Alternatives to income funds

You can leverage 100% with downside protection on managed funds or shares and leverage about 106% on property with no downside protection.

The difference in the maximum leveraging between managed funds and property is 6% not 1000% (10 times) which you eluded to earlier (10% lvr vs 100%).

Our friend Shasta made the comment about shares being able to become worthless ($0.00), the number of listed companies gone busted is 10,000 over the last 100 years according to (Delisted - Home). This is easily solvable with a put option, if somebody is silly enough to sell the put option to cover your risk and it goes belly up it'll be there problem.

That's pretty funny for a few reasons...

1) I'm did post anything saying that "shares average twice as much growth as property". I'm sure HIH shareholders wouldn't agree with your loose statement.

2) It's very easy to buy $1m in shares, like property its a massive market. What I think your trying to say is its no point comparing them when you can't get the same leverage. You can take a line of credit from your house to purchase them, that'll give you 100% LVR with no margin calls. Or like our friend CRC said you can do this through Macquarie or Perpetual.

3) I've seen enough statistics from enough places over the years to know that both property and shares average about 12% pa, over the shorter term they can go up and down in different cycles but on a 20 year frame they are roughly equal depending on whose statistics you look at (and statistics are easily made to favour whichever view the source wants).

4) I don't think Mark would agree with you as he is a financial planner who likes property alot.

5) I'm a financial planner and I look purely at after tax percentage returns, I don't care where the money came from (as long as it's all legal). I care about making my clients money in the most tax-efficient way. You can look up a thread about transitioning to retirement which is about tax-efficient income streams.

6) A couple of years ago property returns kicked ass (mid 30%) so it's a bit silly saying "

" isn't it?

I guess CRC and my idea of Apples and Apples is different somebody elses Apples and Apples.

 

Just to bring it back to the original discussion.

In your original post your proposed a net return of 2%. Gross of 10% less interest expenses.


If you then had $100,000 in a fund that is earning 10% with an LVR of 70% then you have $30k in this deal. At a 2% net you clear $2000.

So on your 30k you are earning $2000. Take into account the volatility risk and it is hardly worth the effort seeing that you could deposit the $30k in the bank and get 7% or $2100 with no risk.

Where your LVR is 50% the minimum return required to match a bank deposit return is over 3% (about 3.5%).

So for the risk involved the returns from any MF has to be better than the returns that you can obtain from a simple bank deposit.

Obviously the higher the gearing the better return from a MF as it is a pure return on the difference between interest costs and interest earned, but with the higher gearing comes increased risk and a lack of control.

This is why in previous discussions on this topic I have stated that my minimum return is 5% nett this being the premium I want for the risk taken.

Alternate strategies all need to be weighed up in relation to their specific risk profiles.

Cheers

 

Hi Dan, can you point me in the direction of property returning 12%PA long term? Are you reffering to the russel report?

My understanding of property returns is that if you look at domain.com property reports, capital growth for property sits at about 9-10%PA, then we get about 3.5-4% in rent.

Then I saw a report saying you need to deduct about 5% in costs associated with holding the property. So the real return is about 8-9% PA

As you pointed out, shares return about 12%PA So given shares return about 4% more, plus franking credits in return for a lower LVR, whereas property returns a lower 8% REAL RETURN in exchange for a higher LVR, however you need to count mortguage insurance and stamp duty and sales costs which reduce your capital return in the end. These are the costs which our property fanboi's friends seem to forget about in their calcualtions.

Property MAY be better for SOME people, I would say someone wanting LVR of 90% and are in a high tax bracket.. but most people would not be buying their 2nd-3rd-4th properties at 90% LVR.. So it may benefit someone having 1-2 IP's with 90% LVR, but beyond that, shares/funds may be a better option.

As I mentioned earlier, IP's benefit over funds is their general higher LVR and tax benefits, other than that, I think shares lower holding cost and aqusition costs benefits out weigh direct property. Not to mention with 1 property, you have zero diversification and limited liquidity options.

