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Building wealth through property

Photo of Peter Mermelas, UBS By Peter Mermelas, UBS

min read

The case to borrow over listed property securities using instalments.

Editor’s note: The ASX Warrants market celebrated its 25th anniversary in late 2016. As part of that milestone, ASX Investor Update is running a series of warrants stories over three issues, each focussing on a different portfolio strategy.

The first story (below), by Peter Mermelas of UBS, considers using instalments over Australian Real Estate Investment Trusts to gain property exposure.

There were 2,804 warrants on ASX at December 2016. To learn more about the features, benefits and risks of warrants and instalments, take the free online ASX Warrants and instalments course.

Investing in property has become a popular choice amongst trustees of self-managed superannuation funds (SMSF) as the property market generated attractive returns in recent years and the Australian Taxation Office clarified its views on SMSFs borrowing to invest in real estate.

The prospect of interest deductions, regular income and long-term capital growth are appealing but a direct investment in property also has its drawbacks – concentrated risk exposure to a single asset (commonly residential property), time and effort involved in managing the property and illiquidity.

So, is there another way for investors to gear into the property market with less of these risks?

The answer may surprise some but for those familiar with investing in the sharemarket it is also entirely logical – look beyond the bricks and mortar, buy listed property securities instead of direct property and obtain gearing via products such as UBS Investment Builders.

A-REITs

There are a multitude of real estate companies and trusts listed on the ASX.  These are commonly referred to as Real Estate Investment Trusts ("A-REITs") and include well-known names such as Mirvac, Westfield, Stockland and many more.  These A-REITs operate businesses that range from development, ownership and management of retail, residential, office and commercial properties, both in Australia and overseas.

A-REIT offer diversified exposure to the property market rather than concentrated exposure to a single asset.  Since these A-REITs are listed on the ASX, they can be bought via your broker without stamp duty and sold on market when you require liquidity.

Furthermore, shares can be traded in small sizes so you can invest in multiple A-REITs for the same amount of capital that you would contribute to buy a single property.

UBS Investment Builders

To package an investment in A-REITs with the type of limited recourse borrowing permitted by the ATO, you can buy instalment warrants such as UBS Investment Builders over A-REITs.  UBS Investment Builders are listed on the ASX like the underlying A-REITs.

You pay a fraction of the price of the A-REIT to buy a UBS Investment Builder over that A-REIT because the balance of the purchase price is funded by a limited recourse loan from UBS.

For as long as you hold the UBS Investment Builder you will have a geared exposure to the underlying A-REIT but you can repay the loan from UBS whenever you want if you wish to take full ownership of the A-REIT.

There are often more than one Series of UBS Investment Builders on offer over a particular A-REIT.  UBS Investment Builders in the same Series have the same loan amount per underlying A-REIT security, loan maturity date, interest payment date(s) and interest rate.  As such, investors can choose from different levels of gearing, loan terms and rates.

In general, the lower the loan amount the more you have to contribute upfront to buy the underlying A-REIT, and the higher the loan amount the higher the interest rate (because of the greater risk that the lender takes).

Like limited recourse loans from a bank, if the underlying asset (A-REIT) value falls to or below the loan amount the lender will only have recourse to the underlying asset itself and not to the other assets in the SMSF. 

Interest on the loan from UBS is prepaid for each interest period.  Interest for the first period is included in the price paid to purchase the UBS Investment Builder.  Interest for each future period is paid by an automatic drawdown under the loan which means the investor does not have to contribute his/her own funds to make those interest payments.

Investors who buy UBS Investment Builders on different dates may pay different interest rates because that rate is influenced by factors including the A-REIT price, volatility of the A-REIT price, yield from the A-REIT and Australian interest rates.

Generally speaking, loans over A-REITs with higher price volatility and yield will carry higher interest rates.  Once purchased, the interest rate applicable to the investor is fixed for the remainder of that interest period.

When the SMSF buys the UBS Investment Builder, it becomes the beneficial owner of the underlying A-REIT and is therefore entitled to all distributions from the underlying A-REIT.  These distributions are passed through to the SMSF in two ways, depending on the type of UBS Investment Builder it has invested in.

There are two types of UBS Investment Builders – UBS Share Builders where distributions are used to pay down the loan (similar to making principal repayments), and UBS Dividend Builders where distributions are paid out to the SMSF (which may appeal to those who want periodic income).    

Tax considerations

Interest paid on the loan in a UBS Investment Builder may be deductible in full or in part, depending on whether the interest rate is less than or greater than the deduction permitted by the capital protected borrowing rules and your specific circumstances.

Many A-REITs pay distributions with tax deferred components because the A-REIT has claimed depreciation benefits on its properties.  This benefit is passed through to holders of UBS Investment Builders over that A-REIT because they do not have to pay tax on the tax deferred component upon receipt and will instead reduce its cost base in the A-REIT when it calculates its Capital Gains Tax (CGT) liability following the sale of the UBS Investment Builder.

