JUNE 2014
PROPERTY OF PITCHER PARTNERS
Š Pitcher Partners 2014
Inside Cover: Melbourne, CBD
Front Cover: Sydney, CBD
CONTENTS 5 WELCOME 6 COMMERCIAL SNAPSHOT 8 RESIDENTIAL SNAPSHOT 10 Funding and Financing for Property 12 Development property finance 13 PROPERTY AND YOUR SUPERANNUATION 14 CROSS BORDER FUNDING AND FINANCING FOR PROPERTY INVESTMENT
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WELCOME By Andrew Beitz, Pitcher Partners, Adelaide At Pitcher Partners we have a passion for the property industry. We are attuned to the needs of all players in this complex and exciting sector – owners, developers, investors, builders, valuers, agents and debt/equity participants. We have a well-established and proven track record in contributing to our clients’ success based on our extensive knowledge and our intimate approach to servicing our clients. This issue of Property of Pitcher Partners focuses on the challenges of funding and finance for the property industry. Firstly, we look at an update of the residential and commercial snapshots where Matt Whitby and Michelle Ciesielski of Knight Frank give us in-depth analysis and trends of both these sectors. Journalist Nigel Hopkins talks to property specialist John Percy who takes us through the current trends in investor demand for different types of property, looking where to invest and how you finance your investment. With the banks lessening development property lending after the GFC, it was inevitable there would be an economic downward spiral of lowering property values, defaults on loans, further tightening of loan funding, and ever decreasing valuations. Grant Parish takes a look at development finance options now the market seems to have bottomed out. Monte Engler looks at using Superannuation to buy property taking us through the types of properties that you can invest in, the rules that are associated with this type of investment and the costs involved in doing so. We then take a look at cross border funding and financing for property investment from a tax perspective. Foreign investment is a common feature of Australia’s property landscape and this is a trend which is only set to continue. Leon Mok and Tim Martino provide some examples of the different finance methods and reiterate the importance of understanding the tax implication of implementing these finance methods. We welcome your feedback – if you have any suggestions on articles you would like us to cover in future editions please send them through to info@pitcher-sa.com.au
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Commercial SNAPSHOT Diagram 1 – Commercial property value cycle
High Activity & Price
NSW
WA
VIC
QLD Increase in Activity & Price
Decline in Activity & Price
SA
Low Activity & Low Price
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Left: Commercial office building
By Matt Whitby, Head of Australian Research, Knight Frank The first quarter of 2014 has seen continued high investment demand across the commercial market with heightened interest and activity particularly in Sydney and Melbourne. The strength of investment demand has continued to far outweigh the underlying strength of the occupier market, however there have been increasing positive signs within a number of markets across Australia that tenant demand, and in particular the propensity of tenants to relocate, is on the increase. Despite this improving sentiment, measurable improvements within the major markets will take some time to flow through. The basic indicators such as rents, incentives and vacancy levels are expected to remain relatively static through to the end of 2014, before showing clear improvements during 2015. In general, the supply of new stock is at lower than average levels which will assist vacancy rates to show some improvement before the expected acceleration in supply from mid-2015 through to 2017. Market rental levels, particularly on an effective basis (which includes the impact of incentives) are currently at, or nearing their expected lows for this cycle. This is stimulating some increased mobility from tenants who are seeing value in upgrading or modernising their accommodation with little out of pocket costs and locking in current rental levels. There are also signs that sub-lease space, particularly in the prime market, is beginning to be taken up, particularly where there is a relatively long lease term remaining.
In contrast to the leasing market, the investment market has seen a sharp increase in demand. Initially this was primarily for modern, long WALE assets but this has also recently broadened to include secondary stock. Following the strong yield compression in the Australian prime markets during 2013 (2560bps), tightening has continued into 2014 and is now being recorded in those parts of the market which had initially seen a more limited pool of investor interest such as the secondary markets or “value add� opportunities. The secondary market is also being supported by the strong offshore and local demand for assets which have a current or future higher and better use for residential conversion. This is particularly in evidence within both Melbourne and Sydney CBD’s and inner ring suburbs and is expected to spread to other markets over the coming year. As underlying fundamentals improve, the prime firming will continue and as purchasers continue to move up the risk curve, secondary yields will also continue to firm, closing the historically high yield gaps currently in evidence. At the smaller end of the scale, boosted by Self Managed Super Fund (SMSF), private investors in the sub-$3 million market are also seeing high activity, particularly for investments with a longer lease and steady tenant in place.
