Brisbane Property Network July 2014 Issues for Property Developers

Introduction ― Welcome ― What is your motivation for being here tonight? ― Is it you are just interested in property? ― Social interaction? ― Professional networking? ― To make money? ― All of these factors play a part but if these sessions were not about making money there would be a lot less people in the room tonight.

Disclaimer The information contained in the presentation today is general in nature and should not be relied upon by anyone without first consulting a professional on the application of any of the information to their circumstances and their own issues. No responsibility is taken for any outcomes (unless they are good) from using the information in tonight’s presentation. All examples shown are hypothetical examples and for demonstration purposes only. Outcomes will differ depending on your personal circumstance.

Investment Options ― Consider your investment options break the types of investment down so they can be compared ― Look at the return on investment, this includes income as well as capital growth. Look at true yield not just cash flow. ― Seek Professional advice. ― Remember that higher return usually means higher risks

Comparing Investment Options For following examples are estimates only for demonstration purposes. Individual circumstances will vary. I have looked at current market conditions and returns, bank lending interest rates, standard bank lending criteria for gearing levels and a tax rate of 40%.

Comparing Investment Options ― Cash in the Bank: Safe but no capital growth. Only return is from the yield which is around 2.5% after tax ― Shares: Not as safe as cash but income yields on average ranging from around 4.5% to 6.4% grossed up for tax credits. Capital growth varies depending on the share from negative to 40%. Google suggests a combined average annual return is around 10 to 12%

Comparing Investment Options – Commercial Property ― Commercial Property – Yield currently averages 7% to 8%. Higher risk in the market now from higher vacancies but demand is high for good properties. ― Capital growth can be patchy – based on rental increases. ― $1M purchase needs around $350,000 equity. Bank lend of 70% the estimated average annual after tax return over 10 years is 12.75% to 15% including capital growth

Comparing Investment Options – Residential Property Property – Residential I have started looking at residential property investment in two classes - Passive Investor – the accumulator who buys and holds; or - Active Investor – the property developer who builds and sells Historically higher interest rates and lower rental returns have seen property returns dragged down because of negative gearing. However, current conditions are seeing many properties neutrally geared or only marginally negatively geared. Thus increasing returns on property.

Residential Property – Passive Investor Example Purchase a residential property for $600,000 Rent at $580 per week. Loan on the property is for 80% Property is managed, usual overhead costs net cost to hold is around $2,000 per annum. If the property increases 5% per annum – average return over 10 years is just under 20% on funds invested.

Residential Property – Passive Investor Example Same property purchase but if interest rates increase by 2% per annum and rent is $30 a week lower – the average annual return drops to 13.5%. This is the impact of negative gearing. Same property but say instead of costing $2,000 per year to keep, the property is cash flow positive of say $2,000 per annum but growth is only 2%, the net return reduces to 7.83% over ten years. You can see the greater impact comes from the lower capital growth

Property Development - Example ― As opposed to passive residential investment, property development is much more active. ― Source the site, see the upside, develop the site, sell the site. ― See example

Try a Building Blocks Approach to Property Development and Investment Step 1 – Review your options Step 2 – Review what you have Step 3 – Dream about what you want Step 4 – Determine how to get there. The working out how to get there is the key – build wealth while managing risk and tax.

Assess where you are – What do I have? -You will almost always have to put in $$ - make sure you have enough -What you have will influence what you can do – you might need to change course. (example) ― Know what the banks are looking for: ― Security for their loans ― Serviceability to make the repayments; and ― Industry experience

Assess where you are – What do I have? Make a financial assessment ― Make two columns, one is assets and one is liabilities ― Leave off cars, boats, furniture and personal items ― Reduce property values by 20% ― Take liabilities away from the assets ― See the example

Assess where you are – What do I have? ― Superannuation ― One major asset potentially available for use is your superannuation. ― The use of your superannuation for investment – via a SMSF – can have benefits in that you can access capital you would not otherwise have been able to and it is low taxed (usually 15%) ― Major risk is that you are using your retirement funds and can put this in jeopardy plus investments are highly regulated.

