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A guide to tax advantaged income

Tax Advantaged Income

One of the main differentiating factors with various investment asset classes is the impact of tax and the treatment of income for taxation purposes.

A comparison of a Natgen Investment Trust with a bank term deposit can be useful, given that bank deposits have no taxation allowances beyond standard taxation law.

A Natgen Investment Trust allows the pass-through of asset-level taxation allowances to the individual taxation returns of the unitholders in the trust – this is known as a pass-through trust. Up to 100% of the income from the units can be offset against the taxation allowances for commercial property ownership, and if the allowance for the year is greater than 100% of the income, the excess allowance can be carried forward to future years.

The taxation allowances which qualify for this treatment are:

Whilst these allowances can substantially reduce the tax burden during the operating period of the trust, they also act to reduce the cost base of the asset when the time comes to sell the asset. This cost base is the figure used to calculate capital gains tax for the units. In this context, the allowances constitute a tax deferral – the taxation payment is deferred a number of years into the future.

However, there is another benefit – the rate of capital gains tax is substantially lower than income tax for many taxpayers:

  • For an individual or a trust, the rate of CGT payable is discounted by 50% compared to the income tax rate for that same amount.
  • For a superannuation fund, the reduction amount is 33.33%.
  • Companies do not get a CGT discount.

Additionally, you may be able to defer income from years where you are paying a high marginal rate to years when your income is less, thus taking advantage of lower marginal tax rates. Or possibly have some capital losses to offset against capital gains (these can’t be offset against income).

So, the benefits of converting income into capital gain can be very substantial indeed.

 

The below case study illustrates this point for an investor taxed at the top marginal rate (+ Medicare Levy), holding bank deposits paying 9% (no tax advantages) and a Natgen Investment Trust paying 9% (100% tax advantaged) held over a five year period.

5 year bank
term deposit
A Natgen
Investment Trust
(5 year term)
9% Interest
9% Distribution
(100% tax
advantaged)
Investment Amount
$100,000
$100,000
Annual Payment to Investor (@9%)
$9,000
$9,000
Income tax payable
$(4,410)
-
Annual free cash after tax
$4,770
$9,000
After 5 years
Total cash received after tax
$23,850
$45,000
CGT payable at end of investment
-
$(11,025)
TOTAL INCOME AFTER ALL TAXES
$23,850
$33,975

 

Of course, the above takes no account of possible capital growth (or reduction) of the value of the units in the Natgen Investment Trust. The bank deposit will only ever return the exact same amount deposited.

Note: The above calculation is for illustrative purposes only and is not intended to be either tax advice or to pertain to your specific circumstances. Bank term deposits are not returning 9% currently, but this high rate has been used for direct comparison to a Natgen Investment Trust.

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The Year in review

Click here for our Corporate Profile

 

As we proceed through 2023, and I look back at my last communication to you in January this year, it is clear that our expectations from the beginning of the year, are in general, coming to fruition.

At the beginning of 2023, I wrote to you about 2023 being a time to rethink our assumptions in changing times.   I think most would agree this year has constituted changing times, and also a good time to rethink assumptions.

It is fair to say that from a domestic economic perspective, 2023 has largely been about higher interest rates designed for curb demand and thus inflation.  Sitting here in December 2023, we are seeing some signs that perhaps the interest rate tightening cycle is achieving these aims, albeit with a reduced expectation of major interest rate drops in the coming 12 months.

Internationally, the turmoil of 2023 has been augmented by other conflicts further destabilising international markets.  However, the major western economies appear to be gaining on the inflationary pressures they are battling and generally economic growth has not fallen off any cliffs.

The Natgen response to 2023 has been to indeed rethink assumptions and respond in real time to the challenges and opportunities presented.

In response to the realisation that higher rates will be more persistent than anticipated at the beginning of the year, we took the difficult decision to revise our return rates on two of our investment trusts to 7% per annum representing a reduction of 1.5% and 2% respectively.  This was entirely due to interest rate impacts on sustainable return rates.

Also, as a response to a specific challenge, Natgen (in its personal capacity) bought the Kingsthorpe Medical Centre (a tenant in our Natgen Investment Trust KT21), specifically to maintain the tenancy mix at that property.  We have significantly improved the services provided by the medical centre and, whilst the business is yet to be profitable, we expect to address this further during 2024.

Our assumptions about the impact of rising interest rates on the price of future acquisitions needed to be re-thought during the year.  After withdrawing fromacquisitions activity early in the year, we found that prices remained at an unsustainable level, given market fundamentals, for much of the year.  Whilst we found it difficult to find value in the standing assets market, we were able to demonstrate value in developments, with 3 new development trusts being presented for investment during the year.   All of our four current development trusts address the demand for industrial space and storage in the high growth areas of the Gold Coast and the Brisbane / Gold Coast corridor.

