Peaks and Troughs

Alexandra Cain reflects on the outlook for the Australian property market in 2016 and finds something of a mixed bag.

Following a number of stunning years for property prices, during which Sydney and Melbourne experienced double-digit growth, the heat has now largely dissipated from the property market. However, there are still plenty of pockets of growth around the country for the astute property investor.

Jan Mason, acting managing director of Defence Housing Australia, notes that although conditions in the property market have been strong in recent years, market data suggests a softening outlook.

“We expect moderate to weak growth across the country, although many of the areas where we have properties are seeing steady growth,” says Mason.

Tim Lawless, head of research at property research house CoreLogic RP Data, says the data shows property prices in Sydney fell 2.3 per cent in the fourth quarter of 2015. Prices in Melbourne fell 1.9 per cent across the same period.

“But this was on the back of strong gains since 2012. We’re likely to see a continuing slowdown in those cities as we see a rebalancing of affordability and rental yields,” says Lawless.

He says the Perth and Darwin markets are also soft, having peaked towards the end of 2014. “We’re still witnessing the effect of the mining slowdown on the housing market.”

Residential property prices in Brisbane and Canberra, however, are expected to rise this year, on the back of rises in 2015. Hobart is another capital where residential property prices are tipped to grow.

Regional focus

While property prices in many capital city markets may be challenging at the moment, the same can’t be said of regional areas.

Mason says the outlook for regional areas is improving because they are often more affordable than capital cities and the infrastructure to support many of the main regional centres is improving.

Michael Workman, senior economist with the Commonwealth Bank, agrees that the regional outlook is mixed.

“Some centres will perform extremely well because of their exposure to the agricultural sector. It’s had a few good years, with food prices, especially for exports, rising,” says Workman.

“There has been a strong increase in volumes of agricultural exports, which is boosting property prices in some regional centres,” he adds.

Workman says the more economic diversity in a regional centre, the better for long-term property prices.

But the mining downturn is reducing property prices in places like regional Western Australia (WA), central Queensland and the Hunter Valley.

“Prices in these centres will go lower as more mines close. There isn’t much potential for energy prices to increase because of the low oil price. The slowdown in China will also indirectly lead to lower property prices in WA and Darwin,” he adds.

Undervalued opportunities

Although the mining downturn is affecting property prices in some towns, there are still opportunities around the country to purchase properties where capital growth is expected.

According to Mason: “The key is to look at the infrastructure and public transport plans in the region you’re considering. It’s possible to identify properties that are not yet serviced by public transport, but where there are future plans to improve transport options, for instance by extending train lines.”

Says Workman: “The idea is to do your homework and look at the rental market. Prices are often driven by the provision of services like transport, hospitals and schools. Investing in areas with these attributes will generate a better return in the short and long term.”

SMSF strategies

Self-managed super fund (SMSF) investors have the opportunity to use their fund to purchase properties using limited recourse borrowing arrangements. It’s an interesting strategy for building long-term wealth.

As Michael Miller, financial adviser, MLC Advice Canberra notes, directors of a family-owned business in particular may be looking at strategies that involve their SMSF purchasing the commercial property that’s used in the business.

“Having the SMSF take out a loan to purchase the property is one option, but it does involve dealing with a smaller pool of lenders, and complying with the additional legislative requirements of SMSF borrowing,” he says.

An alternative strategy, he says, is to set up what’s called a 13.22C trust to purchase the property. “This can have the trust units owned both by an individual and an SMSF. The trust can’t borrow for the property purchase itself, but directors can borrow against other security such as a residential property to fund their own unit-holding.”

For example, say the industrial unit from which a family business has been operating is now on the market for a price of $550,000. Assume the SMSF has $200,000 available for investment, and the business owner is able to borrow up to $400,000 against a residential investment property.

Miller explains a 13.22C unit trust can be established, and the SMSF can subscribe for $200,000 worth of units. The fund members draw on a line of credit secured by the residential investment property to subscribe for $400,000 worth of units. This gives the trust $600,000 to purchase the industrial unit, as well as having funds available to cover the usual purchase costs such as stamp duty, insurance and conveyancing fees.

Nevertheless, the rules around this approach are strict and must be complied with. It’s essential that the trust:

• Does not have an interest in another entity (so it can’t own shares or an interest in another trust).
• Does not make a loan to another entity, except for an Australian bank.
• Does not borrow money, or give a charge over its assets to another party.
• Does not conduct a business.
• Does not enter into a lease with a related party of the super fund, unless the lease relates to business real property.
• Does conduct all transactions on an arm’s length basis.

“Maintaining compliance with these rules will ensure the interest in the trust isn’t considered an in-house asset for the SMSF,” says Miller.

“One of the reasons you might consider this strategy, particularly compared to a limited recourse borrowing arrangement, is if finance costs for a line of credit secured by property are generally lower than those offered for SMSF loans,” he adds.

According to Miller, limited recourse borrowing arrangement restrictions mean it’s not possible to change the character of the asset acquired, preventing strategies such as sub-division, development or substantial renovations.

“Units in the trust can be later acquired by the SMSF to provide access to capital, or to manage capital gains tax obligations.”

Greg Einfeld, a director of self-managed super fund advisers Lime Super, explains that using an SMSF to buy a commercial property, which can be leased to a business owned or operated by the members of the SMSF, can be advantageous.

“One of the reasons that commercial property generally has higher rent than residential property relates to vacancy risk; that is, it can be harder to find a tenant for a commercial property. In this case that risk is removed. The SMSF gets a guaranteed tenant that will pay the rent. The SMSF can borrow to purchase the property, and the rent often covers the interest so the arrangement can be cash-flow positive,” he adds.

He also notes there are substantial business benefits of having a friendly landlord who won’t raise the rent unreasonably. “This is particularly useful for businesses where location is important, such as retail outlets and restaurants.”

As with all SMSF strategies, there are some restrictions of which fund members need to be aware.

“The rental agreement must be on commercial terms, including the amount of rent and who is responsible for outgoings. If the SMSF buys the property from a related party such as the business owner, the purchase price must be a market price, supported by an independent valuation. Stamp duty exemptions can apply in some states,” says Einfeld.

The limited recourse nature of the loan means that if the SMSF can’t meet the repayments, the bank can’t touch the other assets of the SMSF, apart from the property itself.

“However, as a result the bank will usually require a personal guarantee from the members. In addition, if the property is funded by debt, there are restrictions governing improvements to the property. For instance, improvements and maintenance must be paid by cash in the fund,” he adds.

There are two ways to structure this strategy if business partners are buying a property together, says Einfeld. “They could have separate SMSFs which each own a share of the property. Alternatively, the partners could become members of a single SMSF.”

However, he notes it is important to consider liquidity whenever a super fund owns property, and also think about what happens if one owner of the business dies or wants to take their money out of the super fund. Another consideration is what would happen if one party wishes to sell their share in the business.

Says Einfeld: “These scenarios should be carefully considered to ensure the business can continue to operate in the property. It’s wise to take advice in making these decisions.”

Like any strategy involving an SMSF and related parties, it’s important to seek advice and understand the requirements of legislation. Seeking advice prior to entering a transaction is much simpler than remedying a breach after the fact.