To illustrate how to formulate a strategy, we will use the following example. Firstly, you should complete the following activity so that you understand the situation.

 

Activity

Glenn and Diane Murdoch have presented at an interview with you in relation to a property investment opportunity. They are currently both aged 44 with two children in secondary school. One will complete secondary studies in two years’ time and commence university; the other will complete secondary schooling in four years’ time. Glenn is a human resource manager with a large food-store chain and Diane works as a receptionist at a local doctor’s surgery.

  • They have explained their current situation as the following:

Assets

Liabilities

Note: Glenn’s car is provided by his employer and is fully maintained by them.

Glenn and Diane have expressed their desire for investments to provide some tax relief and grow ahead of inflation. Their reason for seeking a property investment is to provide both a residence for their daughters to use for their university years and, after that time, to provide retirement income and eventually an inheritance.

Other goals include wanting to assist with their daughter’s HECS fees through university, as well as being able to travel extensively in their retirement. It is for this latter purpose that the share portfolio has been established.

 

Activity

From these details, what would the Murdochs currently have available for a property investment?

 

Income

The clients are not seeking income directly from the investment before they retire.

Growth

They did not specifically note growth as an issue, but rather associated growth with inflation.

Tax reduction

The clients have stated that they wish to reduce their taxation burden.

Inflation hedge

This was a concern for the clients, they wish to have their investment hedge inflation to ensure that the income provided will assist them in their retirement years.

Time horizon

The clients have noted that this property should be able to be used as an inheritance. This would indicate that the intention is to hold this for the long term throughout retirement, 17 or more years away.

So far we know that the Murdochs are seeking to reduce their tax and provide themselves with a hedge against inflation. It might be that a recently developed property in a growth area would be appropriate.

We now need to consider some further issues:

Location

The property is intended for use by the Murdoch children as a residence during their university years and should be close to services that will allow them easy access to their university.

Maintenance and development

The clients have not expressed any interest in developing a property.

Cost reduction

The clients have identified additional costs such as HECS fees and travel in retirement and they have non-property assets that they wish to retain. Keeping their costs down would be of interest to these clients. These further issues indicate a more specific type of property investment that it be residential and provide easy access to their university, so that it can be used by the Murdoch children.

The investment opportunity is shaping up to be an established property. While maintenance was not noted as an issue, with two students as tenants their aim will be to concentrate on their studies and maintenance of the property should be kept to a minimum. This could indicate a unit or townhouse rather than a larger block that would require more maintenance.

Consideration of the time frame also needs to be made. The eldest daughter will not be attending university for a period of two years and this may mean an off-the-plan development scheduled for completion within the two-year time frame could be considered.

The Murdoch’s current disposable income of $24,525 would service an interest-only loan of $306,000 based on an 8 percent interest rate ($24,525/0.08), which is approximately the long term average borrowing rate for mortgage loans in Australia (albeit that rates are at historic lows midway through 2016).

An off-the-plan investment could help keep costs down through probable savings on stamp duty. However, this varies between the states and you should understand the stamp duty rules for the relevant state. In addition, the delay in the need for funds may allow the use of a deposit bond, which would mean these clients would not have to use their own money to secure the property. Over a 12-month period the clients have shown their capacity to save $24,525, and it may be that they could save a further $20,000 toward the eventual purchase over the next 12 months.

At this point the potential risks to the client need to be assessed.

  • They will be using borrowed funds for the purchase and they need to be made aware of gearing risk.
  • While their time horizon is fairly long, it may pay to remind them that the strategy is recommended from a long-term perspective and any shorter-term sale may have consequences.
  • If buying off the plan, there may be delays to completion and it may be advisable to select an off-the-plan property that is due for completion well before the time it is needed.
  • In any off-the-plan sale the market value may be less on completion than the price paid or it may be more. Sufficient research into the location and its growth potential should indicate the reliability of the asking price for the property under development.
  • If the intention is for the children to use it, it will no longer be income producing and therefore will not qualify for tax deductions. They will also then need to fund mortgage repayments themselves, so this will add to their expenses at a time when they also have increased education

Taking all these considerations into account, your recommendation may be as follows:

‘Purchase a unit or townhouse off the plan in a location which allows easy access to the university, close to public transport. Use a deposit bond to secure this and delay final funding for the 12-month development period. During this time, save a further $20,000 to help fund the property.’