Investing with other people could help you kick start your property portfolio and even fast-track it. But there are issues you need to be aware of when buying with others. Eddie Chung explains.
As housing prices continue to edge upwards, it is becoming increasingly difficult for Australians to enter the property market, whether you are either trying to buy your first home or your first investment property.
To overcome the financial threshold required to buy a property, many people are now joining forces with others who are not their spouse to try and crack into the property market. After all, there is strength in numbers and pooling your money together to buy a property with someone else could make perfect financial sense.
Having said that, apart from the normal issues you need to consider when buying a property by yourself, there are a number of additional issues you should be thinking of when you are buying a property with someone else.
Commercial issues
When you buy a property with someone else, you will not have full control of the property, so you need to be clear with your financial partner as to how you will each be acquiring your respective interests in the property (I will deal with this aspect under the heading ‘Structural issues’ further on), how you will manage the property during your co-ownership of it, and how you will deal with the eventual sale of the property.
To that end, a written agreement setting out all these aspects upfront is highly recommended. While you may have entered into the arrangement with the other person or persons with all the goodwill in the world, you can never fully know what the future may hold, so relying on a ‘verbal agreement’ may create some real difficulties down the track should the unexpected and unplanned happen.
For instance, you and a mate may decide to invest in a property together when you are both single. Somewhere along the line, one or both of you become partnered and you wish to buy a home with your significant other. However, to have enough cash for the deposit, you need to realise your investment in the property. Without a written agreement which specifies
how you could potentially cash-in your investment, your mate may not agree for the property to be sold or buy your interest in it, so you may find yourself stuck in the situation where your wealth is ‘trapped’ because you cannot realise your investment.
In contrast, you and your mate could have signed a written agreement prepared by a lawyer upfront, which clearly sets out what would happen if one of you wishes to sell your interest in the property.
For instance, you may invoke a ‘drag along’ clause in the agreement to causethe property to be sold, which will enable you to exit the investment.
Alternatively, the agreement may provide the party who does not wish to sell the property a ‘first right of refusal’, which means that the party wishing to exit must first offer their interest in the property to the other party at market value (or at a specified price) before they can trigger the contractual right for the property to be sold.
Having these provisions in the agreement in black and white would significantly minimise the chance of a stalemate, and both parties know exactly what to expect if and when their individual circumstances change over time.
Another common aspect that is covered by the agreement pertains to the maintenance of the property. What if the roof starts leaking after a ferocious storm and a new roof is required to weather-proof the property? Who will be responsible for such sizeable capital cost and how much contribution is each party required to make? Again, the presence of an agreement may prove to be extremely useful to eliminate nasty surprises if this kind of situation transpires.
Structuring issues
The most common structure for property co-ownership is to simply have the relevant individuals own a separate interest in the property as individuals. The individuals need not own the property on a 50/50 basis, ie, one individual may own, say, 80% of the property while the other may own the remaining 20%.
The ability of the parties to own different ownership percentages in the property may come in handy where one party has less financial resources at their disposal than the other. Once the respective ownership percentages of the individuals have been agreed upon at the outset, the individuals will generally be entitled to their set percentage of rental income and be liable to their set percentage of rental expenses; when the property is eventually sold, the individuals will be entitled to their set percentage of capital proceeds on sale. Naturally, such a structure may involve more than two individuals. It is not uncommon to find a number of people co-owning a property together, especially when the value of the property is high. For instance, a group of five investors may own an entire block of units together.
Bear in mind that if you are going to co-own a property with someone other than your spouse, you should always insist on owning your interest in the property on a ‘tenants in common’ basis, as opposed to owning the property ‘jointly’.
This is because if you own a property jointly with someone and you die, your interest in the property will automatically be vested in the other person with whom you own the property jointly; in contrast, if you own your interest in the property on a tenants in common basis and you die, your interest in the property will form part of your deceased estate, which can be transferred to your beneficiary by operation of your will. Therefore, the manner in which you hold your interest in the property is extremely important.