The expected recovery in tenant demand, not just in the office market but in industrial and retail as well, is tied to the anticipated improvement in the non-mining sectors with financial/business service and household based elements (ie retail sales) forecast to grow and see flow on effects across the wider economy. It is anticipated that retail expenditure will continue to show modest improvement through 2014, albeit at a slowing pace to that seen in the first few months of the year. After steady monthly falls since November 2013, the April Consumer Sentiment (Westpac/Melbourne Institute) showed a marginal improvement from 99.5 in March to record 99.7 in April. While the overall index remains slightly in the pessimistic territory (under 100 points) some elements of the survey showed strong growth with the assessment of family finances up 6.7% over the past year and expectation of the next two months up a further 2.2%. The May edition of the Westpac Confidence Index has been delayed to capture changes as a result of the Federal Budget, however is expected to show some falls. Despite an expected short term knock to household confidence, the investment market is expected to remain strong during 2014, boosted by broad based and deep demand from investors both local and offshore.
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Residential SNAPSHOT Diagram 2 – Residential property value cycle
High Activity & Price
NSW VIC
Increase in Activity & Price
Decline in Activity & Price
WA
QLD
SA
Low Activity & Low Price
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Left: Residential towers, Gold Coast, QLD
By Michelle Ciesielski, Associate Director – Residential Research, Knight Frank On a global platform, Australian residential investment continues to be appealing with strong population growth, low interest rates and attractive incentives for foreign investment into Australia. The Australian Bureau of Statistics has projected that population will exceed thirty million people in Australia, with projected growth of 34.2%, in 2030. Sydney will retain the highest proportion at 6.12 million persons, expanding by 31.1%. Melbourne and Brisbane are expected to grow by 39.7% and 43.1% respectively. Perth is the standout, projected to grow to 3.18 million persons in 2030; overtaking Brisbane, with growth of 67.2%. The low cash rate environment has been another driver for the increased investment in residential property with a current rate of 2.50%, benefitting borrowers and causing investors to seek alternative investments to cash. These conditions have been in force for the last nine months with steady or downward movement in the cash rate since December 2010. The strong performing Australian dollar, until recently, has led to Australian property being increasingly expensive for foreign investors. Over the last year, the AUD has weakened making Australian property more attractive with particularly strong interest in Sydney and Melbourne. Foreign investment has
been encouraged by the Commonwealth Government with incentives for adding new dwellings to ease the current pressures on housing stock. Coupled with relaxing previously zoned industrial and commercial areas to allow for multi-level residential complexes, building approvals in Australia grew strongly in 2013. Over the past two months the trend estimate for total dwellings approved has fallen (down 0.8% in the month to March 2014) however the annual growth remained high at 21.9%. In contrast approvals for private sector houses, in trend terms, rose 1.1% in March, rising for the fifteenth consecutive month led by South Australia (2.3%) while they fell in Queensland (0.3%). In recent years, low maintenance unit complexes have become desirable and acceptable as an alternative to houses, attracting local investment across Australia. According to Residex, varied results have been recorded for the year ending March 2014, with overall capital growth for units of 7.22% to a median value of $427,000; whilst houses reached $459,500, growing by 6.08%. Over the same period, the number of unit sales rose by 20.79% and houses by 18.27%.
Sydney houses continue to achieve the highest rate of price growth at 14.65%, with a median value of $795,500 in March 2014, followed by Melbourne with growth of 8.05% to $619,000; Perth at $535,000 (up 7.85%), Brisbane at $459,000 (up 6.29%) and Adelaide at $408,000 (up 4.00%). Recording less than 2% growth were the Australian Capital Territory at $533,000 and Darwin at $575,000; whilst Hobart fell 1.51% to a median value of $356,500. The most notable growth in the number of transactions were Hobart units increasing 40.85% to total 631 sales in the twelve months to March 2014. This was followed by Sydney units (up 34.13%) at 47,310 sales and Sydney houses (up 27.99%) to 48,744 sales. At the other end of the scale, the Australian Capital Territory witnessed 3.00% fewer sales at 3,757 while Darwin was down 7.59% to 864 sales. Major markets led by Sydney and Melbourne will continue to influence capital values as they reach peak conditions before growth will start to slow; as smaller markets strive to reach their peak growth for this cycle.
Trending well above the Australian average, Sydney units led growth in capital values of 12.15% to record a median value of $549,500. Hobart (up 7.13%), Perth (up 6.28%) and Melbourne (up 5.90%) followed with median values of $266,000, $464,000 and $454,000 respectively. Capital growth was experienced at sub 5% in Brisbane, Adelaide, Darwin and the Australian Capital Territory over the same time.
