Outlook for Property Improves - Nicholas Dell

The prediction game is always difficult

In mid to late 2008 we were hearing economic forecasters predicting a 20%, 40% even a 50% drop in residential property values. It seems that economic forecasters don't always get it right.

Those out there with significant hands-on property experience could not reconcile what was being said by the commentators to what was happening on the ground. Out in the street demand was buoyant and this demand has intensified of late.

Interestingly, during the sharemarket gyrations of 1987, 1990, 1997, 2000, 2001 and 2008, the Australian public turned to property investment during those tough uncertain times. Bricks and mortar always appear to rule after large share market losses. It is comforting to see and touch your asset in times of economic uncertainty.

Lower interest rates help

In response to the GFC, Australia's official interest rates have been lowered by the RBA to historic lows, resulting in increased affordability by way of lowered mortgage repayments for homeowners and investors. This is one of the main factors in the rebound in Australian residential property values in lower to middle price ranges.

In the last year, the dramatic fall in interest rates in Australia also softened the blow on businesses where their borrowings were not as excessive compared with business borrowings in the US. The fall in our interest rates has also allowed the majority of employers to maintain their headcount albeit with reduced working hours due to reduced output.

A number of factors that seemed to stimulate the residential housing market were:

1. Rapid lowering of interest rates;
2. Government housing grant boost for first home buyers;
3. Investors adding property to their portfolio increasing their property holdings;
4. Reduction in the number of people making a housing upgrade due to economic uncertainty therefore supply was reduced;
5. Investors holding property due to increased affordability and reduced supply;
6. Decrease in credit availability to property developers to finance existing or planned developments. Many factors resulted in lower supply of property together with an unprecedented increase in demand placing upward pressure on property prices.

June 2009 quarter

Figures show that property prices have risen more than 3% nationwide, with a rise of 5.8% in Melbourne and 3.7% in Sydney.

Australian Bureau of Statistics has released figures showing a 7.7% rise in approvals to build new homes in July and the Housing Industry Association reported a 0.1% rise in new home sales in July after a 0.5% rise in June.

Auction clearance rates

Melbourne's year to date auction clearance rate has been approximately 78% compared with 50% in 2008.

Sydney's rate year to date has been approximately 70% compared with 45% in 2008.

On 5 and 6 September 2009 in Melbourne records were broken with 85% of 620 properties up for auction being sold. This was the strongest weekend since the best weekend of the 2007 market. In Sydney, 72% of properties up for auction were sold providing the strongest result in the market since 2005.

Whilst there are some who continue to paint a bleak picture on the future of residential property in Australia, others have reported that, relative to incomes, Melbourne hasn't been this affordable for 4 years and in Sydney, affordability is at a 10 year high.

Is this sustainable?

The factors expected to affect the residential property market are as follows:

Immediate

• Potential for official interest rate rises prior to year end - reducing current affordability levels and potentially reducing demand;
• Government grant boost reduction, so first home buyers will reduce in numbers;
• Economic outlook uncertain;
• More people selling in a traditional spring market resulting in increased supply;
• Some property investors will attempt to off load property a little too late in an attempt to cash in on the current bonanza resulting in increased supply.

Mid 2010 to 2011

• Unemployment may rise further;
• Further interest rate rises;
• Possible supply exceeding demand;
• Over development with latest figures showing that there was a 48% increase in approvals for multilevel unit development.

As these factors begin to unfold, they will directly impact the selling expectations of owners . Owners will expect today's prices, and buyers won't come to the party. This will likely impact clearance rates as more properties will be passed in. As always, an eerie moment of adjustment will begin to take place. The common run of desperation bidding seen at most auctions today, will be far less frequent.

We believe it will take a lot of negativity to douse the current demand and love for property in Australia. Property is an extremely rewarding investment over time and with professional guidance, strategic investments can be made at any time.

Nicholas Dell - Principal, Lachlan Partners Property Services

Visit the Investing Times online - www.investingtimes.com.au 
This article is an extract from the September 2009 issue of Investing Times newsletter.

