Passionate about property
article is an excerpt from Russell Medcraft’s forthcoming
book, 'Super Rich: How to create a tax-free income for
life', to be published by Wiley in January 2008
www.johnwiley.com.au/trade " This chapter was contributed by
Anthony J Cordato to the book.
Property as a superannuation investment
Does property have a place in a super fund? As I discussed
in chapter 6, there are arguments for and against. In this
chapter, we’ll look at the advantages of property as a super
investment. I’ll explain how property works as a tax shelter
outside and inside an SMSF, and how to ﬁnd and acquire
If you are reading this chapter, chances are you’re a
property person, or you’d like to be one. Some people prefer
shares or cash as their investment class of choice, but
property people love to invest in property, over and above
owning their own home. They usually invest directly, buying
in their name or in the name of a company or a trust. Some
may invest indirectly in property syndicates or property
trusts, or in commercial property. On the following pages
I’ll look at the four main reasons that property people are
passionate about their investment choice.
Property is low risk
Many people find the fact that you can see the bricks and
mortar of property comforting. Property is tangible - you
can touch it, unlike shares.
You can minimise the risk of damage to any improvements on
the property by taking out building insurance. Public risk
insurance will cover any possible injuries.
There are other risks, which can be identified and managed:
- Rental security. Residential property is
low-risk in terms of security of rentals. Housing is a
basic requirement. Factory, office and retail tenancies
are a little more risky, being aligned to the economic
health of the business tenant. Proper tenancy selection
processes can also reduce tenancy risks.
- Title risk. This is practically zero in
Australia, where state governments guarantee land titles
and registries are maintained to record interests in
property. The guarantee is that the registered owner has
full control and entitlements, in terms of renting it
out, mortgage and sale.
Property is a hedge against inflation
Inflation favours tangible assets such as property because
the value of real assets rises with inflation. If you put
$100 into the bank, in ﬁve years’ time you will still have
$100, with a little interest. If you put that $100 into
property, it will always be worth more - and what’s more,
the rental price will keep up with the cost of living.
Taking the Reserve Bank of Australia’s inflation target range
of 2 to 3 per cent, property values and rents will rise in
value annually at an average of 2.5 per cent simply on
account of inflation. In fact, headline inflation, as
measured by the Consumer Price Index (CPI), rose 2.4 per
cent in 2003, 2.6 per cent in 2004, 2.8 per cent in 2005 and
almost 4 per cent in 2006.
Inflation detracts from the value of financial assets such as
bonds and interest-bearing accounts, which reduce in value
by the inflation rate. The interest received must be viewed
net of inflation. That is, if the interest is 5.5 per cent a
year and inflation is 2.5 per cent, the real return is 3 per
Inflation is only one factor underpinning increases in
property values. Other factors include:
- wage increases
- building cost increases
- reducing interest rates
- easy availability finance
- rent increases
- booming local economies.
As a rule of thumb, property prices double every eight to 10
years. Prices can remain flat in some periods and rise
strongly at other times. According to the Reserve Bank of
Australia, ‘Average capital city house prices have grown by
around 175 per cent since the mid 1990s. Prices outside the
capital cities have risen by a broadly similar magnitude’
(RBA, Statement on Monetary Policy, February 2007).
But during the same period, rental growth has lagged, going
up by between 35 and 60 per cent. The Reserve Bank notes
that, as a result of low investment in new property because
of low yields, the national vacancy rate is low and rents
will continue to climb. In the 1970s and 1980s, a 10 per
cent a year inflation rate underpinned unusually high
increases in property values and rents. In the 30-year
period between 1977 and 2007, a tenfold price property price
increase was experienced in many parts of Australia.
Is another burst of inflation around the corner? Property
people will be waiting!
Property has low price volatility
Property is a stable investment in terms of price. Property
prices can rise quickly - in a boom market, by 20 per cent
in three months. But conversely, property prices fall
slowly. In a ‘bust’ market, prices may fall by 20 per cent,
but this is over a one- to two-year term.
Property does not undergo price fluctuations daily, weekly or
monthly, as shares do. But having said that, it’s a
long-term investment, largely because of the transaction
costs and time lags experienced in the buying and selling of
property. It is often considered that seven years is a
minimum term for holding property.
Property provides a positive tax environment
Property receives favourable tax treatment, regardless of
whether it is bought in a personal name, or through a
company, a trust or a superannuation fund. Some of the tax
advantages are outlined on the following pages.