Through Natgen Development Trusts, we have been able to provide our investors with a valuable alternative whilst we were struggling to ascertain value in the broader market.  It is a matter of pride to us that we don’t offer investments when we cannot see value. 

Another response to the circumstances of 2023 was to postpone the introduction of Natgen Liquidity Trust CF22 until the interest rate markets settle and we can be certain of our forecasting.

I hope that the theme that you ascertain for the above is caution.  As I have said in the past, we take the stewardship of your investment funds very seriously and seek always to balance opportunity with caution.

2023 Investment Trusts Closed

March 2023

Self Storage

8 year Term

May 2023

Industrial Showroom

2 year Term

September 2023

Industrial Showroom

2 year Term

The Opportunities of 2024

We foresee 2024 as providing greater opportunities than the year past. This optimism is based on current observations of some value re-entering the market. We thus expect to be able to bring you more consistent Natgen Investment Trust offers during 2024. As always, our offers will accord with our acquisition focus for the year and our general views relating to value – both short and long term.

As expectations of higher interest rates abate, we are now able to make more confident forecasts about future debt costs and thus returns from various asset types.

The broader economy continues to show signs of remarkable resilience, however we will continue to take a conservative approach given the complexity of the global political and economic situation.

New Head of Acquisitions - Jeff Gardner

In November this year, we welcomed Jeff Gardner to the Natgen team, fulfilling the role of Head of Acquisitions.

Jeff has been long known to me and we have worked together over a period approaching 20 years. Jeff’s long background in commercial property includes development management, property information systems and the full gamut of knowledge relating to markets and their dynamics.

With this valuable experience, Jeff adds a great deal of knowledge to our team. Jeff has already isolated a number of acquisitions targets based on the Natgen acquisitions focus areas.

Jeff will also be engaged in strategically reviewing and contributing to our future target areas.

Natgen - A helping hand in commercial property investment and development

Natgen has recently produced a document outlining some of the considerations to be taken into account when considering the inclusion of commercial real estate into a balanced investment portfolio.

I am pleased to provide you with a copy of this document at the link below.

Natgen Foundation - Supporting Legacy

For 2023, Natgen Foundation has chosen the Legacy – Bring it Home Campaign as the major recipient of charitable contributions from the Foundation.

As Chair of the Campaign Cabinet, I am pleased to advise that the campaign is closing in on $8.5 million raised of the total target of $9.5 million.

This money is for the construction of a new Legacy House at Greenslopes Hospital in Brisbane.

The new Legacy House will be a focal point for the provision of Legacy Services in South East Queensland and beyond, responding to the changing needs of the families of our veterans returning from service to their country. It will be a model which we hope to roll out across the country in the coming years.

We plan to provide opportunities in 2024 for the Natgen community to help us with the last push toward achieving the total target. I thank you in advance for your interest and support in this endeavour.

Natgen Christmas Function

Thank you to all of our investors and consultants who were able to attend this year’s Christmas party held at the Southport Yacht Club.

Thank you for 2023

As we come to the end of another year, we want to take a moment to express our gratitude and well wishes to all our investors and partners. This year has been full of challenges and opportunities, but we are thankful for the trust and support you have given us. We hope that this holiday season brings you joy, peace, and rest.

Kind regards

Steven Goakes

Managing Director

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The market in clearer focus

As we proceed through 2023, and I look back at my last communication to you in January this year, it is clear that our expectations from the beginning of the year, are in general, coming to fruition.

The market in clearer focus

As we reach near the top of the interest rate cycle, I feel that the outlook ahead for commercial property is coming into somewhat clearer focus.  This is providing us at Natgen with the confidence needed to re-enter the market for investment assets for Natgen Investment Trusts, after a hiatus of nearly 6 months.   Our acquisition activities will be centred around the areas previously outlined for our attention, namely:

  1. Non-CBD office; 
  2. Regional convenience retail; and
  3. Value-add industrial assets. 

Added to this will be areas addressing the long term trends outlined in my last letter. There remains a great deal of commentary about the directions of markets and possible mid-term and longer-term outcomes.  We are seeking to stick to the basics in setting our own view of future interest rate movements and property values.  

On this basis, we expect to be using 5% per annum as our long term average interest rate for our forecasting purposes.  