To order a complimentary copy of the subscribing to the Investing Times Newsletter email susan@investingtimes.com.au or phone 1300 131 526.

Build a foundation for sensible investing   -  Andrew Page

K.I.S.S.

We in the investment world love a bit of jargon, and certainly have plenty of time for a good acronym. For instance, after evaluating the PE, ROE, MACD and OBV you can buy some CFD's, ETF's, LIC's, REIT's or maybe just some good old fashioned FPO's for your SMSF on the ASX through the SEATS platform, receive your CHESS holding statement and HIN after T+3, and sleep well in the knowledge that you are backed by the NGF and that ASIC is keeping a watchful eye on things. As a shareholder you can attend the AGM, hear what the CEO and CFO have to say on the EBIT, NTA and DPS of the business and enquire as to whether a DRP will be offered. If you didn't follow a word of that, don't worry.

The point I want to make is that the share market is a place where average investors can quickly become overwhelmed by jargon and esoteric concepts. These can be overcome easily enough for those who are prepared to do a bit of study, but unfortunately it is common for us to lose sight of the basics along the way. The foundations of sensible investing have changed little over the years, and will remain true for a long time yet, so regardless of whether you are a seasoned trader or a complete novice, it is important to understand these principles. When it comes to investing, the most important acronym is KISS: Keep It Simple, Stupid.

Spend less than what you earn

The most important thing to recognise is that the single most influential factor that will impact on your long term wealth is the amount you manage to save. This is so amazingly obvious, yet it is so often overlooked that it really needs to be reiterated as often as possible. You may be able to outperform the market by 10% each and every year, but if you invest with only a small amount and never add to your investments, even a spectacular out performance will fail to build a reasonable nest egg.

On my way home the other night a local radio show was asking callers what advice they would give to their 18 year old selves if they could go back in time. Unsurprisingly, a very common answer was 'save more'.

Accept some risk

The next thing to recognise is that in order to generate a reasonable return you must be prepared to accept some risk. Of course there is risk and then there is risk, but putting your money under the mattress or even in a savings account is unlikely to help you build much wealth over the long term, due largely to the effects of inflation. One dollar in 1989 had the same purchasing power that $1.71 has today. That's an average annual rate of inflation of almost 3% over the past 20 years. So in other words, if we assume that inflation will grow at a similar pace for the next couple of decades, you would need to grow your capital at 3% pa just to keep your purchasing power steady. One million dollars may seem like an awful lot, but in 2029 it is likely to be 'worth' just $542,000 in today's terms.

So we need to make some investments outside of cash, and this is where things can start to get tricky if you're not careful. Taking risk doesn't necessarily mean adopting an aggressively leveraged position on the futures market, but it does mean you will need at least some exposure to the best performing asset classes: shares and property. Most Australians will gain exposure to property through the family home, however outside of Superannuation most people do have any direct exposure to the share market. (According to the ASX Share ownership survey for 2008, only 36% of the adult population own shares directly, down from 41% in 2006).

Avoid most managed funds

Unfortunately many people, about 800,000 Australians, gain exposure to the share market through managed funds, and this is very unfortunate in my opinion. The main reason for this is that the vast majority of actively managed funds fail to consistently outperform the market - that is, despite the best efforts of some of the smartest and best trained financial experts in the industry, they rarely provide you with returns that are consistently better than the market average over the long term. The reason this is unacceptable is that most funds charge a fee for this mediocrity, often as much as 2.5% pa. Coupled with the effects of inflation, these funds need to generate an annual return of between 5-6% just to stay even.

A better option

If you don't know much about stock selection, risk management and all the nuances of share market investing, and quite frankly you couldn't be bothered, a great option is to buy shares in a listed investment company with a sensible long term approach to share market investing, such as Argo Investments or Milton Corp. They have very straightforward mandates, tend to do better than most managed funds over the long term, and charge management fees that are less than 0.2%pa. They give you exposure to the share market, are very well diversified and you don't need to understand anything about financial statements, fundamental ratios or esoteric technical indicators. (In the interests of disclosure I should point out that I am a unit holder in Argo, and a very happy one at that!)

