Mortgage or Super?

admin — Sun, 17 Jan 2010 23:22:02 +0000

Are you better off reducing your mortgage or contributing to super?A lot of people ask this question. Unfortunately, as with many wealth management decisions there is no straight forward answer. The appropriate choice depends on a number of issues, some of which we address in this article.The obvious starting point is to look at the numbers. Assume you have 15 years until you can access your superannuation benefits free of tax. You have a mortgage that is costing you 7.0% a year (after tax) and a small amount of super. Over the next 15 years, you expect to have at least $13,375[1] a year of surplus cash flow.What should you do with this additional surplus?We assessed two scenarios:Scenario 1 assumes that you use the $13,375 p.a. surplus to make additional payments to your mortgage.Scenario 2 assumes that you contribute $25,000 a year to super, as salary sacrifice or as a personal tax deductible super contribution. As a result, your surplus after-tax cash flow reduces by $13,375 a year. We have assumed you are on the top marginal tax rate.We also assume that you take no additional investment risk in your super account. In other words, you invest the additional after tax super contributions in cash (earning a rate 5.0% per annum).But the numbers alone may not be the only consideration …There may be other issues to take into account, including: 1. How much flexibility do you need or want in your affairs? To obtain the tax benefits of contributing to super you need to be confident of your future cash flow. You don’t want to experience a lack of cash when you need it most. An investment in longer term planning can help you make the decision with confidence; 2. Your long term super contribution strategy. The “use it or lose it” nature of super contribution limits means that you cannot delay making contributions until just before retirement. Imagine directing surplus cash flow towards the mortgage only to find that you have significantly underestimated your annual cash flow surpluses. You may now find that your ability to contribute to super is undesirably restricted; 3. Don’t forget about legislative risk. While the recent trend has seen superannuation improve in attractiveness, this may not always be the case. The rules can change, invalidating an earlier decision; 4. Don’t unwittingly expose yourself to more risk than you need to. If you choose the super contribution alternative over the mortgage reduction option and invest the proceeds in growth assets, you increase your risk exposure. You are effectively funding the super contributions by using non-deductible debt (i.e. by choosing not to repay it). So, the strategy has an element of gearing to it. If you want to increase the certainty of the strategy paying off you need to direct the additional super contributions to low risk assets. Investing in higher risk assets will increase the chance that you may end up worse off; and 5. Don’t ignore the emotional burden of debt. Despite the mathematics, some people will sleep better with less debt. While it may have a financial cost, the emotional pay off may be greater.Take a comprehensive and long term viewThe mathematics suggest it’s better to make pre-tax contributions to super, even if they’re funded by non-deductible debt. Yet there are a lot of other considerations to take into account.Often, the numbers based answer may not be appropriate in light of your broader personal circumstances and objectives. Also, the more qualitative factors (e.g. the emotional burden of debt) may outweigh the purely quantitative factors.Potential future opportunities (and problems) are revealed from a taking a comprehensive and long term view. In our experience, decisions that are thorough and specifically applied to your affairs not only prove to be less complex and less costly, but also produce results that are far more likely to achieve your objectives.

Property Investing – Listed or Unlisted?

admin — Sun, 20 Dec 2009 11:48:59 +0000

The Government’s plan to provide a rescue package to help the ailing commercial property sector has sent shivers down the spines of many investors. The package is driven by the fear of property trusts being unable to refinance their short term debt. Most notably, the probability of refinance by foreign lenders, who are coping with their own problems at home, is considered to be quite low.The implications of not being able to obtain funding (i.e. re-financing) are that property assets may have to be sold in a short period of time. This is likely to result in ‘fire sale’ prices for those forced to sell. The concern for those not forced to sell is that these sales are likely to drive down the valuations of all properties which may trigger covenant breaches on existing loans that are not due for re-finance. It may also have an impact of the value of residential property as both commercial and residential property markets, while different, are based on the valuation of land. This would then affect the banks and the wider community. But would this be such a dilemma if the properties were valued at their current market sale price? It seems that the current dilemma is an issue that has arisen as a result of property managers being reluctant to value their properties at or near actual market values. Surely, if they were valued at close to market value the prospect of a quick sale would not be such a current issue. It would certainly cause a fair bit of pain to re-value these assets but it would allow investors and lenders a far more transparent view of the situation. The lack of sales is quite evident. Sales of commercial property (i.e. office, retail and industrial) totalled $16.5 billion in 2007 compared to only $5 billion for the equivalent period last year.[1] This seems to highlight the fear property managers have of selling their assets to provide liquidity. It also highlights their reliance on bank funding as their only alternative. A number of unlisted property trusts have frozen investor redemptions on the basis that selling properties now would not generate proceeds that reflect the ‘fair’ value of the properties theyhold. Their solution is to stick with their ‘fair’ valuations in the hope that things improve within the next few months to enable sales to occur at prices that are closer to their book values. It basically confirms that they believe their own valuations are optimistic.But what about the listed property sector?The value of these property trusts is driven by the market price of their units. This is driven by market sentiment about the sector and each participant. It is not based exclusively on the book value of their property assets.This has been the worst performing sector of the market over the past year. The question is will it get worse given the dire expectations for commercial property?Well, the short answer is that it could. However, it seems that the listed property trust sector, while on the surface being a much poorer recent performer than unlisted commercial property and residential property, has taken a lot more of the downside on the chin. The market sentiment, which takes into account the current re-financing risks, is already being factored into the prices of the listed sector. Those securities that have been unable, or considered unlikely, to obtain refinance have already been severely downgraded by the market.A premium indicates that the market’s value of the pool of property assets is greater than the book valuation of these assets. A discount indicates that the market’s valuation is lower than the book values.Currently, the market is valuing the sector at a 30% discount to the book value of its assets. This compares to the 5- year average of a 5% discount.However, the unlisted trust sector is still valuing itself based on book value, with valuations of some properties as much as two or three years old. The concern is that funding problems will force asset sales in thin markets, exposing the yawning gap between book value and market reality.So, should you still be investing in property?We believe there is still a place for property in an investor’s portfolio. We make the following observations:1. Property provides a good addition to any growth portfolio. It’s correlation to other asset classes is relatively low and it therefore continues to add diversification benefits;2. Broad diversification within the property sector is preferred to a concentrated exposure;3. Listed Property exposure provides more liquidity than unlisted exposure and/or direct property exposure. The listed mechanism provides investors with the opportunity to buy and sell partial exposures and provides a transparent price at all times. This considerably improves an investor’s ability to manage their risk exposure. It does however come with a higher degree of price volatility. As stated in previous articles, this is more a factor of the frequency of valuation rather than a difference in the underlying assets;4. Based on the above discussion, it would appear that on a relative basis listed property has more upside potential than unlisted and direct property exposures. This does not imply that we are forecasting the listed property sector to have bottomed (although with time that may prove to be the case), it is simply better placed on a relative basis. For those with both listed and unlisted/direct exposure and a concern about an over weighting in the property sector, reducing your unlisted and/or direct exposure first is considered a more prudent option.SummaryThe listed property sector has experienced a significant and severe shakeout over the past 12-15 months. Whether this will continue is anyone’s guess. The current market for listed property securities (and all listed securities) reflects investor expectation of the future. For prices to fall further, those already negative expectations would have to worsen.The fortunes of unlisted and direct property sectors are equally difficult to predict. However, it appears that they have not adjusted to market realities evidenced by the performance of the listed sector. On a relative basis, the listed sector appears to have more upside and far more flexibility than the unlisted and direct sectors.

Options as a Strategic Investment » Strategic Financial Planning

Mortgage or Super?

Property Investing – Listed or Unlisted?