Welcome to the May 22nd edition of the Hudson Report.

In this edition of the Hudson Report, Stephen Rake discusses gearing within superannuation, and what the new legislation allows.

All the best,
Lauren Coar
THE HUDSON INSTITUTE

The introduction of legislation last year allowing superannuation gearing has led to a lot of interest, particularly from trustees of Self Managed Superannuation Funds (SMSFs), eager to get the ball rolling and use gearing strategies within their SMSFs.  However, there are still some question marks in relation to the scope of the strategies allowable, which indicate it may be better to wait for further guidance from the Government and the ATO.

The amendments to the legislation came into play on 24 September 2007 and added an exception to the prohibition against borrowing.  The amendments gave certainty surrounding the use of instalment warrants in SMSFs, however the legislation has given the potential for much broader applications.

The new legislation permits SMSFs to borrow for investment purposes, provided the SMSF trustee borrows the money in accordance with an arrangement that meets the following criteria:

• The borrowing is used to acquire an investment asset.

• The asset is held on trust so that the SMSF trustee receives a beneficial interest and a right to acquire the legal ownership of the asset through the payment of instalments.

• The lender’s recourse against the SMSF trustee in the event of default on the borrowing is limited to rights relating to the asset only. That is, while there is no legislated limitation on the total amount that can be borrowed by a fund, the lenders security must be limited to the underlying asset subject to the borrowing.

• The loan arrangement must be on an arm’s-length basis and the asset must be one that the SMSF trustee is permitted to acquire under current SMSF legislation.

Interestingly, there are no limitations in the legislation on the source of the loan and eligible lenders can include banks, private organisations, relatives and members of the fund.  When the lending is sourced from a member, it must be:

• For the sole purpose of providing retirement benefits for members,

• Conducted on an arm’s length basis, and

• Comparable to what a financial institution would provide regarding the terms and rate of interest offered.

The new rules do not allow super funds to borrow in regards to an asset that is already held by the fund and in-house assets rules still apply.  Therefore, trustees will be unable to purchase assets they already own, either in their own name or through any related party.  An exception to this relates to business property, which may be permitted, however specialist advice should always be obtained.

Why Borrow In A Super Fund?

Gearing allows you to borrow money to increase your investments and can be a way of speeding up wealth creation, as you have more money working for you. This can have the effect of accelerating your capital gains.

The principle behind gearing is that the growth in the value of your investment will exceed the cost of borrowing the money to finance that investment. While borrowing to invest increases the potential profits on your investment, you should also consider the fact that in a period of negative returns potential losses are also magnified.

Before undertaking a gearing strategy, (whether within a super fund or outside) you should ensure it is in line with you risk profile, your investment goals and objectives and importantly, your investment timeframe.

The new rules allow investors, who were looking to acquire assets for their fund, which they previously could not afford, the scope to now do so.  This is of particular advantage to investors interested in purchasing residential property within their SMSF.

Points For Consideration

• With borrowings restricted to limited recourse loans, a potential issue for trustees will be attracting potential lenders.  And to what level will they lend and at what interest rate, when they only have limited recourse.  The legislation does not forbid the possibility that persons outside the super fund may offer personal guarantees to provide the additional level of security lenders may be looking for.  However, the presence of such a third party could possibly impact on the arm’s length nature of the agreement.

• Without an appropriate trust in place, SMSF trustees will not be able to take advantage of the new provisions.

• Using a trust can increase the risk of double stamp duty costs.  Ordinary stamp duty costs apply on the original purchase of the asset, but how the trust is established can impact on whether or not there will be a second amount payable on completion of the debt arrangement.

• The stated purpose of the investment (capital growth or income) will have significant bearing on how the interest costs incurred are treated for tax purposes.

• There has been comment that the new rules may be used to circumvent the superannuation contribution caps.  Therefore, it is quite possible further legislation may be issued on how a loan and interest payments should be made and whether or not it would be possible to circumvent the contributions cap.

• There are areas that have not yet been addressed in the legislation (e.g. processes to ensure assets are appropriately priced).

All of these issues add to the already heavy compliance on SMSFs.  The real risk is where SMSF trustees are found to be acting outside the spirit of the legislation.  As such, it may be better to wait until further understanding of the legislation is gained, before rushing into a SMSF gearing strategy. Or at least, follow well-established lines with the assistance of professional advice.