Property tax is deferred until sale
The tax on the capital gain in a property is not payable
annually, as it would be if it were subject to income tax.
Capital gains tax is paid only when the property is sold.
The liability to pay capital gains tax can therefore be
deferred for many years simply by holding on to the
property. Tax deferred is tax saved. The low volatility of
property values makes a holding strategy a sustainable
strategy. Let’s take a look at an example, to illustrate
this point further.
A unit is bought for $100 000, and sold eight years later
for $195 000.
Capital gains tax on $80 000 ($95 000 gain less $15 000
expenses) is $18 000 (at 22.5 cents in the dollar).
For the eight years the property was held, the $18 000 that
would be payable as tax on sale has been retained and used
to generate income - at 5 per cent a year the income would
be $900 a year.
Concessional tax rate for capital gains
If the property is owned for 12 months, and if it’s bought
in the name of an individual (or the individual receives a
benefit from the sale under a discretionary trust), then
half of the capital gain (net of expenses) is added on to
the taxpayer’s income. Therefore, if the added income brings
the taxpayer into the top tax rate of 45 cents in the
dollar, because only one half the gain is brought to tax,
the effective tax rate will be one half; that is, 22.5 cents
in the dollar.
The 50 per cent discount applies for individuals and trusts.
A 33.3 per cent discount applies for complying
superannuation funds, making the tax rate 10 cents in the
dollar. No discount applies for companies.
Tax-free family homes
No capital gains tax is payable on the sale of the family
home, as long as the family home is bought in the personal
name of an occupier of the home and the occupier lives
The proceeds of sale of the family home may be tax-free in
some circumstances, such as the owner leaving, the property
being sold within 12 months of death, the property having
been purchased before 20 September 1985, or a marriage
breakdown rollover applying.
Tax benefits for rentals
There are a few things to consider when you’re thinking of
renting out your investment property.
Keep in mind that rent is taxable income. Tax is payable on
the net amount of the rent, after allowable expenses, not on
the gross rent received. The expenses that are deductible
include loan interest, repairs and maintenance, council
rates, water rates, strata levies, real estate management
fees, gardening and rubbish removal.
The most controversial of these expenses is the loan
interest expense, which is discussed later in this chapter.
We’ll also look at depreciation deduction, which is commonly
touted in the sale of new property.
Gear for wealth - but think positive
Gearing is a shorthand term for borrowing against a
property. It is generally accepted that borrowing is
advantageous for the purchase of a property, where the aim
is to build wealth.
This strategy is attractive for wealth creation in the
high-income years (when you’re aged 30 to 50), but it can
also be used in superannuation funds under some
The fact that interest paid on the borrowings will absorb
some or all of the rent, and the fact that the property may
need to be subsidised using other income, is not important,
because surplus income is available from other sources, and
the gearing multiplies the gain.
The following example shows how gearing of 80 per cent of
the price will magnify the capital gain on cash invested
compared with no gearing at all.
In this example we’ll make the following assumptions about
Property purchase price $300 000
Add 5% acquisition costs $15 000
Total $315 000
Loan of 80% of purchase price $240 000
Cash outlay — funds invested $75 000
Total $315 000
We’ll assume that the value of the property increases at a
rate of 8 per cent every year, which is the percentage
calculated by BIS Shrapnel as the rate by which property
prices increase in the long term. We’ll also assume that the
property is cash flow neutral, meaning that no further cash
outlay is required.
After five years of 8 per cent a year increases, the value
of the property (compounded) is $440 800. After deducting
acquisition costs of $15 000, the amount of growth is $125
800 ($440 800 minus $300 000 minus $15 000).
This represents a 167.7 per cent return on funds invested
over five years, or $125 800 divided by $75 000. Contrast
the return on funds invested without gearing. The return
would be 39.7 per cent ($125 800 divided by $315 000).
If the interest expense, when taken together with the other
expenses, exceeds the rent, there is a net loss on that
property. The loss is known as ‘negative gearing’. The tax
laws permit this loss to be applied against a taxpayer’s
income from other sources, which reduces the income upon
which tax is payable. This is the tax shelter.
Some commentators suggest that the losses from negative
gearing be confined to the property, and be available only to
offset future rents or capital gains on the property. But
when this suggestion was implemented between 1985 and 1987,
it was quickly abandoned because investors suddenly pulled
out of the market. Rentals also rocketed.
Caution must be exercised on the level of gearing. Negative
gearing is to be avoided as it will fetter a person’s
income, and constrain them from building a deposit for the
purchase of more investment property.
