CoreLogic reported that the total value of Australian property stands at an impressive $11 trillion, surpassing the combined worth of all listed companies on the Australian Stock Exchange by more than five times.
Despite this staggering figure, financial advisors have typically concentrated their efforts on shares, bonds and superannuation, often treating property as an afterthought.
In my experience, many individuals make only a handful of property decisions, whether related to their home or investments, over their lifetime.
These choices can significantly impact personal wealth and have far-reaching consequences on other financial decisions.
Unfortunately, these critical property decisions have historically been ignored by financial advisors.
In this blog, I will share real-life examples that illustrate how property decisions are intertwined with various financial planning and lifestyle choices, ultimately shaping a comprehensive financial strategy.
That is why financial advisors must accumulate more knowledge and experience so that they can help their clients make smart property decisions.
Why don’t financial advisors offer property advice?
Just over a decade ago, many financial advisors primarily relied on commissions from investment products as their main source of income.
This created a clear financial incentive for them to direct clients toward the share market while steering them away from direct property investments.
Also, some property developers used to pay commissions to financial advisors who successfully recommended their clients buy their off-the-plan properties, often at inflated prices.
Unfortunately, this frequently ended poorly for clients, leading many dealer groups (businesses that license financial advisors) to prohibit property-related advice.
As a result, most financial advisors now have limited direct knowledge and experience in property.
Consequently, many Australians turn to buyer’s agents for property advice and financial advisors for other matters.
However, this division is not ideal.
Buyer’s agents often lack the comprehensive financial planning expertise needed to fully understand the broader implications of property decisions.
To improve this situation, the industry must attract new talent that isn’t constrained by outdated financial planning practices.
We need professionals who are eager to learn about property and who can integrate both asset classes into a cohesive financial strategy.
Here are a few examples that show how closely property advice and overall financial planning are interconnected.
When to sell an underperforming investment
Our client owned two investment properties, neither of which were high-quality assets; both had some impairments that impacted their overall investment returns i.e., income and growth.
The client wanted to buy a holiday home, and we determined that it would be best for them to sell one of the investment properties.
This approach would allow them to avoid borrowing money for the holiday home, especially since they were approaching retirement.
After analysing the investment properties and comparing the capital gains tax (CGT) liabilities, we identified which property to sell.
We decided it was wiser to hold off on selling the underperforming investment property until after the holiday home purchase.
This way, we could delay the CGT liability as long as possible.
The client successfully purchased the holiday home and later sold the investment property to its existing tenant.
Determining how to fund the holiday home required a multifaceted approach.
We had to consider various factors, including taxation implications, asset class options (the client could have sold either property or shares to finance the purchase), investment property expertise to assess the properties’ attributes and potential future returns, and overall financial planning to integrate all these elements.
I’ve often heard clients say that previous financial advisors advised them to sell their investment properties without any clear justification, and those clients would have been worse off if they’d followed that advice.
I approach the recommendation to divest from a property with great caution.
I never take this decision lightly; it’s crucial to conduct a thorough analysis to ensure that selling is truly the right move for the client.
Managing debt so you can comfortably transition into retirement
Our firm recently created a holistic wealth strategy for a new client who was nearing retirement.
This client had several million dollars in investment debt but maintained a very conservative loan-to-value ratio of around 35%.
The issue was that their interest-only period had expired, and the bank was unwilling to extend it.
As a result, their loan repayments were set to switch to principal and interest over the remaining 20-year term, resulting in annual payments of several hundred thousand dollars.
To address this, we developed a strategy that involved selling 2 of their 7 existing investment properties – one now and another within the next couple of years.
We were also able to refinance most of the loans back to interest-only and minimise capital gains tax by starting a pension in his SMSF.
Creating this plan required a multifaceted approach, incorporating mortgage broking, tax planning, property advice and traditional financial planning. It was essential to have a financial advisor who understands property.
While we are grateful the client sought our advice when they did, I can’t help but think that we could have achieved an even better outcome if they had engaged with us a few years earlier.
I have written about how important it is for investors to understand property cash flows, especially if they are within 10 years of retirement.
Renovate versus upgrading
As part of a broader holistic wealth strategy, our senior financial advisor, Campbell Wallace, recently assisted a client in evaluating whether to renovate his existing home or upgrade to a new one that better suited his needs, all while staying in the same blue-chip suburb.