After speaking to one of our financial advisers and property partners, you have decided to purchase a property, but it is “off the plan”.  That is to say, construction of the building into which you are buying has not yet begun or is not completed at the time you purchase your property. This means that settlement of your property purchase is likely to be a year or more after you sign the purchase contract.

You may ask, “What is different about buying an “off the plan” property compared to buying an existing property?"

Buying “off the plan” can give you certain benefits including:

• Purchasing at today’s price and hopefully acquiring some capital growth between purchase and settlement.

• 10% deposit only required.

• Minimum cash flow required to hold the property between purchase and settlement.

However there are a couple of important differences that you must be aware of, to ensure that your purchase makes it to settlement without a hitch.

In both cases (off the plan or existing property), before committing yourself you would speak to our finance department to determine whether you can obtain the necessary lending for the potential property purchase. The lender will determine whether you can service the property AS OF NOW.  

Here is the first difference – when buying off the plan, what needs to be considered is whether you can service this property in a year's time or two year's time. And this is what we will look at when helping you to find the best loan product for your “off the plan” property.

The next main difference is the terms of the Contract. When purchasing an existing property your Contract is usually subject to a 10% deposit and a finance clause. In order to meet these clauses you obtain an Unconditional Approval from a lender for the property and you pay the 10% deposit. Once this has been done the Contract of Sale goes unconditional. This means that you are now locked into that contract for settlement.

With an “off the plan” property, the Contract is generally subject to the same clauses, but because it is “off the plan” the lenders cannot issue an Unconditional Approval for the lending – they can only issue an Approval In Principle. This means that given your circumstances at the time of applying they would approve the loan as long as the valuation on the property comes in at an acceptable level at the time of settlement.  This is the time when we can arrange for payment of your 10% deposit.  This can be arranged from any one of the following sources:

• Deposit Bond

• Cash

• Line of credit or redraw

• Bank Guarantee

The best option for paying your deposit will depend on the particular development and settlement time frame involved.  In some cases developers may pay interest on cash deposits, some may not, some developers will not accept deposit bonds, some will.  All these factors will determine which is your best option.

It is extremely important to ensure that there are no major changes in your circumstances between committing to purchase a property “Off the Plan” and the settlement of the property. 

Such changes in circumstances could include:

• Change of job with a lower income level

• Financing of another property

• Financing for the purchase of shares or managed funds

If you are considering any of these types of options between purchase and settlement, then you can simply run the scenario by Hudson’s finance broker, Matthew Kerr, to ensure that it doesn’t jeopardize your chances of settling on the property at the settlement date. 

It is also important to note, that in some cases, settlement time frames can be brought forward from the estimated dates and as such, you may need to be ready to settle earlier than expected. 

Overall, if you are thinking about purchasing a property off the plan don’t forget to speak with your advisor for advice on the potential purchase, and they will in turn book you in to speak with Matthew Kerr (Hudson Finance Manager) to discuss your lending options including affordability, deposit options, structuring etc.

Well, it’s that time of year again, with the end of financial year quickly approaching.  To assist you in preparing for this usually hectic time of year, we have prepared a checklist of some of the factors you could be considering:

• Prepaying interest on eligible investment loans to bring forward tax deductions.

• Review investments – in particular review possible capital gains and losses incurred.  Deductions allowable and income earned.

• Are you eligible for the Government superannuation co-contribution scheme for this financial year?  If so, have you made sufficient non-concessional contributions to super?

• Review superannuation salary sacrifice arrangement and ensure you are within contribution caps.

• Will you (or do you wish to) maximise contributions to superannuation within the annual superannuation contribution caps?

• For self-employed people – are you intending to make a superannuation contribution and claim a tax deduction?

• Should you split any concessional superannuation contributions made in the 2006/2007 financial year with your spouse? Applications generally close 30 June 2008.

• Are you eligible to make a contribution to superannuation on behalf of your spouse and claim a tax rebate?

• Review possible personal deductions.

These are just a handful of issues to consider.  There may be plenty of others – just don’t leave it all until it’s too late.

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The All Ordinaries finally hit the 6,000 point mark again during the week, but did finish slightly weaker on Wednesday closing at 5,916 points, while the benchmark S&P/ASX 200 closing at 5,823 points. 