 

Hi CRC,

Yes (Russell Long Term Investing Report 2006, ASX - Australian Securities Exchange)

The like I said before the LPT sector kicked butt and had a great roll for the 04 to 06 season as well. Clearly, on the graph, LPT outperformed Shares for that season.

Cheers,

Dan

 

Or will Mr Bean invest in property because the primary reason is the higher gearing available? I know thats a main reason I want to invest in property. Take my current unit. With first home owners grant and stamp duty concessions, I get to control a property valued at purchase at 180k for only 6k down, this is at 95% lvr, the LMI capitolised on the loan. The unit is worth 200k one year later. 20K growth for 6k down aint too bad.

If I wanted to control 180k worth of shares it at 50%lvr it would cost me 90K. I dont have that kind of cash.

 

I would like to know how they work out that figure, cause as I mentioned, domain.com shows a capital growth of 9-10% for property, plus 3.5-4% yield, subtract 5% in IP holding/disposal/aquisition costs..

This doesn't ad up to 12% REAL return.. after costs the RR shows.

Here is a melbourne suburb burwood (eastern suburbs) http://www.domain.com.au/public/sub...search&suburb=Burwood&postcode=3125#mapanchor

The region actually shows a 9% long term growth. plus 3.5% rental yield less holding costs down't show 12% average return to me..

 

yes, so in your situation, property was better.. but you cant keep on replicating that.. Once the high LVR of property is taken out of the equastion, its attractivess is reduced.

Plus you didnt make 20k net capital growth. Thats your gross capital growth but not your net return. Did you take out $12,000 stamp duty you paid? Did you take out $3500 mortguage insurance you paid? What about $15,000 in interest holding costs over the 12 months? Did you have any rates to pay? What about repairs or insurance? To me your real return looks more like you just broke even in the exercise or even made a loss.

And what would happen if Mr Bean couldn't hold down a job.. how would he service his loan? In that case, he would be better off with a managed fund portifilo.

if property was such a good investment, then how come no investment banks have managed funds which invest into residential property? Probably because their returns would be very poor.

 

you cant really include the mortgage cost on the ppor as its pretty bloody close to rent. I have to live somewhere!

 

Um...St George co-own Ascalon who market boutique fund managers. One of the funds that Ascalon market is Fortuna Funds Management whose flagship fund is "Residential Property Trust of Australia". See http://www.invested.com.au/7/new-residential-property-managed-fund-510/

Also Westpac are releasing a fund to do with defence personnel (DHA) soon.

The reason fund managers have traditionally stayed away from residential is because it is alot easier for them to manage a $600m building than it is to manage 1,000 $600k properties.

You can see in the Fortuna PDS that it is not a cheap fund to enter with a 6.3% buy spread and a 2.33% sell spread. An MER of 1.45% is also on the very boutique end of town. Plus outperformance fees if outperform 10% in any year of 18.45% of the outperformance (so 18.45% of any return above 10%).

Cheers,

Dan

The above information is a recommendation to invest. Speak to your FPA registered Financial Planner, Accountant or Tax Adviser before making an investment decision.

 

Sorry property hasn't grown by 20% PA over the last 5 years.. but yes it could drop by 20% given market conditions.

Really? Try to tell that to all the Sydney families which now have negative equity..

So invest into a managed fund... who actively manages risk and diversifies so if one company does go bust, it doesn't clean you up. or invest into listed property.. it wont go 'bust' either.. or even infrustrue, like macquarie airports.. the airport will always be there

Land can dissapear when the government decides to build a freeway through your lot..

 

Handyandy
That is a valid point, however the point of the particular structure I discussed was purely in response to the problem of funding the negative gearing shortfall on another asset.
If you put your money in the bank, it wont go a hell of a long way towards helping you fund your higher leveraged growth inevstment. Although the 2% net return is not fantastic by itself, if it allows you to hang onto another asset that has had good growth at high leverage, then it is your total portfolio return that is the key. Without setting up that structure you may not be able to hold the negatively geared asset.
It is simply an example to address one particular portfolio associated problem. Obviously the higher return you got the better the whole thing would work.

 

I much prefer the deals where I have nothing in by it being equity funded. To me doing it that way anything over holding costs + inflation is a bonus.