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Funding and Financing for Property By Nigel Hopkins, Journalist Investing in property inherently contains risks, as does any investment, but today’s property market is especially demanding and getting the right advice has become all-important. “The current property market is all out of kilter, not just in Australia but globally,” says Pitcher Partners Senior Property Specialist John Percy. “In my 26 years in the property business I’ve never seen anything quite like it.” Percy has a unique perspective on the Australian property market having worked in both the corporate and private investor sectors, including stints with Jones Lang, Pennant Group and Charter Hall as well as 13 years as Asset Manager for a high net worth private investor He says that while investor demand for certain types of property has never been higher, the reality is that even in these sectors there is softening tenant demand. “What’s happening in Australia right now is probably an aberration as we follow the trend in the rest of the world, whereas during the GFC we went contrary to the global trend,” he says. “It means the risks are inherently greater and you can’t afford just to walk into a new place and say I like that, I’ll go and buy it. Right now you can’t afford to get it wrong.” Despite this, Percy says, the demand from the investment market is “running rampant” at a time when some of the property rental and leasing markets are softening, especially the office market. While investor demand is at an all time high, finding tenants is extremely difficult. If you own an office building your rental levels have to be well priced, your building has to be up to current requirements and well maintained and upgraded, and you’re still going to be in a bun fight with about 20 other buildings in trying to secure tenants.” Percy says it’s not so much a matter of office oversupply but more one of quietening business demand, typified in Western Australia, for example, by a cooling in the resource sector but reflected generally across Australia: “The office sector tends to mirror the overall economy,” he says.
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So if office building investment is still a proposition but abnormally challenging at the moment, where should savvy property investors put their money? “Over the last 18 years the people I’ve worked for wouldn’t have looked at either the hotel or entertainment sectors,” Percy says. “These are very specialist areas that often rely on high levels of trust with the operators – hotels, for example, these days generally run under management arrangements and, as the investor, you have to sit on the sidelines and hope that the hotel operator is doing the right thing for you. “They tended to look more at office blocks, shopping centres and industrial premises because these are areas where they can control their own destiny, and right now they’re all red hot with investors, especially low cost money from overseas investors.” While office block tenancy demand tends to be driven by the state of the business economy, shopping centres are driven by population growth and discretionary and non-discretionary spending, while industrial premises tend to have longer term leases and are generally cheaper to acquire, making these two property sectors a safer bet for many investors. “That’s why every property investor in Australia right now is chasing around looking for those property classes in particular,” Percy says. “I’ve had some of the people I deal with say they’d love to get their hands on half a dozen shopping centres because they could sell them in a heartbeat, there is so much pent up demand. “Despite internet shopping, shopping centre performance continues to improve, people still need clothes and they need to eat, while the bigger industrial properties are considered very blue chip, possibly with 20 year leases, a low risk form of investment.”
If you’ve been lucky enough to find a property that ticks all the boxes, what’s the best way to finance the purchase? “Clearly the cheapest form of debt is through the mainstream banks,” Percy says. “But at the same time the banks are also reasonably conservative, so they will go through everything, look at property profile structures, including how secure is the income and the tenants. Their loan to value ratios (LVRs) will be much softer, probably around 50% - meaning that the investor will have to have 50% equity. “Most property financiers these days will look at what cash flow the property will generate, where are its potential risks, where are the holes and what are the strategies to manage the problem, where will the tenants come from, and what is the business structure moving forward? These are all questions the banks are likely to throw at you.” Percy says there are, alternatively, second tier lenders such as GE Capital, which has gone out of mainstream property ownership and into property lending, often with an LVR of up to 70%, but charging a premium on the interest. “They tend to be very hands on, working with people to monitor what’s going on and providing assistance if necessary with issues that arise.”
After that you get into areas such as mezzanine finance, “which is definitely at the riskier end of the lending spectrum when you look at the interest rates this sort of debt generates. They (the lenders) tend to be extremely hands on, but they’re also charging at the very high end of the interest rates range. You would need a very good plan on the future direction of that property, what you planned to do with it and how you would progress forward.” Syndicated loans are a possibility but are generally quite rare and usually only for very large projects that might involve a number of banks and very large sums of money – such as Gina Rinehart and her Roy Hill development, which has a global syndicate of 15 banks. And the golden rule for property investors? “The first thing you should think of when you buy a property is ‘when am I going to sell it?’,” Percy advises. “You have to have an exit strategy, a plan for the timing of disposal of the property, even though you might never sell. If you’re a trader, then at some point you’ll want to dispose of it. Whatever happens and whatever course is adopted the underlying requirement is to plan for the future of the asset.”