Negative gearing is a bet that the value of the property
will increase by more than the money outlaid to pay for the
cash flow loss. If this doesn’t happen - which is likely if
you buy and sell within five years - negative gearing
will result in a loss, even though the property may have
increased in value. This is because the money outlaid
during the five years has exceeded the increase in value of the
The recommended strategy is therefore to be cash flow
neutral, or better still, cash flow positive, so that the
rental exceeds the interest payments and other property
For a positive cash flow investment, tax can be minimised by
investing in newer properties and taking advantage of the
depreciation, which requires no cash outlay. A relatively
new property can have $5000 a year in depreciation benefits,
which can then be deducted from tax.
Every part of a building will need repair or replacement in
the long run. The fact that the Income Tax Act 1986 allows
depreciation to be deducted against income provides a useful
reference of how long it will be before an item needs to be
substantially repaired or replaced (see the depreciation
Building depreciation and fittings and fixtures depreciation
under the Income Tax Act provide a noncash tax benefit in
that these form part of the purchase cost, yet are
deductible over many years as an ‘expense’. This benefit only
applies to newly built or recently built improvements,
although for building depreciation (for buildings after
1983), it continues for 40 years.
Examples of depreciation include:
- building depreciation: 2.5 per cent a year
- bathroom fittings: 5 per cent a year
- kitchen cook tops and ovens: 10 per cent a year
- carpets, linoleum and vinyl: 10 per cent a year
- dishwasher, range hood: 12 per cent a year
- hot water system: 12 per cent a year.
Superannuation as a property tax shelter
Superannuation is the latest tax shelter for property. It is
attractive for maximising income during a person’s
retirement years from their 60s. Property is a tax shelter
in that the rental income and the capital gains are
sheltered from full rates of taxation. Income and gains in a
super fund are taxed at a concessional rate of tax, 15 cents
in the dollar, rather than the individual’s marginal tax
rate, which could be as high as 45 cents in the dollar (plus
the 1.5 cent Medicare levy).
It works like this:
- Property tax deferral and discount applies. Superannuation
funds are not taxed annually on the increases in value of
their assets. So an increase in a property’s value will not
be taxable until the property is sold. Note that when a
complying superannuation fund sells a property, if it has
been owned for 12 months, the capital gain for tax purposes
is 10 cents in the dollar.
- Expenses and depreciation apply. The normal property
deductions are available, being for repairs and maintenance,
council rates, water rates, strata levies, real estate
management fees, gardening and rubbish removal. Building and
fittings depreciation also applies to be offset against
rental income. There is no interest deduction, as there are
- The family home. The family home should never be bought
inside or transferred into a superannuation fund. The only
exception may be if it ceases to be the family home, but
rarely do stand-alone residences make suitable investment
properties (as we’ll discuss later in this chapter).
Creative property acquisition
Two main factors should be considered when acquiring
property for your SMSF:
- The acquisition must be for the sole purpose of paying benefits
to members of the fund when they retire or meet the
prescribed age or die. A super fund cannot acquire a holiday
apartment for use by members of the fund before retirement.
- The property must be suitable for the super fund to acquire.
This is a subjective, rather than a legal, requirement. The
property must be suitable in terms of a high rental return
and low outgoings and maintenance, so that it can be a
If the super fund has sufficient cash
resources to acquire the property, then it
can do so. If not, money can be borrowed
through your super fund to finance the property.
In the past, property investors and their accountants put
their heads together to come up with some very clever
strategies for investors (such as buying property jointly,
or becoming a unit holder) to allow their superannuation
nest egg to get some leverage and borrow.
Various structures got hit on the head by the regulators and
many investors sought to close down their SMSFs because it
was too complicated and expensive to keep running trusts
that ran alongside SMSFs to borrow money.
That all changed and was made simpler in September 2007,
when new laws were introduced giving us the ability to
borrow against a new asset that sits in a superannuation
fund. Section 67 (4) of the Superannuation Industry
(Supervision) Act 1993 was repealed effective 24 September
2007. This section formerly read that superannuation funds
were not allowed to borrow. There is now an exception to
this, in the form of instalment warrants. The exception
means that trustees are no longer prohibited from borrowing
money, or maintaining a borrowing, under an arrangement in
which the following conditions are met:
- The money is for the acquisition of an asset other than one
prohibited by law.
- The original asset - or another asset that is purchased in
replacement to the original asset (and that is also not
prohibited by law) - is held on trust so that the trustee
acquires a beneficial interest in it.
