I was recently asked my thoughts on buying property in an SMSF and the possible removal of negative gearing when being interviewed by PropertyBooks.com.au.
As these topics are of wide interest to property investors here’s a summary of what I had to say:
Tell us a little about your background and how you developed your keen interest in property taxation?
My Uncle’s name is Bernard Chan and he was in the BRW’s 200 Richest Men in Australia.
All of his wealth was in real estate and he had a property portfolio worth around $300 million.
He has since passed away and handed his $300 million fortune to his 3 children and they appear in the BRW 200 Richest families in Australia.
During family gatherings they would talk about property and I got an early education to the merits of property. In fact property discussions were very frequent.
They are listed as the “Chan Family” each year and you can read about them when the next issue comes out, if they are still there as they were towards the bottom of the 200 list and people towards the bottom drop in and out from year to year.
However when I was practicing tax and accounting, I would see clients who got themselves into problems and I would try to solve their problems for them.
Over the years I have gathered an enormous amount of concentrated experience in the area around property tax, especially around prevention and avoiding future problems.
This unique experience gathered over 30 years of practicing allowed me to develop many strategies around asset protection, proper structuring to legally minimize tax’s such as capital gains tax, land tax, income tax and stamp duty.
Chan & Naylor then grew to around 15 offices around Australia offering the same knowledge around Property Tax.
What inspired you to write your 3 best selling books?
Well I have actually written 4 books and the last one is called “Good To Great” which is about Chan & Naylor. How we turned a small business into a national investment that pays a passive income.
Whilst the book is about small business and the challenges faced by small businesses, it shows how a small business can transcend into an investment that pays a dividend and the road map to get there.
So ultimately it is still a book about investments.
What inspired me to write these books is a passion to help people succeed based on hard won practical experience and the best way to share that with as many people as possible was via books.
The type of people who should read them are those who would like to create a passive income as opposed to those who want to earn personal exertion income.
Chan & Naylor Accountants won the award for the BRW Fastest Growing Accounting Firm in 2013. What would you say has been your most successful strategies?
Most of the richest people in the world have created their wealth through building businesses.
Whether the business is a tax and accounting business or whether it’s an electrical or plumbing or car business or whether it’s a “business of property” is irrelevant as the business principles are the same.
The most successful businesses are those that specialise. Gerry Harvey of Harvey Norman specialised in retail, Frank Lowey of Westfield specialised in shopping centres, Richard Branson specialised in partnering up with someone who has an expertise in a vertical market and putting his Virgin Brand to it.
We specialised in property tax and structuring.
Even in property those who are specialist are much more successful.
For example those who simply build project homes and nothing else or those who simply do renovations. Others concentrate on bathroom renovations etc…
My Uncle Bernard specialised in Retail Commercial Properties.
It does not matter what industry you picked as long as you specialise in it.
The reason why specialists make more money is because if one does one thing a thousand times one gets really good at it versus doing a thousand things once.
As an example a Heart specialist makes more money than a GP.
4) Do you see the ability for Australian’s to purchase residential real estate in their SMSF continuing or do you think there may be regulatory changes over the coming years?
The use of Super money used to buy property via a Self Managed Superfund has become popular because of the poor returns from Industry Funds and the high fees being charged.
There is also the Control aspect. People would rather control their own money.
The use of a SMSF allows ordinary people to leverage their assets and get a much better return when compered to Industry Supers.
For example if one had $200,000 in an Industry Super earning 4%pa is $8,000pa.
They can roll that $200,000 into their own SMSF and use that as a 30% deposit and this allows them to borrow $460,000 to buy a $660,000 property. They now have $660,000 making them money instead of $200,000 making them money.
If $660,000 was earning a rental of 4% pa plus a capital gain of 5%pa is $59,400pa less interest on the loan of $(24,380) leaves a gain of $35,020pa or a 17.51%pa return on the original $200,000.
The cash flow is positive by $2,020pa so this becomes self funding but it achieves a better return than sitting in an Industry Fund earning 4% ($8,000pa) versus 17.51% ($35,020pa).
Disclaimer: the above is not intended as financial advice and should not be relied upon to apply to their own circumstances. It’s simply for illustration purposes and one should seek individual advice before deciding on whether it’s appropriate to their own circumstances.
As you can see if properly managed this is a perfectly legitimate strategy for SMSF’s.
It’s safely invested into residential real estate and the cash flow is positive and the returns have been estimated at a conservative 5% pa capital growth.
Naturally the returns are even better if the capital gain is more on the average of 7% rather than the 5% used in our example.
However like most things there are a few people who either over extend themselves or they do not take proper advice and enter into the wrong structures and get themselves into trouble and the Authorities end up throwing the baby out with the bath water when small tweaks is all that is needed.
I believe there will be a tightening up of the regulations around SMSF’s and borrowing to buy property
What do you think will happen to negative gearing?
Every year there is a campaign to remove negative gearing around property investments.
This is the most misunderstood area and could have serious implications if negative gearing is removed for the economy.
Firstly “negative gearing” means that you are losing money.
No one in their right mind would enter into an investment that loses money. No matter the tax benefits.
So sensible people would not deliberately lose money unless there was a benefit to compensate for the risk of the losses.
The theory is that because it’s tax deductible the loses are halved and the gamble is that the capital gain makes you back your losses plus some.
Naturally investors are taking a gamble because if there was no capital gain than they would have lost money.
Many people lose money in property and its not a given.
The people who want negative gearing removed argue the following:
1. The rich are getting an unfair tax advantage
2. It’s costing the Government around $13 billion a year in lost revenue due to losses claimed by property investors.
3. It’s unfairly pushing the house prices up
4. It’s causing rental to go up
Let’s answer these one by one
1. Most people (around 76% or more) own one investment property and according to the ATO earn income of around $80,000pa so clearly they are not classified rich.
They are not getting a tax advantage because anyone who runs a business is entitled to deduct costs (including interest on a loan) against the income earned (rent) and if they make a loss can either offset that loss against other income or carry it forward to future years to offset against future profits (or capital gain in sale of property).
I cannot see how a government can discriminate against one group of businesses versus another group of businesses.
Owning investment properties is a “business of property”.
Further these people are funding their own retirements to save the government from paying them a pension in the future.
They also provide housing for tenants which is saving the government billions of dollars as the private sector provides around 96% of housing and the government only provides 4%.
If the private sector ceased investing in housing the government would need to fund the shortfall.
2. It’s not true that its costing the government $13 trillion in lost revenue due to negative gearing
At an average tax rate of 30% its only costing the government around $4 trillion however since governments only provide 4% of housing and the private sector provides 96% it would cost the government a lot more than $4 trillion in lost tax revenue if it was to carry a larger percentage of the housing supply.
In fact it would be in the hundreds of billions and would send the government broke.
Paul Keating removed negative gearing in the 80’s and the public housing waiting list doubled and he quickly replaced it.
3. It’s not true that its pushing the housing prices up.
There is no evidence of this.
House prices are pushed up due to supply and demand and there is currently a shortage of supply.
The factors of supply and finance and wages growth and immigration which has a far greater impact on house prices than negative gearing.
4. It actually reduces rental as more supply comes onto the market as negative gearing is an incentive for people to invest in real estate and therefore provide more supply.
Often people speak out against negative gearing because of ideology, jealousy or here say and not based on facts.