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Development Property Finance By Grant Parish, Pitcher Partners, Sydney It is well known that the banks pretty much closed their books to development property lending after the GFC, resulting in the typical economic downward spiral of lowering property values, defaults on loans and resulting receivership sales, further tightening of loan funding, ever decreasing valuations and the cycle continues. This sent many property developers and investors to the wall, or for those with the capacity to hold for the longer term eroded the value of their assets significantly. This market now appears to have bottomed out and in line with the residential property market progressing well, the development property values are improving as is the banks willingness to lend. Many developments that were previously shelved or have been purchased post GFC are now lining up to be developed. The problem of funding however still remains, so how do you get that much needed finance?
Banks The banks are back in the market however remain very selective, so if you have a development in a capital city, and you are able to market it well and achieve 80% presales, the banks are interested. If not you may need to look further afield, however it may still be worth asking the question.
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Mezzanine Finance This form of debt has always been around however comes with hefty interest rates which often make a project unprofitable, but may be useful as a short term solution.
Mortgage Brokers There are a number of property specialist mortgage brokers with access to a world of second tier finance with a willingness to lend and a commercial approach to structuring facilities. There are large sums of private wealth and investment capital looking for better returns than deposit rates. If development projections stack up and the funder is adequately covered from a risk point of view a commercial deal can be struck that is beneficial to both parties. This may include things such as timeframe of facility, periods of capitalised interest, non-recourse facilities, no director or personal guarantees etc. The facility may need to be tailored by the broker with the funds being sourced from a range of providers (possibly even including a bank) resulting in the interest rates varying subject to the complexity and risk levels. It should be clear however these facilities do come at a cost, generally being an upfront fee to put a facility together and also a brokerage fee on the settlement of a facility, all of which can vary significantly, so as always, you need to read the fine print and choose wisely. If you have had difficulty locating a financier to get a development off the ground it may be worth reviewing your options and realising the potential of your investment.
Property and your Superannuation By Monte Engler, Pitcher Partners, Adelaide We often hear a variant of the following statement, ‘I didn’t know I could buy property with my superannuation.’ The simple answer is yes you can. However, there are a number of other considerations that may mean that it might not be right for you. This article attempts to address a number of the considerations to provide a brief overview.
Property types Pretty much any type of property that you can think of can be held in a Superannuation Fund: • Residential homes and units; • Holiday homes, caravan parks, hotel units; • C ommercial property-small and large scale (petrol stations to office blocks to surgeries to industrial warehouses); • Options over property; • Farms; and • Foreign property Property can be directly or indirectly held; alternatively, you can get exposure to property through listed property investments. There is no restriction on the type of property that can be held within a superannuation fund; instead, the rules guide how that property can be acquired, held and used.
Some of the rules
Costs
he list of rules is long and varied depending T on your particular circumstances. However, there are a number of general themes that can be considered:
The costs of holding property in superannuation does not change when compared to other structures. You will continue to have:
• I nvestments must meet the ‘sole purpose test’ of solely providing retirement benefits to fund members – receiving benefits personally (whilst not in pension mode) carries harsh penalties; • I nvestments must not be acquired from a related party of the fund – unless strict conditions are met – generally commercial property can be acquired from a related party; • T he property cannot be lived in by or rented to a fund member or any fund members’ related parties; »» T he exception to the rule is commercial property. A related party can rent the property as long as the rental is based on prevailing market rates and the rent paid to the SMSF. • Y ou can borrow to buy. There are a number of specific rules surrounding complying loans. However, in general, gearing in a structure that has a low tax rate has less of a tax benefit than utilising other structures. Care needs to be taken prior to entering into superannuation borrowings as you will need to plan for:
• L egal fees in relation to lease arrangements; • Advice fees; • Property management fees; • Council rates; • Bank fees; • Insurance costs; and • Land tax may or may not be applicable. At times there can be additional cost burdens of superannuation: • Revaluation fees; and • Issues surrounding death benefit payouts. You might begin to ask ‘Why do people continue to invest in property in superannuation?’ The simple answer is that it can be a great vehicle to structure purchases in. It’s a viable investment class and the choice will depend on your individual circumstances. Before making any decision, ensure you speak to us to get the best possible advice that is tailored to your individual situation.