Don't lose sight of the forest for the trees

While the share market has always provided the best long term returns they come at a price. Specifically, you need to be aware the in the short term the share market can be a very volatile place. Between November 2007 and March 2009, the share market essentially halved in value. However, since then it has experienced one of the strongest rallies on record. Those that didn't panic and resisted the urge to sell out in fear, are now in a significantly better position. If we factor in the effects of dividends (and why wouldn't we), anyone who invested prior to November 2006 is now back in profit.

Even for those who invested at the absolute high of the market in 2007, could now be sitting on a healthy return provided they continued to make regular investments along the way. Still, it's not the kind of thing one hopes to experience, but at the same time it is not too bad given we have just experienced a global financial crisis and one of the worst market corrections in history.

The point is that you should never invest with money that you are likely to need in the next few years. If you stay focused on the longer term you will most likely be able to ride out any short term volatility, and although that's easier said than done, history has repeatedly shown that it is the patient investor who most often does best. So forget the day to day gyrations of stock prices, and instead focus on the bigger picture.

Be realistic

Another problem associated with the share market is that people often approach it with wildly unrealistic expectations. Without doubt there are some great success stories out there, and these often lead people to expect that they too could experience similar gains.

The truth is that those that have experienced phenomenal gains have done so because they have accepted a huge degree of risk, most probably through highly leveraged instruments and with a focus on only a handful of speculative stocks. High risk strategies like this pay extremely well when they work, but what you need to remember is that the losses can be just as spectacular. So unless you are prepared to gamble with your life savings, it is best to hold more reasonable expectations. Over the past 20 years, the Australian market has averaged a total investment return of about 10% pa.

Summary

So there you have it. Before you get too engrossed in the detail of share market, remember the golden rules of investment and wealth creation. Plan to live within your means, save what you can and make some sensible long term investments. Understand that while the share market can be a volatile place, it has consistently delivered attractive and highly tax effective returns over time.

This approach certainly won't make you an instant millionaire, but it will ensure your capital is put to work in an effective and sensible manner, and over time it will help you build far more wealth than you ever would through your average savings account or indeed, more often than not, reckless and highly speculative trading systems. Keep it simple, stupid.

Andrew Page -  Media & eLearning Manager - Hubb Financial Group

Download HUBB's free scanning & charting software at www.hubbinvestor.com

All recommendations are provided without consideration of any specific reader's investment objectives, financial situation or particular needs. Those acting upon such recommendations do so entirely at their own risk.

Depreciation, repairs and tax ramifications need to be weighed up before you move out of your so that tenants can move in. - Julia Hartman

IF the thought of all that non-deductible interest we talked about last month hasn't put you off the idea of keeping your old home as a rental, here's a look at some of the other ramifications.

DEPRECIATION

When you purchase an established property the depreciation base of the plant and equipment, such as carpets, curtains, the stove and hot water system, is their secondhand value at the time you buy the property. These items are depreciated over their effective life whether the property is a rental or not, but it must be a rental for you to be able to claim a tax deduction for the depreciation. For example, carpets have an effective life of 10 years so the depreciation rate is 10 per cent prime or 20 per cent diminishing value. If you've already lived in the property for four years then rent it out, under the prime cost method you can continue to claim10 per cent of the secondhand value for the next six years.

The diminishing value method is a bit more complicated and best explained by example. If the carpet had a secondhand value of $1000 when you purchased the house, then depreciation would have been 20 per cent of $1000, which equates to $200 in the first year. The second year it's 20 per cent of $800 ($1000 less $200) which equals $160; the third year $640 multiplied by 20 per cent which equals $128; the fourth year $512 x 20 per cent = $102. So by the time you start to rent the property out you only have $402 left to claim and you must continue at the 20 per cent diminishing rate. If you bought your home new then just substitute the actual new cost of the plant and equipment for the secondhand value in the calculation above. If you bought plant or equipment after you purchased the house then the depreciation starts from that date using the price you paid.