What do you need and want? Your Income and your ability to earn: ― Along with your physical assets – you equal biggest asset is you! ― Your income from working (or lack thereof) is a major factor in assessing loans and the bank’s willingness to give you credit. ― Protect you asset, have you income protection insurance reviewed and if necessary updated. It is an investment not a cost.

What do I need and want? You need so much – you want more – how much are you willing to risk? ― Steph and Ben have savings and want to invest but they don’t want to risk their capital ― Jon and Patrick are substantial investors with structures to protect their assets. They have passive and active investments. ― Each have different risk profiles

When you know what you want to do – chose your structure. The structure will impact on: ― The income tax payable on any profits; ― Your ability to access profits for private use; ― Your ability to access capital gains tax concessions; ― You access to any losses made; and ― Your personal liability exposure. The Development Structure

Ownership Structure ― Determine the structure prior to purchase – have an entity set up ready to go ― Change to your structure can be costly ― Consider your circumstances – one size does not fit all.

Five Basic Structures 1.Individual or Sole Trader 2.Partnership 3.Company 4.Trust 5.Superannuation Fund ―Company and Trust are most common

Private Proprietary Company Advantages of Company Structure: ― Company is a separate legal entity and its use creates a limitation of personal liability ― New investors can easily be admitted as a shareholder ― Flat rate of 30% tax

Advantages of Company Structure Continued: ― Shareholders have a clearly identifiable entitlement to income and capital ― Profits can be retained in the company ― The structure can be used with a holding company for tax effect. Private Proprietary Company

Disadvantages of a company structure : ― 50% exemption for capital gains tax not allowed ― Difficult for tax-free amounts to pass to shareholders ― Directors can still be held personally liable ― Can not distribute losses to shareholders

Unit and Discretionary Trusts ― Unit Trust: used by non-related investors looking to ensure their investment entitlements are clearly identifiable ― Discretionary Trust: generally used by family groups and have no fixed entitlement to income or capital. Distributions are at the discretion of the trustee

Unit Trust Advantages of a Unit Trust: ― Provides asset protection when used with a corporate trustee – Not for the individual investor ― Unit holders have a fixed interest and entitlement ― The 50% CGT discount is available ― Profits can be passed out to investors without tax having to have been paid which can be seen by some investors as a benefit

Unit Trust Disadvantages of a Fixed Trust: ― Can not distribute losses to individual investors ― Income must be distributed at year end or is taxed at highest marginal tax rate

Discretionary Trust When used with a company trustee the structure can be used as either: ― The investment entity by which you hold your interest in the development; or ― The actual entity carrying out the development

Discretionary Trust Advantages of a Discretionary Trust: ― Provides excellent asset protection with a corporate trustee ― Liability can be limited using a corporate trustee ― Flexible capital and income distributions ― Access to the 50% CGT discount ― No restrictions on tax free distributions

Discretionary Trust Disadvantages of a Discretionary Trust: ― Can not distribute losses to beneficiaries ― Beneficiaries do not have a transferrable interest

Self Managed Superannuation Fund (SMSF) ― An SMSF can not generally undertake a development directly ― Main use is as an investor to receive profits and an additional source of capital ― An SMSF is a variation of a trust structure so requires a trustee and deed

Self Managed Superannuation Fund “How much do I need to start one?” This question is hard to answer but you need to look at the following: ― Why do you want to own an SMSF? ― What would you like to do with the money? ― Do you understand your obligations? ― How much do you already have in super?

Self Managed Superannuation Fund How much do I need? ― Base level say $100,000 relates to fees you are already paying ― Allow $2,500 minimum each year What do I need to set one up? ― A trustee which can be a company or individuals. Use a company it will be easier in the long run ― Cost is around $2,000

Self Managed Superannuation Fund Disadvantages of a Superannuation Fund: ― Difficult to access profits ― Highly regulated and restricted operations ― Can impact on your ability to borrow

Trust Structure – Working Example Audience participation time!!

Conclusion Your professional advisors can really have a beneficial impact on your development career. Experienced specialist advisors have insight and knowledge to help you. We do cost money though – see it as an investment not a cost. We are happy to assist with any accounting and taxation queries or advice that you may require.