One thing that has been drilled into me by one particular family office since I started MP Group is that the path to real wealth is to acquire and hold income-producing, capital-appreciating property assets, to take advantage of not only growth but tax benefits enabled by holding assets long-term as they appreciate in value.
This creates the benefit of annuity cash flow but importantly the capital appreciation in the asset itself. As long as it is held and not sold, the gain is protected from tax erosion, enabling compounded growth.
With this in mind, buying high quality, well located assets, which can be kept in perpetuity and improved, value-added or repositioned to enhance investment performance is the golden ticket.
Tax erosion on realised gains is the largest prohibitor to compounding investment growth and building wealth. However, trading and realising a gain has the benefit of creating liquidity, enabling the after-tax gain to be banked, taken off the table so to speak and deployed elsewhere.
So there are two schools of thought and it depends on what your motivator is as to how you construct a portfolio.
Trade vs hold/ Revenue vs capital account
Think about when you realise a gain on an investment, I know for us when we provide capital investment for the development of a property or syndicated deal with an end date it’s exciting to look at the total returns and outperformance achieved. But when you realise the gain and receive the money in the bank, the next step is paying a significant amount of it away in tax.
A lot of our larger high net-worth and institutional investors will utilise offshore structures to be more tax effective. The offshore entity will come into a deal as debt, which enables a 10% withholding tax to be payable when the gain is realised, which is a lower tax rate than Australian domestically domiciled investors.
Nonetheless, once the gain is realised, tax is still payable and that capital needs to find a new home, so you are back on the hunt for a new investment to re-deploy the capital with strong downside protection which will provide outperformance, and so the cycle continues.
The hunt for a new deal is both capital, time and resource intensive.
So it would seem that for private investors looking to build and accumulate wealth (who don’t have an end date on the provision of their capital and are not IRR - driven) finding an asset you can sit on in perpetuity, which can be ‘value added’ to or repositioned as time goes on and property occupier behaviour evolves, would be a more resource and tax-effective approach.
If a gain is realised and a sale of an asset is made, the ATO has different tax rates for Revenue (or trade) accounts vs what it deems as an asset held on Capital (or hold) account; read more here.
Whilst taxed less aggressively when a gain is ultimately realised, the downside with respect to a ‘hold’ approach is that it’s a longer-term and less liquid solution as opposed to the ‘trade’. ‘
‘Trade’ deals will generally be related to a property development of some kind, or a property repositioning and will often have a realisation period of 2-3 years.
Flips of fate
And then there is those ‘flips of fate’, where in an upswinging market, sites and assets are optioned or are acquired on terms by a buyer – ‘buyer A’ and then prior to settlement another purchaser, ‘buyer B’ will pay buyer A two or five times the price agreed in the original transaction.
An example below is developer Pointcorp who had exchanged contracts to buy a site in Brisbane for $23 million. Before they settled the sale, however, a Chinese developer acquired the site from Pointcorp for $82.5m, enabling Pointcorp to banking a tidy (pre-tax) trading profit; read more here.
But this also cuts both ways, for example in the late 80’s Australia Square, a 13-level 52,000 sqm approx core Sydney CBD asset owned by GTP, was worth approximately half a billion dollars and then in the recession of the early 90’s the asset was worth half that value. Fast forward to today, and the asset is worth over a billion dollars.
The key is to have assets with strong defensible cash flow and low gearing so as to not only be tax effective but to withstand volatility and market cycles over the long term.
Two worlds collide
I have two particular investors I deal with who are of a similar age but very different backgrounds and philosophies, for the sake of this example let’s call one my mentor and the other my first investor.
My first investor
My first investor I met by chance whilst holidaying in the Yasawas Fiji.
I was at the bar reading a book and he came in from his yacht with his crew for a drink. We got chatting an it turned out that among his many homes and investments dotted around the globe, he had one in Double Bay, which was on my morning running route back at home in Sydney.
We got talking and quickly established a strong rapport.
What was immediately apparent to me was not only his ability to cut to the quick of a commercial situation but the sharpness of his mind and his zest for life in every sense. Born in Calcutta, domiciled in Monaco having lived in London, LA, Sydney, New Zealand and a host of other locations, he founded one of the preeminent global logistics chains; he was a world citizen in every aspect of the word. He had offices in every region with a shipping port around the globe and was rarely in one place for more than a week.
Moving from India to closer to Australia when he was young and playing competitive Hockey in the national league, he loved sport and was incredibly patriotic. He started local rugby clubs and owned a national football team, supported men's and women's first-grade rugby, the Olympic hockey teams and had built a business school for a national university. He was also the patron and sole benefactor of orphanages and schools in various locations around the world.
And he was self-made to boot, starting his business with just two thousand dollars, he managed to amass a personal fortune separate to the primary logistics business and then sold his business for 500 million US dollars in cash in 2012.
We became fast friends as soon as we met – me asking as many questions as I could about business and philanthropy and soaking the answers up like a sponge.