REPAIRS

If you do repairs before you put your home on the market to rent out you're not going to get a deduction for them. Even once it becomes a rental property, repairs that relate to your period of occupancy, either because of a fault present before it became a rental that has later caused damage or just things you hadn't gotten around to fixing, then the expense is apportioned between the number of weeks it was rented that year and the number of weeks it wasn't, the former being the only portion claimable.

On the other hand, if you wait until the following financial year when it has been a rental all year the repair expense is fully deductible even if it became necessary while you were living there. Note, an overriding rule when there's some private use during the year is it must actually produce rental income in the year of the repair for a deduction to be considered. It isn't enough that it's available for rent.

If the repair was actually necessary when you purchased the property then no deduction is claimable, it can only increase your cost base for capital gains tax (CGT) purposes and the amount of special building write-off you can claim.

If your home becoming a rental property causes the cost base to be reset at market value, as we discuss later, then think hard about the timing of a repair that was necessary before you purchased the property. If it mainly involves your own labour and will increase the market value of the property then it's best done before it becomes a rental. On the other hand, if the cost to you of the repair exceeds the amount it will increase the value of the property, it's best done after the 'reset at market' value is triggered.

CGT.

If the property was purchased by you before September 20, 1985 you don't have to worry about the CGT ramifications at all and the fact that the property will continue to be exempt from CGT for as long as you own it is a very good reason for holding on to it, if you can, even though your interest deductions may be low.

For all properties purchased after September 19, 1985, CGT can apply if it's no longer covered by your main residence exemption. This would be the case if you choose to cover your new home with the main residence exemption, or it becomes compulsory after the property has been rented out for six years straight.

If this is the first time since you've owned the property that it has been used to produce income, then its cost base is reset to the market value upon it first earning rent. This is automatic, not optional, but it must have been fully exempt from CGT up to that date. In cases where you are only entitled to a part exemption because you have been using it as a place of business as well as your home from the time you purchased it, or you did not move into it as soon as practical after settlement, or it started to produce income in someway before August 20, 1996 your cost base calculation starts with the original cost of the purchase. If it was your home from the start but at some time after that you started to use it to produce income (i.e. running a business from home or renting out a room) then you start your cost base calculation with the market value at that time.

MARKET VALUE.

If, as discussed above, you need to start your cost base with the market value then to calculate your actual capital gain nothing that was incurred before the date the cost base was reset at market value can be included in the CGT cost base. If the property was purchased or the cost base reset after August 20, 1991 then you can include in the cost base ownership costs such as repairs, insurance, rates, interest, cleaning, maintenance etc., as long as they haven't been claimed as a tax deduction. Note, the value of your own labour can't be included. This is one advantage of having the cost base reset because it's quite likely the market value of improvements before that date will effectively include your labour. Then there are the costs of selling. Deduct all these costs from the selling price to work out your capital gain. If it has been covered by your main residence exemption at some time since the cost base has been reset or since you purchased the property then you need to work out how many days it was covered and how many it wasn't, then apportion the gain proportionately over these periods.

The taxable amount is the portion that represents the days it wasn't covered and this will qualify for the 50 per cent discount if it has been more than 12 months since the cost base has been reset.

ORIGINAL PURCHASE PRICE.

If you need to start your cost base with the original cost then, providing you purchased the property after August 20, 1991, you can include in the cost base any cost associated with the property that you haven't otherwise claimed as a tax deduction - even interest, cleaning, lawnmower fuel etc. If you purchased the property before that date then you can only include costs associated with buying and selling and professional assistance in that regard. Also costs of any improvements.

MAIN RESIDENCE EXEMPTION.

If you construct your new home and you want to cover it with your main residence exemption from the time you purchased the land you'll have to expose your old home while you're living there. You can't use the six months overlap rule in these circumstances because it's a requirement of this rule that the old home can't be a rental in the 12 months before it's sold. The six-year rule (section 118-145 of the Income Tax Assessment Act) applied to the old home or the four-year rule (section 118-150) applied to the new one will let you choose which property you cover with your main residence exemption after you've lived in it as your home. You don't have to make this choice until you sell one of the properties.

