PROPERTY REVIEWERREAL ESTATE INVESTMENT TRUSTS & FUNDS

Unlisted property: An attractive asset class with tax planning benefits

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OPINION: WITH attractive yields and potential tax benefits, unlisted property is a popular option amongst income-focused investors, writes Cromwell Property Group’s Head of Retail Funds Management, Hamish Wehl.

Searching for reliable, consistent sources of income in the current market has become a real challenge for investors.

Savers have been hit by record-low interest rates on cash and term deposits, investors are paying higher prices for declining yields in bond markets, and equity markets are arguably looking fully priced.

As a result, many investors are turning to alternative asset classes, such as unlisted property, for sources of both income and diversification in their portfolios.

Stable income with capital growth potential

The Australian commercial property sector delivered an income return of 5.4%1 for the 12 months to 30 June 2019 with a total return of 8.2%. Over ten years, the figure is even more impressive with income of 6.8% p.a. and capital gain of 3.3% p.a. offering investors consistent stable monthly income with some capital gain upside.

Unlisted property is a diverse asset class, encompassing retail, office, industrial, and specialist properties such as hospitals, aged care facilities, childcare centres, and storage facilities.

Unlike listed property (A-REITs), unlisted property is not correlated to equity markets, meaning it can provide attractive portfolio diversification factors. Investors benefit from returns that are made up of income from rents, along with capital growth potential as the price of the underlying property assets increase.

An easy way to invest in the sector is via a professionally managed unlisted property trust, which provides access to a ready-made property portfolio, often diversified across different sectors, tenants, geographies, and lease terms.

Tax-deferred income

Tax-deferred distributions are a benefit of unlisted property often overlooked by investors. It represents a distribution of non-assessable income due to a trust’s rental income being higher than its taxable income. Property trusts can reduce their taxable income by claiming deductions on items such as depreciation, capital allowances, and the costs of raising equity and establishing debt facilities.

Most property trusts make monthly income payments to investors, typically from income received from tenants of property assets held in the fund. Part, or all, of these distributions may contain a ‘tax-deferred’ component – usually 50-100% of the distribution.

As long as the unitholder’s accumulated tax deferred distribution income is less than the acquisition cost, the tax is generally able to be deferred. Tax is only paid, in whole or in part, when a capital gains event occurs – for instance, if the investment is sold or the property trust wound up.

This means tax-deferred distributions are generally non-taxable when received by investors. Instead, the investor’s cost base for capital gains tax (CGT) purposes is reduced by the amount of the tax-deferred distributions received.

From an investor perspective, this can mean a significant boost to the end return. This is because cash that is not paid out as tax can be kept within the investment, accruing more income and capital gains over time. Where tax-deferred distributions are received before retirement they may effectively be received tax free if the units are disposed of after transitioning to pension phase.

Tax-advantaged income case study2

The case study below shows the effect of tax-advantaged distributions for an investor on the top marginal tax rate (inclusive of the 2% Medicare levy). The case study compares a hypothetical investment of $100,000 into an interest-bearing investment earning 8% per annum with a property investment paying 8% distributions.

ABC Interest Investment

($100,000 initial investment)

XYZ Property Trust Investment

($100,000 initial investment)

Difference
Interest Tax Payable Net Income Distribution Tax Payable Net Income  
Year 1 $8,000 $3,760 $4,240 $8,000 $8,000 $3,760
Year 2 $8,000 $3,760 $4,240 $8,000 $8,000 $3,760
Year 3 $8,000 $3,760 $4,240 $8,000 $8,000 $3,760
Year 4 $0 $0 $0 $5,640(1) -$5,640 -$5,640
TOTAL $24,000 $11,280 $12,720 $24,000 $5,640 $18,360 $5,640

As you can see, an investor on the top marginal tax rate is $5,640 better off over the three-year investment period, equivalent to approximately a 44% improvement in the after-tax returns, and a better cash flow profile under the capital gains taxation regime. This calculation is shown below.

Capital gain = $100,000 capital redemption less reduced cost base of $76,000 ($100,000 initial investment less $24,000 tax deferred distributions = $76,000) = $24,000. Tax payable = $24,000 x 47.0% x 50% = $5,640.

Selecting the right unlisted investment

Funds that mainly hold older properties are likely to offer lower tax-deferred income as tax breaks tend to reduce as a property ages, while those that hold newer assets or continue to buy properties will likely offer higher tax-deferred income. For example, Cromwell’s Direct Property Fund, which recently purchased Altitude Corporate Centre in Mascot NSW, offers investors 5.8% returns with ~50% of income tax-deferred for the financial year ending 30 June 2019.

Some other key considerations when choosing an unlisted property fund include management expertise and track record. Commercial property tenants usually have complex requirements, which require strong management. An experienced investment team will also be able to diversify assets and negotiate longer leasing terms, leading to better investment outcomes.

The level of risk in the fund is also important. Quality buildings, tenants, and lease terms are important for generating stable returns over time. In addition, borrowings can also magnify both capital gains as capital losses. As a guide, the loan to value ratio of new trusts tends to be below 50%.

Finally, investors should determine their investment timeframe before making any investment. Open-ended property funds hold cash, allowing investors to exit at any time, while syndicates are illiquid, with an expectation that unitholders will hold the investment to term – usually five to ten years.

Unlisted property offers many attractive benefits for investors, with returns in the form of capital gains and regular distributions. The tax-deferred distributions on offer from many of these investments also have the potential to enable better long-term returns and greater reinvestment.

By Hamish Wehl, Head of Retail Funds Management, Cromwell Property Group.*


  1. PCA/IPD Australian All Property Digest (Source: MSCI) as at 30 June 2019
  2. Assumptions used in the case study:
  3. The property trust pays tax advantaged distributions.
  4. An investor invests $100,000 into XYZ Property Investment (for example, an unlisted property trust) on 1 July of year one at a cost of $1.00 per unit (XYZ Investment).
  5. The XYZ Investment is redeemed after three years at a unit price of $1.00. No allowance has been made for any potential capital gain or loss from unit price increases/decreases during the period the investment is held. This would also have CGT implications.
  6. Distributions from XYZ Investment are declared 100% to be tax advantaged distributions for the full period of the investment.
  7. XYZ Investment distributes 8.0 cents per unit per annum.
  8. The investor does not have any capital losses available to offset gains.
  9. The tax rate used of 47% consists of the top marginal tax rate of 45% plus Medicare levy of 2%.

The above commentary and case study has been prepared for general information purposes only and should not be relied upon as tax advice. An investment into property trusts can give rise to complex tax issues and each unitholder’s circumstances will be different. As such, we recommend before taking any action, that you consult your professional tax advisor for specific advice in relation to the tax implications.

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