- The trustee has a right to acquire legal ownership of the
asset by making payments after acquiring the beneficial
- The rights of the lender against the trustee for default on
the borrowing, or on the sum of borrowing and charges
relating to the borrowing, are limited to rights relating to
- If, under the arrangement, the trustee has a right relating
the asset (other than a right to acquire legal ownership, as
described above), the rights of the lender against the
trustee for the exercise of the trustee’s right are limited
to rights relating to the asset.
So what does this mean? It is now
possible to buy property by instalment.
That is, you can use your superannuation
as a deposit and the regulated
superannuation fund trustee (you) can
borrow the rest. The superannuation fund
must enjoy a right but not an obligation
to acquire the legal ownership of the
asset. The definition of asset does not just relate to
property but also listed shares, works of art and any other
asset that would be appropriate for the trustees.
For an instalment plan to work, you need to establish a debt
relationship though a trust. We’ll call this a debt
instalment trust (DIT). As a trustee you are precluded from
acquiring an asset from a related party. The lender of the
money for the purchase of the asset is only limited to the
asset as far as their security goes. The lender cannot
recover other assets from the superannuation fund in the
event of a default.
There is also no limit as to who the lender could be. It
could conceivably be the fund itself. This would be ideal
for members in pension mode, as they could lend money back
to the fund at a notional interest rate, which is
commercial. The income will be tax free, but the interest
expense could be deductible to the fund because of the
You need to be careful about the setting up of arrangements
to take advantage of the DIT. It’s a good idea to consult an
experienced superannuation tax lawyer so that you do not pay
unnecessary stamp duty on both the establishment of the
trust and purchase of the asset, and the final instalment
paid by the super fund, which will then dissolve the trust.
You may be wondering why the legislation been changed to
accommodate instalment lending. Instalment warrants have
been around for years and have been marketed by the big
wealth managers. They have, however, been marketing
instalment warrants in a very uncertain tax environment. The
new legislation gives us some real clarity around the
principles and rules and allows us to apply these principles
to other assets.
Acquiring a property with external finance
If your super fund is in accumulation mode, you will often
be looking for a gearing strategy with the intent that
future contributions into the fund will repay the loan.
Let’s look at the various possible scenarios for this.
Unit holder in a unit trust
Until 1998, the commonly accepted means of buying a property
for a super fund, with gearing, was for the fund to set up a
unit trust, with a corporate trustee, and invest in the unit
trust by taking an allotment and issue of units. The
following example explains this process.
A property is to be bought for $300 000 in the name of a
unit trust. The super fund subscribes $100 000 and is
allotted 10 units with entitlements to income. The unit
trust borrows the balance price of $200 000 and the
acquisition costs of $15 000. The property is cash flow
After a year, contributions have flowed into the super fund,
so that it has $20 000 to outlay for the issue of another
two units. The funds are paid into the trust and $20 000 of
the debt is retired. The super fund now has 12 units. And so
it goes on until the debt is retired.
For investment in unit trusts since 1998, the ATO has
applied the ‘control’ test, which means that the beneficiaries
of the super fund can’t control the unit
trust. So the unit trust must be at
arm’s length, which is easy to satisfy
for investment in publicly listed
trusts, but much harder when the trust
is private. The definition of ‘control’ for these
purposes is technical, and its examination is outside the
scope of this book.
Participant in a property syndicate
Syndicates are property partnerships,
but instead of the property purchase
being made in the name of the syndicate
members, it’s made in the name of a
nominee company. Even though the nominee
company pays with external finance, and
the guarantees of the syndicate members
are not required by the financier, the
super fund can’t participate in the
syndicate unless it has no ‘control’, as
defined by law.
Acquiring a property with vendor finance
Vendor finance, in terms of permitting
the buyer to pay the purchase price over
time, is thought of as ‘finance’ in the
broad sense of the word, but does not necessarily constitute
By this means, a super fund could buy from a third party,
and subject to a market valuation to support the price,
could buy from a related party. Provided that the
instalments add up to the price and no interest is charged,
then a transfer by this means should not breach the
prohibition on borrowings by a super fund.
Because the title to the property isn’t
transferred until completion - that is,
when the final instalment is paid - the
only documentation is a contract for the sale of land. The
contract specifies that the price is payable by instalments
there’s no mortgage.