Key things to consider

For those interested in gearing into the real estate market, UBS Investment Builders over A-REITs are an alternative to borrowing from the bank to buy a property.  You need to do your homework on the underlying A-REIT to understand its business and its risk profile, much like what you would do when you research the suburb and perform building inspections when you buy a house.

However, by investing in the property market via a A-REIT, you gain access to a diversified pool of assets (often extending beyond residential properties) which are managed by professionals day-in day-out.     

Interest rates applicable to UBS Investment Builders are variable from one interest period to the next and will be different for different underlying A-REITs.  Those interest rates can be higher or lower than an investment property loan from a bank, depending on multiple factors related to the underlying A-REIT and Australian-dollar interest rates in general.  However, there are no credit checks, establishment fees or stamp duty when you buy UBS Investment Builders.

Furthermore, you do not need to engage lawyers to prepare contracts if you wish to sell and you will receive proceeds within a few days (rather than a few weeks) of executing your sale.  Brokerage and/or financial adviser fees may apply though, depending on your circumstances.

Understand the risks

Ownership of direct property exposes you to risks which are specific to that property.  Ownership of an A-REIT can expose you to risks of the share market in general and a variety of factors outside of your control which affect the profitability of the A-REIT.  The risk of capital loss is there just like a direct investment because the underlying asset can fall in value and you may not receive sufficient income to cover your interest cost.

When you buy a UBS Investment Builder, you are the borrower and the beneficial owner of the underlying A-REIT.  Subject to compliance with the capital protected borrowing rules and your personal circumstances, interest on the loan may be deductible in full or in part.  The benefits of tax deferred distributions and availability of discount CGT treatment will also be passed through to you.

However, UBS Investment Builders may be subject to special terms, including the possibility of early termination if UBS decides not to extend the loan beyond the end of the current interest period.  If this happens you will need to refinance your loan in order to continue to hold the investment but subject to compliance with the Superannuation Industry (Supervision) Act, this can be done by rolling into a different Series of UBS Investment Builders if it is available.      

Next steps

The above discussion focussed primarily on SMSFs gearing into A-REITs using UBS Investment Builders but this strategy can be adopted by other types of investors such as individuals.  You should seek advice on how this strategy will work in your particular circumstances because outcomes may vary.

To purchase UBS Investment Builders you need to set up a warrants broking account with your broker, or apply using an application form submitted via a UBS approved financial adviser.  More information is available here.

UBS Investment Builders are available over the following A-REITs:

• CLW – Charter Hall Long Wale A-REIT – management of Australian office, retail and industrial properties
• DXS – Dexus Property Group – owner, manager and developer of Australian office, retail and industrial properties
• GPT – GPT Group – owner and manager of Australian retail, office and logistics and business parks property assets
• MGR – Mirvac Group – development and construction of Australian office, retail, industrial and residential properties
• SCG – Scentre Group – design, construction, development and management of Australian and New Zealand retail properties
• SGP – Stockland – development, ownership and management of Australian residential properties, commercial properties and retirement living communities
• WFD – Westfield Corporation – developer, owner and manager of shopping centres in Australia and overseas

 

About the author

Peter Mermelas is a Director of UBS.

Follow: @UBS

From ASX

Warrants has information on the features, benefit and risks of investment and trading warrants.

This information is communicated by UBS AG Australia Branch (ABN: 47 088 129 613, AFSL: 231087) and/or its affiliates ("UBS"). Before making an investment decision, you should read the corresponding Master Product Disclosure Statement (PDS) (for UBS Share Builders the Master PDS dated 25 September 2014 or 16 October 2015 (as applicable), and for UBS Dividend Builders the Master PDS dated 17 October 2014), the relevant Term Sheet applicable to the Series they wish to invest in (together the "PDS") and any applicable Supplementary Product Disclosure Statement(s) ("SPDS"), including sections relating to Key Risks. These documents are available by calling UBS on 1800 633 100 or on the website www.ubs.com/investmentbuilders

This document does not take into account your investment objectives, financial situation or particular needs. Accordingly, nothing in this document, the PDS or any SPDS is a recommendation by UBS or its related entities or by any other person concerning investment in any financial product and before acting on this information, you should consider its appropriateness having regard to your situation. We recommend that you not only consider the information in the PDS and SPDS but also obtain independent financial, legal and taxation advice as to the suitability of an investment in a financial product (bearing in mind your investment objectives, financial situation and particular needs).

Structured products and UBS Investment Builders are complex and may involve a high risk of loss. An investment in UBS Investment Builders is only available to persons receiving the PDS and SPDS in Australia. The PDS and SPDS do not constitute an offer of any financial product in any place in which, or to any person to whom, it would not be lawful to make such an offer. The distribution of the PDS and SPDS in jurisdictions outside Australia may be restricted by law and any person who resides outside Australia into whose possession this information comes (including nominees, trustees or custodians) should seek advice on and observe those restrictions. The financial products discussed in the this document, the PDS and SPDS may not be offered or sold in the United States of America (US) or to, or for the account of or benefit of, US persons. Accordingly none of the PDS, SPDS or the Application Form may be sent to persons in the US or otherwise distributed in the US.

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