Since the quality of the underlying land was similar in both scenarios, the main differences were a slightly larger block of land and larger accommodation.
In our view, these advantages did not justify the transactional costs associated with buying and selling.
Therefore, we recommended that the client improve his existing home instead.
Lifestyle and financial goals are often deeply interconnected.
Decisions about renovations, purchasing a “forever” home, or upgrading can have significant long-term consequences.
For instance, if these choices lead to substantial non-tax-deductible debt, they can hinder your ability to invest and ultimately impact your future wealth negatively.
Given that your home is often your most valuable asset, it’s crucial to make informed decisions in this area.
Buy a future home now or a pure investment
In 2022, I developed a strategy for a client who will be living and working overseas for the next 6-7 years.
After this time, they plan to return to Melbourne, which will be their long-term home.
We spent considerable time analysing and comparing three scenarios:
- Buying a house in a location they might like to live in, focusing primarily on the underlying land value rather than the dwelling itself and directing cash flow towards repaying debt over the next 6-7 years.
- Not purchasing any property but instead investing in shares.
- Buying an investment-grade villa unit or house that would serve purely as an investment property, not one they would occupy and investing in shares over the next 6-7 years.
The tax treatment of property and shares for Australian non-tax residents differs significantly.
For example, capital gains on shares are tax-free, while capital gains on property are taxed at marginal rates without the benefit of the 50% CGT discount.
However, property allows for gearing, which enables us to leverage capital growth.
In this client’s case, there was a risk that property prices in Melbourne could increase faster than share investments, making it less affordable to buy a home in 6-7 years.
After thorough analysis, we recommended option 3, as it best balanced the advantages and disadvantages of these two asset classes.
We discounted option 1 because they were not certain where they may want to reside in the long term.
Creating this strategy required a deep understanding of property fundamentals, including what attributes can be achieved at different price points, as well as a comprehensive appreciation of the property market.
Additionally, we had to consider various taxation implications and traditional financial planning elements.
This strategy is a perfect illustration of how complex decision-making can be when it comes to property and investment planning.
It was certainly one of the more challenging strategies that I have worked on.
Providing for an eventual primary residence
Our senior planner, Campbell, recently completed a holistic wealth strategy for a new client who is currently living in a rental property in Sydney and is content to continue renting for the foreseeable future.
However, in my experience over the past two decades, clients often reach a point where they are no longer comfortable with renting and desire to own a home.
Because of this, it’s essential that every plan is flexible enough to accommodate the eventual goal of homeownership.
Buying a home in the future will likely be more expensive because prices trend higher over time, and it will need to be funded with after-tax dollars, which can be costly.
This underscores the need for careful planning.
In this case, Campbell recommended two key actions for this client.
First, they should purchase a property in an investment-grade location that is likely to meet their needs.
We believe this can be achieved without compromising the quality of the investment.
The dwelling may be modest, but the land will be highly desirable.
Second, the clients will accumulate an investment portfolio within a tax-efficient structure over the next 10-20 years.
This pool of assets can later be used to fund demolishing the existing dwelling and constructing a brand-new home, should they decide they no longer want to rent.
The strategy of rentvesting is becoming increasingly popular.
However, based on my experience, most people ultimately want to own their home, so I believe that all financial strategies must provide the flexibility to accommodate this desire.
Private school versus good public school zone
Schooling considerations can significantly influence the choice of a home and its location.
I remember working with some clients many years ago whose strategy involved upgrading their homes to be within a well-regarded public school zone.
This move allowed them to avoid the high costs of private school fees, as there weren’t any good public schools in their current area.
Additionally, properties located in sought-after public school zones often experience a higher rate of capital growth due to increased demand.
This means that not only do they save on avoiding substantial non-tax-deductible school fees, but they also benefit from tax-free capital growth on their home.
Financial planners need to have property expertise
The examples above illustrate how property decisions can profoundly affect one’s personal financial strategy and future financial position.
This goes beyond simply advising clients on how, where, and what to invest in property.
That’s why it’s crucial for financial advisors to have extensive experience and knowledge in property.
This expertise is essential for helping clients maximise their wealth potential.