Many years later, in a twist of fate I had just started MP Group and was doing a lot of property advisory work. My investor had just sold his business and invested a sizable sum into a property joint venture in London, which turned sour. When the opportunity presented, I couldn’t get myself on a plane quick enough and before I knew it I was in Mayfair, elbows deep in a convoluted web of shareholder agreements, shell company incorporation documents and trust deeds which tangled themselves through the tax havens of the BVI, Jersey, to arrive at the commercial conclusion that the fundamental JV was rife with conflicts of interest and fraudulent conduct. We got an injunction and at the same time, my investor handed me a large sum of capital that he had set aside and wanted invested.
“I want a 20% return, 2-3-year investment duration and don’t lose the money, ok Mandi?” was his instruction.
The ultimate trader.
I said OK, and as a duty of care, before I embarked on the mandate, I took my investor to meet with my mentor.
In 2009, just before leaving to start MP Group I was working at Savills and brokered the sale of a significant landholding close to Sydney’s CBD for around 20 million dollars. The vendor was in his 70s, second generation, with the family source of wealth initially coming from a supermarket chain founded by his father. The success of the retailing venture and eventual sale lead to the establishment of the family office which managed a portfolio of high-quality institutional-grade properties, and international equities. With discipline diligence and prudent management, the family had amassed a significant fortune over time.
Over a period of several years we stayed in contact I would always pay a visit and ask many questions. Over time and as the relationship developed, he became a mentor and every three to six months we’d catch up and he’d kindly answer any questions I had and help guide me through my business and investment journey.
Exceptionally conservative and deeply principled on all fronts, the family was coming into its third generation. They had a philosophy not to utilise debt in any of their vast property holdings and to always look for bluechip assets, which they would acquire and hold for the long term to reap the benefits of tax-deferred, compounded growth.
Trading deals and the mandate that I was about to implement for my investor were generally against their investment philosophy.
Out of a duty of care for my investor, I wanted him to hear a different and possibly more conservative viewpoint before we embarked on his 20% mandate, so I arranged a meeting between my investor and my mentor.
There were some similarities between them – two very financially successful men of a similar age – but their principals and drivers were very different. One conservative and one more aggressive. My mentor spoke about the benefits of patience and targeting high quality assets with the view to hold for the long term and be satisfied with a lower ongoing investment return for the safety and quality of the asset.
My investor listened and after we left he said “Mandi, I don’t have the benefit of having a generation before me who has passed me a legacy to grow. I have a family to provide for and I want deals with a 2-3 year duration or less and a 20% return, so I can choose to redeploy the capital if the market shifts for maximum benefit. I have a small period of time left and I need to be using the time I have now to be making a return on my capital so I know my family is cared for.”
His appetite was to trade and so we did.
We invested all the capital he had allocated into investment grade transactions, predominantly residential construction finance and core-plus commercial assets, and provided a 21% (IRR) annual return on the portfolio in the specified time.
The key point that my investor made is that whilst we can always learn better disciplines and investment principals, the entrepreneurial spirit is what creates the free capital to invest in the first instance.
This entrepreneurial spirit is what he had utilised to amass his fortune via his business activities and through this same lens is how he approached investment, which suited his individual circumstance and risk appetite.
What I have learned over the years is that making money, i.e. 'trading' type deals on revenue account where a faster gain is realised, requires a set of particular skills, principals and disciplines.
Warehousing profits that have been generated via 'trading' or revenue account deals is what the 'hold' or capital account type deals are suitable for. Its a 'shift in gears' so to speak, and requires a different set of particular skills, principals and disciplines.
Investing in high quality, well located and good cash flowing defensible 'hold' deals on capital account, with low gearing and more weighting to equity protection can buoy portfolios through the more trying economic times.
Whilst there are tried tested, and dependable investment principals, how we get to a certain point will be a combination of how risk and return are approached and entrepreneurial spirit based individual circumstance. There are examples of outstandingly successful investors who have utilised both trade and hold real estate strategies to amass significant wealth.
USA based Sam Zell, who is self-made has successfully held, developed and traded eventually amassing a portfolio in Equity Office which he sold off to Blackstone in 2006 for 36 billion dollars. The deal made history at the time as the largest-ever leveraged buy-out.
Australian Harry Triguboff who is frequently top of the Rich List, owns and holds over 3000 rental apartments and over 4500 serviced apartments, with the rental apartments alone bringing in over 100 million dollars in annual income. But it is his residential apartment development business, and developing and trading those apartments which enabled him to amass the capital to transition to be a long term holder of apartments.
Both examples have utilised a combination of trading and holding at various times to build their businesses and portfolios to where they are today.
Listening to Sam Zell speak about the market just last week, one of the fundamental points that he makes is; "No one ever made money by buying a market, you make money on an individual deal." Investment decisions are based on individual deal attributes and how that specific deal is positioned to mitigate downside and create an outperformance.
It is about having the ability to be nimble enough and educated enough to do both trade and hold so that you can act to take advantage of different market cycles and opportunity.
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Enjoyable article. Thanks Mandi.