A more complex structure for multiple parties to own a property is for the parties to use different types of entities. For example, while you may want to own your interest in the property as an individual, the other party may use their company to own their interest in the property. You and the company may then co-own the property on a tenants in common basis.
Alternatively, instead of co-owning a property, it is possible for the property to be owned by a company or a unit trust and the underlying owners own shares in the company or units in the unit trust. The entity that owns the shares or units need not be individuals either, eg, you may use your family trust to own units in a unit trust that owns the property (to be technically correct, the property is legally owned by the trustee of the unit trust on behalf of the underlying unit holders, and the unit holders have beneficial ownership of their proportionate interest in the property).
In other words, there are many structural permutations under which the property may be co-owned. To that end, perhaps the biggest take home advice on how to structure a property co-ownership arrangement is that each party should seek independent professional advice because the parties’ individual circumstances may be very different. Depending on the structure chosen, particularly more complex structures, the parties could encounter pitfalls or unintended tax consequences without sound professional advice.
For instance, one of the individuals may have a family trust with tax losses that could be used to offset the rental income while the other individual may wish to negative gear their share of the property. In which case, it would not serve the first individual’s purpose if a unit trust is established and the units are simply issued to the two individuals.
In this situation, the first individual could not offset the rental income against the family trust losses. It would be better for the first individual to have the units issued to their family trust. For the second individual, there may be issues in relation to financing the negative gearing of their units as discussed below under the heading ‘Financing issues’.
Like any structuring exercise, a professional property tax adviser and financial adviser can help you formulate a suitable structure that would best serve all the co-owners involved, having regard to factors such as asset protection, liability quarantine and protection, exit strategy and succession, taxation, etc.
It is important that an appropriate structure is established upfront as any subsequent change to the structure after the property has been acquired may give rise to taxation and stamp duty liabilities.
Financing issues
If you need to borrow in order to buy the property, which is likely in the majority of cases, financing the property purchase may be less straightforward when buying with others than if you were buying the property by yourself.
For instance, if you and the other party opt to draw down separate loans to buy your share of interest in the property, it is likely that the bank would want all the parties to cross-guarantee each other’s loans.
At the very least, if the parties refuse to provide such a guarantee, the financier would require an undertaking by all the owners that if a party defaults on their loan, the other owners must contractually agree for the property to be sold to enable the financier to recover the defaulted loan. This may become even more complicated if the parties use different banks to fund the purchase of their respective interests in the property.
Due to the potential complications involved, financing arrangements involving multiple parties co-owning a property may at times be more expensive to implement in terms of borrowing costs and interest rates, which is why it may sometimes be worthwhile to enlist the help of a professional debt adviser, who may procure a debt from a banker who is experienced in more complicated property financing transactions.
Also, it is becoming increasingly popular for people to use their self-managed superannuation funds (SMSF) to co-own properties with others.
However, these arrangements may be problematic if not implemented under strict professional guidance.
In these circumstances, bear in mind that while it is possible for a SMSF to borrow to buy investments these days, if the borrowing arrangement is not implemented properly and carefully, it may inadvertently breach the Superannuation Industry (Supervision) Act 1993, which may give rise to severely adverse taxation consequences.
To that end, while a SMSF may theoretically purchase a property under a limited recourse borrowing arrangement (LRBA) with other parties on a tenants in common basis, it may be difficult for the other parties to obtain finance, as a SMSF must not allow cross-securitisation of its interest in the property, ie, it is unlikely that the bank would lend monies to the other parties requiring finance if the SMSF does not provide its interest in the property as security for the loan.
Therefore, this type of arrangement may only work if the SMSF is borrowing and the other parties are willing to hold out their interests in the property as security for the SMSF’s loan but not vice versa. In any event, borrowing involving a SMSF is highly complex and should not be implemented without professional advice.
Eddie Chung is Partner, tax & advisory, property & construction, at BDO (QLD) Pty.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualified professional person. The article is provided for general information only and the author and BDO (QLD) Pty Ltd are not engaged to render professional advice or services through this article. The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article.