 

What about something like BBI or VIR shares. Income is 100% Tax Deferred for the next few years at least with distributions @ 9% and 10%.

Leverage at 90% using an LOC at 7.62% interest and both shares pay their interest costs with a little left over for loan reduction. With no income to declare, you get a tax refund of your marginal rate x interest paid. ROI on your equity invested is >40% with a 31.5% tax rate. which also goes into reducing loan principle.

With enough invested, you get the government to help you with your super contributions.

Anyone see any downside to this as a means of building a progressively increasing income stream?

 

Exactly how does this work?
Commonwelth bank says they will count 70-75% of my rental income for Serviceability calculations but only 20% of my Share and MF income.

70% of my (average) 8% rental return (8IPs in 8 years)seems better than 20% of 15% return on any new shares and MFs I might buy.

How do others get around this? I seem to be reducing my serviceabilty by buying shares and MFs with Commonwealth Lines of Credit. I'd rather not use higher interest rate margin loans.

 

Hi Venger,

I'd be checking out Colonial's Calia plus product (https://www.colonialgearedinvestments.com.au/Default.asp).
If you ask CBA about it they'll think your crazy as Colonial is a very separate division of the bank.

Cheers,

Dan

This is not advice to invest in Colonial Calia or any other investment. Speak to your FPA registered Financial Planner, Accountant or Tax Adviser before making an investment decision.

 

Well for a start I wouldnt be using commonwealth bank. Use a broker to find a loan provider who will consider your serviceability more accurately.

 

That is exactly the sort of stuff I was hoping would come up in this thread, cheers mate!
That sounds really good, using such a method you could also potentially get your income down to a level where you get full family tax benefit (if applicable) making it even more attractive!

 

my (limited) understanding is that some lenders will take more of your share/mf income into consideration. I definitely stand to be corrected though

 

Hi Guys,

Interesting. I'll paint a rubbery example based loosely on my situation to illustrate why I use an income managed fund. But I welcome insight into how I could optimise my structure. The numbers are rubbish, but the principal is accurate.

Lest assume I have $1M in the income managed fund. Last year it did 20% so that's $200K income. Lets assume my interest bill (all borrowed, a mix of LOC and ML) is $90K for a net profit before tax of $110K. Woohoo!

Lets also assume I have an IP worth $1M which cost me $110K in negative gearing shortfall. Not so cool from a paper loss perspective, but its a development site and my capital gain potential next year is off the scale! So, I'll wear the short term pain for some medium term gain.

I hold both my assets in a company structure, so, in effect, my tax bill in the company will be zero ($110K MF income - $110K IP paper loss). I'm happy because the cost of holding my IP whilst simultaneously incurring other expenses related to pursuing a DA through council for a MUH development has been entirely borne by my income managed fund profits. Because its all in the one structure I don't pay any tax on those profits.

However, reading Coopranos' original post. Potentially a growth fund might have worked even better. If I understand it correctly, that would preserve the deductability of my $90K IP loss as there's no offsetting income per se. The only issue is that the loss is within a structure so I'm not sure how to pass it out to me as a deduction, and that's not the intent of this thread so I won't go there.

At least I hope that painting the picture shows how the fund did serve a purpose in my situation, and I'd welcome some insight into potentially more tax effective or lucrative financial (not legal) structures. Basically, I just needed that cashflow so I could pursue my IP interests. And the complementary nature of the cashflows meant my net position was pretty much neutral so its all tax free.

Cheers,
Michael.

Disclaimer: Just to re-iterate that those numbers above are all very very "rubbery". Don't read anything into the numbers themselves...

 

Purely from a tax planning point of view, why are you holding appreciating (passive) capital assets in a company ? (Unless you mean the company is a trustee).

Fundamentally, capital gains tax is deferred until the asset is realised. If held by individuals or trusts then CGT concessions may be claimed when realised.

Therefore, you may want to forego some immediate (taxed) income to generate a future capital gain.

It depends on your finacial objectives. You always need some cash flow.

Cheers,

Rob