»» cash flow considerations, »» l oans are typically at a higher interest rate, and »» y ou cannot directly re-borrow against any of the future equity built up in the fund. • Y ou can develop property in a superannuation fund; however, the superannuation fund cannot borrow to fund the developments of an existing property held in superannuation. Non-SMSF owners could borrow to fund development and undertake joint ventures with the SMSF.
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Cross Border Funding and Financing for Property Investment – A Tax Perspective By Leon Mok and Tim Martino, Pitcher Partners, Perth Foreign investment is a common feature of Australia’s property landscape and this is a trend which is only set to continue. Factors such as Australia’s low sovereign risk levels, high yields and close geographic proximity to growing Asian wealth present an attractive opportunity for foreign investors. When considering how to finance a property investment into Australia from overseas, it is important to consider Australian tax laws, as the overall rate of return from the investment can be significantly affected by the tax implications. Property investments often involve some degree of leveraged finance, whether it be traditional loan funding, mezzanine finance or more exotic arrangements such as Islamic finance. The characterisation of the financing arrangement as equity, debt or some other type of arrangement for tax purposes is crucial in understanding the tax implications. The characterisation is especially important when the funding is from offshore sources as additional rules will apply.
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Broadly, returns on equity funding will be treated like dividends whereas returns on debt funding will be treated like interest payments. Dividends are generally not tax deductible and represent a return of post-tax profits. In contrast, interest payments are generally tax deductible and represent a return of pre-tax profits. Arrangements such as Islamic finance present a particular challenge as there is currently no specific regime in Australia to cater for such arrangements. As such, each arrangement will need to be analysed individually and may result in vastly different outcomes. The tax implications can be both positive and negative. Current tax rules in Australia actually provide offshore investors with some tax planning opportunities that are not available to domestic investors. Appropriate structuring of funding arrangements can result in a significant reduction in the effective tax rate for investors. Conversely, a lack of planning and non-compliance with various tax rules will be detrimental to the tax efficiency of the funding arrangements.
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Some examples of Australian tax rules that offshore investors and funders need to be aware of include: he thin capitalisation regime, which • T is designed to deter investors from excessively funding their investments with debt. The regime limits the Australian tax deductions which can be claimed where debt to equity ratios exceed certain thresholds. ransfer pricing rules, which can apply to • T adjust the pricing of debt finance for tax purposes where the interest charged is not considered to be arm’s length. ithholding tax rules, which apply • W to interest and also dividend returns. Withholding tax rates can be reduced (sometimes to nil) under Double Tax Agreements (DTAs) where applicable. pecific rules regarding foreign currency • S gains and losses, which apply to nonAustralian dollar arrangements. Ultimately it must be remembered that, although funding arrangements are primarily influenced by commercial factors, consideration of the tax implications is crucial to ensure the tax-efficiency of the overall structure.
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Adelaide Andrew Beitz Principal, Chair South Australia Property Committee Telephone +61 8 8179 2848 andrew.beitz@pitcher-sa.com.au
Perth Leon Mok Executive Director Telephone +61 8 9322 2022 mokl@pitcher-wa.com.au
Brisbane Nigel Fischer Partner Telephone +61 7 3222 8444 nfischer@pitcherpartners.com.au
Sydney Deborah Cartwright Partner Telephone +61 2 9228 2240 dcartwright@pitcher-nsw.com.au
Melbourne John Brazzale Managing Partner, Co-Chair National Property Committee Telephone +61 3 8610 5110 john.brazzale@pitcher.com.au
Newcastle Greg Farrow Managing Partner Telephone +61 2 4911 2000 greg.farrow@pitcher.com.au
Melbourne Telephone +61 3 8610 5000 partners@pitcher.com.au
Sydney Telephone +61 2 9221 2099 partners@pitcher-nsw.com.au
PERTH Telephone +61 8 9322 2022 partners@pitcher-wa.com.au
Adelaide Telephone +61 8 8179 2800 partners@pitcher-sa.com.au
Brisbane Telephone +61 7 3222 8444 partners@pitcherpartners.com.au
NEWCASTLE Telephone +61 2 4911 2000 greg.farrow@pitcher.com.au
The material contained in this publication is general commentary only for distribution to clients of Pitcher Partners. None of the material is, or should be regarded as advice. Accordingly, no person should rely on any of the contents of this publication without first obtaining specific advice from one of the Partners of Pitcher Partners. Pitcher Partners, its Principals & agents accept no responsibility to any person who acts or relies in any way on any of the material without first obtaining such specific advice. Š Pitcher Partners 2013 PrintPost Approved PP381827/0043 Pitcher Partners is an association of independent firms. Liability limited by a scheme approved under Professional Standards Legislation.