Shares in Biota Holdings (BTA) found support over the past week after its anti-influenza drug Relenza, was found to be more effective against certain strains of the virus than a rival product. Shares closed at $1.09 on Wednesday.

The banking sector finished weaker on Wednesday, with Commonwealth Bank (CBA) down $1.20 to $42.58, National Australia Bank (NAB) losing 29c to close at $33.47 and Westpac (WBC) closing at $23.53, down 62c.

Lion Nathan (LNN) finished 20c stronger at $8.85 after reporting first half net profit after tax of A$164.6m.  This was above their forecasts, with stronger operating profits from Australian and New Zealand beer and wine sales.

It’s been two weeks since the last share market update and the major global indexes have traded lower over this time.

• Dow Jones : 419 points weaker, closing at 12,601

• Nikkei 225 (Japan):  176 points weaker, closing at 13,926

• Hang Sang (Hong Kong): has fallen 150 points to close at 25,460

• S&P 500 (US): closed 28 points down at 1,390

• FTSE 100 (UK): closed at 6,198, an fall of 17 points

 

Macquarie Group Limited (MQG)

Macquarie Group is Australia’s premier listed investment bank, with activities in corporate finance, treasury and commodities, equity markets, funds management and property.

The group surprised with a 45% increases in Net Profit After Tax for the first half of the 2008 financial year.  Management have however, erred on the side of caution, in stating that they only expect to meet full year expectations and as promised delivered a $1.8 billion net profit this week with a much better second half.

The group is well placed despite the current turmoil in the global credit markets.  Sound risk management has minimised the impact of the sub-prime fallout.

Some of the strengths of Macquarie include:

• The bank has a well-diversified revenue base both by geography and by business mix, which moderates the risk profile.

• The bank is focused on growing its annuity-style revenues.  This focus will provide the bank potential to achieve high earnings growth through sustainable earnings over the long term.

• The bank has large financial capacity to fund growth opportunities, including offshore plans and new product initiatives.

Buy for long-term capital growth.  Shares in Macquarie Group closed at $58.50 on Wednesday.

Hudson’s Buy Recommendation - MQG @ under $59.00

Current P/E Ratio	8.7
Dividend cents/share	345c
Dividend Yield	5.90%
52 week high	$92.99
52 week low	$42.95

General Advice Warning

Information contained herein is general financial product advice and does not take into account individual situations, needs or goals. It should not be relied upon and persons should satisfy themselves through independent means that any decisions based on this material are appropriate. 

We recommend that you consult with your qualified and licensed Hudson Adviser who will be able to make a recommendation based on your specific circumstance

Disclosure

The Hudson Institute is not a stock broker. The research for our stock recommendations is collected from our various share market partners: Intelligent Investor, Investor Web, Ord Minnett, ABN Amro Morgans and Citigroup.

DISCLOSURE: Employees of Mainview Securities Pty Ltd currently hold shares in: ASX Codes: AMC, AMP, ANN, ATG, BHP, COH, CML, CSR, FLT, HHG, HHV, MAX, MPR, MGW, NAB,NCP, NLX, PBB, PBL, PMC, PMN, RIO, RSP, SGS, SGT, SOT, SUN, TOL, UNW, WES, WDC, WOW,CBA CPU BXB SIP DYE PTM ABQ SHL RMD; Managed Funds APIR Codes: ADV0013AU, HOW0143AU, FSF0035AU, FSF0007AU, FSF0145AU, FSF0041AU, JBW0102AU, PER0038AU, PPL0108AU, PLA0002AU

This is not a recommendation

Copyright

The material provided in the Hudson Report and at Hudson Institute web site by Mainview Securities Pty Ltd, is copyright protected.As this information is copyright protected, It is not for distribution. Any requests to use information provided for commercial use may be directed to - Lauren Coar

The Hudson Report Online is published by The Hudson Institute, trading under Mainview Securities Pty Ltd, Australian Financial Services Licence No. 241177

Credits

This week's Hudson Report was prepared by: Stephen Rake

Financial Adviser
Authorised Representative
Mainview Securities Pty Ltd
T/A THE HUDSON INSTITUTE

The Hudson Report is edited and formatted by Lauren Coar