The seller, if they are a related party, would obtain tax
advice to defer payment of capital gains tax until the price
instalments are received. The seller may allow the buyer to
take the benefit of possession, on the entry of the
contract. If the property is rented out, this would mean
that the super fund could apply rentals from the property
towards payment of the price instalments.
Transfers of property into a super fund are fully liable for
transfer or stamp duty, calculated on the value of the
In South Australia, legislation applies to limit the number
of instalments to four. In Queensland, legislation applies
to require the title of the property to be transferred once
one third of the price has been paid. The other states have
no such limitations.
Suitable property for a super fund
Not all property is suitable for investment, or acquisition
by a super fund. The criteria outlined here should be kept
in mind when you’re looking for a super investment property.
Maximising income through land content
When considering whether property is suitable for purchase
in a super fund, the emphasis should be on maximising
income, rather than maximising capital gains.
Income will be maximised when the land content is low
relative to the value of the improvements, while income will
be minimised when the land content is high and the value of
the improvements is low.
Examples of low land content relative to
improvements include home units, villas,
terrace houses, shops and offices. Examples of high land content include detached houses,
vacant land and hobby farms.
Assume that a two-bedroom house will rent for $250 a week,
and the two-bedroom unit next door to it will rent for $220
For the two-bedroom house, the value of the house
improvements might be $200 000, and the land value might be
$150 000. The gross rental return will be 3.7 per cent - or
$250 multiplied by 52 ($13 000), divided by $350 000. For
the two-bedroom unit, the value of the improvements might be
$175 000, and the land value might be $75 000. The gross
rental return will be 4.6 per cent - or $220 multiplied by
52 ($11 440), divided by $250 000.
In addition, outgoings such as council rates and water
rates, and repairs and maintenance, will be higher for a
two-bedroom house than for a two-bedroom unit, because the
cost of these is based on land value.
Maximising income by having more than one rental
It may be possible to derive more than one income from a
property, by separately renting out parts. The classic
example is a shop, with a residence upstairs, which is
Perhaps there is also a garage at the rear, which can also
be separately rented.
Another example is a split-level house, where the fl at
underneath is separately rented. My personal favourite is to
build a studio/ garage - which consists of a garage
underneath and a studio above - that can be rented out
separately from the house/terrace at the street front.
Experienced investors will buy property that doesn’t have
large or difﬁcult-to-maintain exteriors. Investors will buy
a block of flats, home units, or a row of villas or terraces
where there are common walls or it’s all under the same
My father always pointed out that if you buy a house you
have four external walls and one roof. If you buy a block of
flats you have four walls and one roof - but you have four,
six or more rentals from a block of flats, compared with a
house, and almost the same external repair requirements in
Smart investors will buy property where the building, the ﬁ
t-out and the appliances are in good condition and where
their useful life can be extended by repair rather than by
Buildings that are built with low-maintenance materials
should be favoured. Following are some tips and traps to
look out for:
- Exposed brick is always lower maintenance than painted
cement render. Most exposed brick is found externally.
Sometimes the exposed brick is internal, where it matters
less if it is painted as it is less exposed to the weather.
- Tiled roofs maintain their appearance long after Colorbond,
or, worse still, galvanised iron roofs
deteriorate. Skylights last longer if they are glass rather
than a polymer.
- Aluminium external windows, door frames and screens require
less painting than wooden windows and frames.
- Tiled floors in kitchens and dining areas are easier to
maintain and last longer than linoleum.
- Wall tiling floor-to-ceiling in bathrooms takes away the need
to repaint walls.
- Polished floorboards are, for
the most part, far more durable than
carpet - particularly if the floorboards are polished
professionally, or the carpet is low-quality.
Experienced investors will avoid
buying property in high-maintenance
locations. They avoid seaside
locations where the salt spray and
the salt air will accelerate the
deterioration of the exteriors -
particularly windows. They will also
avoid locations near heavy industry
or mining where ‘acid rain’ will
accelerate the deterioration of
As a rule, tenants don’t look after large gardens or
properties. They don’t mow large areas of lawn, don’t keep
plants and bushes trimmed and don’t keep fences in good
repair. At the end of the tenancy, the cost of bringing the
grounds to a good state will often fall upon the landlord,
as it is difﬁ cult to satisfactorily cover the care and
maintenance of the grounds in a lease agreements.
The solution is small yards, easy-to-maintain garden areas
and extensive paved areas, which can easily be cleaned up at
the end of the tenancy.
The bottom line is that if you follow some basic principles,
buy wisely and get good advice, you can follow your passion
and use your positive cash flow property to help fund a proﬁ