If you choose to expose your new home you'll have a sleeping CGT problem and a record-keeping nightmare but the CGT might not be that bad because you can increase your cost base by all the ownership costs, even lawn mowing and cleaning products. Also, if when you die it's still considered your main residence (even by using the six-year rule) then all the CGT liability is for given because your heirs will inherit it at market value at your date of death, regardless of any CGT you would have had to pay if you sold it while you were alive.

© Australian Property Investor magazine - www.apimagazine.com.au. Reproduced with permission.

This information is of a general nature only and does not constitute professional advice. You must seek professional advice in relation to your particular circumstances before acting. Please read our warning and disclaimer.

Helping to secure a better lifestyle - Laura Menschik

Protecting your wealth

Australian executives are working longer hours than ever before. The events of the past 18 months are only beginning to be felt in slashed bonuses and a steep drop in remuneration across the board. But the pressure to perform has never been greater.

Something has to give. And it's usually your personal and financial well being. Senior executives have the expertise to manage their own finances, but too often they simply don't have the time. The increasingly complex array of financial products, and the pressure of regulation and compliance, makes it almost impossible for you to stay on top of it all. As an example, SMSF investors can be fined up to $220,000, and face up to 5 years prison for non-compliance. Even in less extreme cases, the consequences can be devastating. Your assets may be taxed at the punitive rate of 47%.

Take responsibility or leave your family vulnerable

Putting off engaging with your personal finances not only costs you opportunities, and saddles you with tax inefficiencies. Failure to take responsibility for income protection, life insurance and estate planning leaves you and your family vulnerable. If the worst were to happen, how long could your family meet property and other loan repayments - and maintain their current lifestyle?

Are you taking risks without realising it?

We all know the importance of going to the doctor for a regular health check - particularly as we get older. But when is the last time you got a financial health check? Most of us already know what we should be doing. But, with the demands of work and family, it just doesn't get done. We get swept along by life, career, health and family events, and sometimes we get blown off course.

What should you investigate?

The essential aspects of executive financial planning cover investment strategies to estate planning. No-one's circumstances are exactly alike, and the higher your income, the more complex your affairs are likely to be. This means there will be plenty of opportunities for consolidation, streamlining and efficiency savings.

In extensive research on both the financial and psychological aspects of planning the following issues need to be addressed:

• The main questions to ask any financial advisor - before you hand over your money and your family's future
• 'Sanity Check' - are you really where you think you are financially?
• Risk profiling - how to strike the right balance of growth and security
• Stress testing - are you taking risks without realising it?
• Long and short term goal setting - designing the lifestyle you want
• How to make your portfolio more efficient - stop wasting your free time
• Wealth Accumulation in adverse market conditions:
  • Long term planning
  • Negative, neutral and positive gearing
  • Benefits and risks
• Tax strategies and compliance to keep you in the clear
• Looking after the next generation - while making them independent
• How trends in executive remuneration could affect you:
  • Options and tax
  • Cap/Collar strategies
  • Accessing value

Proper planning can contribute to your financial future, in areas such as:

• Discretionary, unit, hybrid and testamentary trusts - how they can protect your assets
• Taking advantage of imputation benefits
• Residential, Commercial, Industrial and Retail property investment
• Securing your family's well being with the right insurance

A high income alone is no guarantee of financial freedom in the future. Your lifestyle can make serious inroads on your ability to save. And beyond a comfortable life now and in the future, you most likely would want to be able to provide for your children's future - to help them buy that first car and home, and to support them when they start their own family.

Taking control

Taking control of this vital area of your life can bring many positive changes:

• Real freedom to design your lifestyle - now and in the future
• Security and peace of mind for you and your family
• No more missed opportunities or wondering 'what might have been'
• Inside knowledge on the best deals
• Clarity, order and purpose
• The satisfaction of knowing that your affairs are in order - without spending too much of your free time on your investments

In future money.com.au newsletters we will cover the various individual issues, mentioned above, in more detail as well as try to answer any questions that readers may send in. As with all aspects of your financial affairs, you should to seek professional advice to ensure that your personal circumstances are well considered and advice is suitable to your needs.

