Making the most of capital gains

Property syndicates might have suffered the slings and arrows of rising interest rates, but David Davies argues their potential for capital gain means they are still very attractive investment vehicles.

Property syndicates might have suffered the slings and arrows of rising interest rates, but David Davies argues their potential for capital gain means they are still very attractive investment vehicles.

Property syndicates have the advantage over their traditional competitors - property trusts - in that they have the potential to offer investors significant capital gains.

However, advisers must be aware that in order to capitalise on these gains, syndicate managers should:

1. Maximise the potential for capital gain when selecting properties for syndication.

2. Buy only in low vacancy areas where demand will ensure increasing rental returns.

3. Consider developing their own properties and create syndicates for them.

4. Focus on the maximum depreciation allowance that comes with a brand new building.

5. Think about smaller syndicates, mostly under $10 million.

6. Put a ceiling on interest rates by using risk management products.

Capital gains are uncertain and difficult to quantify - you can't estimate them accurately nor can you quote a guesstimate in a prospectus.

The following test points can help to measure the potential of buildings for capital growth.

1. Efficiency of the floor plates.

2. Car parking

3. Views

4. Quality of the building fabric

5. Access to arterial roads

6. Availability of additional land.

Developing their own properties allows managers to achieve economies at the development stage which can be passed on to the syndicate. This can produce better-value purchases as well as giving the syndicate manager some leeway to absorb formation costs. Savings that result in an extra 0.5 per cent a year return of income make a big difference in the current climate.

More importantly, managers who develop their own properties are able to offer investors a brand-new property. This is important because the newer the building the greater the depreciation allowance - and depreciation can help offset capital gains tax (CGT) liabilities.

Break out case study

Depreciation and CGT

A recent prospectus for a new $6.9 million commercial building in NSW offered 15 shares at $271,000 each.

Each share earned total first year income of $24,390.00 of which 72 per cent ($17,560.00) was tax-deferred in the first year. This ability to defer tax is the big advantage of having a substantial depreciation allowance.

Of the $24,390 first-year income, 72 per cent ($17,560) can be claimed as depreciation allowance and the difference ($6,830) is taxed at the investors' current rate. An investor on the top marginal tax rate (48.5 per cent) will pay $3,312.55 in tax.

However $17,560 depreciation comes off the cost base, reducing the cost of each share to $253,440.

The effect of reducing the cost base is critical when the building is sold on conclusion of a syndicate - usually after seven years.

In this example, depreciation over seven years would come to $79,200, bringing the true cost base of each share to $191,800.

Assume the share has grown in value to $350,000 by the end of the syndicate period. Capital gains tax is payable on the difference between the value of the share ($350,000) and the true cost base of each share ($191,800) $350,000-$191,800 = $158,200. GST payable is calculated at the new rate of 24.25 per cent = 24.25% x $158,200 = $38,363.50.

This is $16,677 less than the $55,040 that would have been due last year before abolition of the inflation index and reduction of the maximum capital gains tax.

David Davies is chief executive of Austgrowth Property Syndicates Limited