these investors would be better off investing in a State with lower stamp duty first, and then investing beyond that State when they have accumulated some equity. Land tax is particularly insidious because investors only feel the consequences of land tax after they have held the investments for a few years. Land tax is often most costly in retirement -- a time when you need to be paying less tax, not more. Therefore, when developing your portfolio strategy, you must consider how your property is owned and where it is located as this will affect your potential land tax liability in the future -- particularly in retirement. Many investors own all their property in one State and one ownership structure, e.g., all in the dentist's name. This often means they'll pay quite high land tax. I compared an example of an investor owning five investment properties in NSW with a land value of $2 million ($400k each) versus an investor that owns one property in each of VIC, NSW, QLD, WA and SA (against $400k each). The land tax expense based on current rates would be $26,084 under the first scenario versus $1,789 when investments are spread across various States. That is a massive annual difference and might mean the difference between being able to retire or not. When we produce financial strategies for our clients, we identify that land tax can often eat up 30% or more of an investors net rental income if left unchecked. That is a large proportion of passive income to give away in retirement. Investors can minimize land tax by spreading investments across a number of States and using different ownership structures in different States. However, one caution in regards to structuring is to be mindful that laws can, and probably will, change. Therefore, structuring your portfolio solely on the basis of land tax is a flawed approach. Land tax is one of many considerations. PORTFOLIO STRATEGY AIMS The overriding aim of portfolio construction is to maximize wealth and minimize investment risk. Diversification involves reducing risk by investing in different types of properties in different locations. If each property's value and income do not move up and down in perfect synchrony, a diversified portfolio will have less risk as it smooths out unsystematic risk, i.e., risk that's inherent to each property or location so that the positive performance of some investments will neutralize the negative performance of others. A smooth investment return is important for investors that use leverage (borrowings) to build wealth. Most investors use equity in investment properties to acquire further assets. If all your property values are stagnant for an extended period of time (maybe because they are similar property types in the same location) then the investor's capacity to acquire further investment will be hampered. However, if you own three investment properties in different locations and two increase in value while one remains stagnant, you can revalue only the two that increased and continue to invest. Holding all your properties in one location can delay further investment. This can be very costly in the long-term and may prevent you from meeting your financial goals. A perfect property portfolio should diversify location, property types and tenant types. In terms of locations, we tend to stick to proven and established suburbs in major capital cities. Generally, we like to see a client hold their investments across two to three States and hold a diversified portfolio of property types of houses and apartments ranging from one to three bedrooms. This will also appeal to different types of tenants. Considered property portfolio construction can and should be tailored to an individual investor's requirements and goals for example, planning around an existing asset, preparing for retirement, or just a strong bias for investing in the client's domicile State (initially). As well we need to consider tax. Not only do we need to consider stamp duty and land tax, but also income and capital gains tax. Certain properties with certain income and capital return characteristics will be more suited to certain ownership structures. For example, assuming we have identified that a client should own at least one property in a discretionary trust and at least one (two bedroom) apartment, we may be inclined to allocate this investment to Queensland because it has one of the highest land tax thresholds for properties held in a trust. This is because an apartment is likely to have a lower assessed land value compared to a house and therefore is more likely to remain under the land tax-free threshold. Similarly, we might plan to put an investment property (a house this time) in a self managed super fund knowing that the client will probably need to sell one property soon after retirement to eliminate debt, potentially taking advantage of CGT concessions inside super. Property types, locations, ownership structures and tax are all major variables that need to be carefully considered when structuring a property portfolio. One is rarely more important than the other -- they all need to be balanced out. WHO CAN HELP? Who can provide this advice? Some buyer's agents (or investment property advisors) can assist with certain aspects of structuring a property portfolio. However, be aware they are property professionals and not financial advisors. Therefore, their advice will be limited to property. They will not necessarily be able to comment on other issues such as taxation, estate and retirement planning and so on. Your accountant might be able to help with structuring an ownership and tax strategy, but might not know enough about property investing or other non-tax related issue (such as estate planning and retirement strategies). A financial planner will be able to develop a financial and retirement strategy (as well as other things such as risk management, estate planning, asset protection, etc.,) but won't necessarily have much knowledge and experience with property. Assuming you can't find one professional to cover all these issues (there aren't many of us around), you really need to assemble a team and have all these advisors provide input into your strategy. Once you have an astute strategy, an absolutely critical element in executing it is selecting the right properties to invest in. You must seek advice on this aspect -- particularly if you are investing outside your domicile State (as you might not be as familiar with the local market or markets). Make sure you locate a reputable investment property advisor (buyer's agent) that you are comfortable with. Whilst there's a cost associated with appointing an investment property advisor, the long-term benefits of achieving diversification should more than offset this additional cost. Most property investors tend to 'accumulate' a property portfolio on an ad hoc basis without any predetermined strategy. This can result in tremendous inefficiencies and financial 'waste' many years down the track (when it's too costly to correct a broken structure). Therefore, it makes good sense to invest time proactively structuring your property portfolio in advance. Good luck (although this shouldn't really come into it if you have done all the 'right things')! 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 by providing financial and mortgage advice. ProSolution will be exhibiting at the Australian Dental Congress 2011. Contact: firstname.lastname@example.org business perspectives
ADA News Bulletin November 2010
ADA News Bulletin February 2011