Laura Menschik
Director and Authorised Representative
WLM Financial Services Pty Ltd.
CERTIFIED FINANCIAL PLANNER TM - SMSF SPECIALIST ADVISER TM
Fellow of the Financial Planning Association of Australia Limited

WLM provides wealth and lifestyle management services in a professional and personalised manner, by qualified advisers, on a fee-for-service basis. WLM is independently owned by its Directors. Visit WLM Financial Services online wlm.com.au

Finding Small Cap Stocks takes time but can be worth the effort - Julia Lee

Small Cap companies are those companies with a market capitalisation of less than $300 million on the Australian sharemarket, there are lots of them, so if you want to find the next Microsoft or the next Cochlear it's not as easy as it seems.

The market capitalisation of a listed company is found by multiplying the number of shares on issue by the current price of the share. For example 10,000,000 shares at $1 would give a company a market capitalisation of $10 million. Australia's largest company by market capitalisation is BHP Billiton Limited with a market capitalisation of more than $124 billion currently. Each trading day when a listed company's share price rises or falls so does the market capitalisation.

There are over 1000 small capitalisation companies listed on the ASX.

How do you sort the potential diamonds from the dirt when there is not always a lot of information around these companies and certainty not a lot of research available?

Researching Small Cap Stocks

Brokerage houses and analysts tend to stick to the top 200 stocks on the Australian market so it's a case of finding a research group that specialises in small caps or to do it yourself.

If you want to invest in a basket of small caps, there is the ASX small cap index which invests in the top 300 companies which are not also in the top 100 index.

Small Cap Stocks in Bear and Bull Markets

Companies tend to have their own life cycle. With small caps you are usually looking at businesses which are focused on growth. With the growth focus also comes the extra risk and then the potential for a greater return.

Growth tends to be popular when the market is rising but highly unpopular when the market is falling.

If the market is in a bear market cycle (falling) then the chances are that any small cap stocks that you have will be hammered. That's because risk is the first thing that tends to be eliminated from portfolios when the market is falling.

Investors and traders have a tendency to rush back to safe havens like cash or relative safe havens such as the defensive blue chip companies.

On the flipside, in a bull (rising) market, small caps will usually tend to perform relatively well as a group as investors add risk back to portfolios.

The problem with small caps is that many of them are not yet turning over a profit so it's quite difficult to evaluate them from an earnings prospective. The traditional ratios such as P/E and return on equity (ROE) aren't relevant when there aren't any historical earnings. If the company has sales, you can look at sales growth and the price to sales ratio. At some point the sales will have to translate into profit for the business model to be viable.

Here are a few tips on helping you to find these diamonds in the rough yourself:

• Look at the shareholders of the company. Does it have the backing of a larger organisation or perhaps even a venture capital firm that has taken a majority stake. Although it's not foolproof, it is a sign that someone may have done the hard yards and looked hard and fast at the business potential of the underlying business.
  
  
• How many years until commercialisation and what's the probability of commercialisation? Have a read through the annual report to work out a time line and the business plan for the organisation. What is the potential market once commercialisation has been achieved. What P/E ratios are potential competitors or similar companies trading at. What type of return can you hope for based on those valuations.
  
  
• Who are management? Do they have expertise in doing the same type of thing before? Is there visibility on what is happening within the business or as a shareholder or will it be a guessing game?
  
  
• Cash is King. Have a look at how much cash they have in the bank. After all, there is an endless stream of good ideas, the goal is to be able to bankroll the idea until commercialization.
  
  

Investing in small caps usually takes time

It usually takes a lot of faith to weather the ups and downs of a smaller growing company. It's highly risky but on the flipside there are the companies that become the next Cochlear, Resmed or Fortescue.

Happy trading!

Julia Lee - Equities Analyst - Bell Direct

To buy or sell shares from as little as $15 per trade, go to www.belldirect.com.au  

Bell Direct does not provide investment advice. This information is general information only. You should consider your own financial situation, particular needs and investment objectives before acting.

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