Whilst we expect spikes and dips in this average rate, we believe this to be consistent with market indications at the moment and consistent with long term interest rate trends. Whilst there are market expectations of a softening of yields in the market due to increasing interest rates, there are also some contra-indicators.  For example, as inflation rises, expectations of rental rates increases and the cost of replacement of commercial stock increases in line with construction cost increases.  It is these competing factors which ensures the long term value of commercial property when well located and maintained.

Natgen development projects

 The various Natgen development projects are progressing apace, with design and funding activities running alongside with the finalisation of the Natgen Development Trust ML23 capital raising. The demographics of the Gold Coast region have provided significant impetus to the growth of the self storage market, which is at the centre of much of our current development activity. 

Legacy – 100 years

In this 100th anniversary year of Legacy, and as Anzac Day approaches, I wanted to share that my newest role is as Campaign Chair for Legacy’s Bring it Home Campaign to raise funds needed to build a new Legacy House at Greenslopes. The new Legacy House will deliver on an old promise, respond to today’s needs and create a new link in the chain of care for veterans’ families which Legacy commenced a century ago this year.The new Legacy House will be a warm, welcoming centre where veterans’ widows and families can receive the support they need, close to the Greenslopes Hospital and medical research precinct and will house several key veterans’ support services, who will work collaboratively together.Like most everyone, I have known of Legacy my whole life and could not think of a more worthy organisation to support. The renewal and focus on family outcomes for veterans really appeals to me as a very positive approach to very difficult circumstances in which today’s military families can find themselves.Over the next 6 – 9 months I look forward to having conversations with people who might want to be involved in this important project. Please let me know if you would like to hear more.

Future events 

As we await the federal budget in the coming days, we have been reminded that there are emerging spending priorities which will need addressing in this and future budgets.  Much has been made of defence spending, but other priorities will also need addressing, including NDIS blow-outs, housing stock replacement and augmentation and the inherent costs of energy transition.  On this basis, I believe that building on the tax base through reduction of allowances and possible extension of the attack on superannuation taxation concessions are likely to continue.   In this environment, tax efficient investment choices will be paramount.  In this sense, commercial property performs solidly in all economic environments.  I wish you well until we next correspond.

Regards

Steven Goakes

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Cash Vs Natgen Investment Trusts – Are You Getting The Full Story?

Natgen managing director, Steven Goakes explains pro’s and con’s of staying in cash when inflation is rising.

As cash interest rates have increased recently, I have been asked by a number of potential investors to explain how Natgen commercial property trusts compare, when the ‘headline rate’ does not seem to be that much higher than bank deposit rates.

For example, currently banks are offering around 4.95% p.a. for 5 year deposits.  When compared with, say, 8% from a Natgen Investment Trust, the differential does not seem so great.

In fact, comparing the two headline rates is like comparing apples with oranges.

Cash deposits have only one form of return, and that is the interest rate paid on the capital. 

With Natgen Investment Trusts, investors have access to three forms of return:

  1. Cash income distributions;
  2. Taxation benefits; and
  3. Capital appreciation.

In our case, the ‘headline rate’ only relates to the first of these types of return.

The below example is designed to illustrate the differences between these types of investment.

Investment 1:   5 year bank term deposit @ 4.95% p.a. (return paid annually)

Investment 2:  Natgen Investment Trust (return paid monthly)
Example inflation rate: 6.1%

 Term Deposit

 Natgen Trust

Annual Return

 $4,950.00

 $8,000.00

Tax Payable

 $(2,326.50)

 nil*

Free Cash

 $2,623.50

 $8,000.00

Inflation Impact

 $(6,100.00)

 $(6,100.00)

Net Position

 $(3,476.50)

 $1,900.00

* The tax not paid here will reduce the cost base of the asset for CGT purposes, therefore tax saved now will be payable as CGT upon the disposal of the units in the Trust.  But, for individuals and trusts, CGT will be discounted by 50% due to the assets having been held for over 12 months.  (The discount for Super Funds is 33%, and no discount for company investors.).

BUT, this is not the full story. 

With the TERM DEPOSIT, you have the benefit of the government guarantee (for less than $250k deposits), in this case, you have a guarantee of a loss of $3,476.50 per annum.

With a NATGEN INVESTMENT TRUST, you have the opportunity of capital growth of the property during the term.

And whilst we hesitate to forecast capital growth for a particular asset over the particular timeframe, we do have excellent data for the past performance of commercial property across Australia for the past 40 years.

And it looks like …

The above graph shows the rolling total returns on Australian commercial property since 1986.  My observations on this graph are as follows:

  1. The total return over the years have been remarkably consistent and reduced or negative returns have happened sharply and recovered quickly when they have happened.
  2. Regardless of the level of capital returns, the income return level is very consistent and continues even when capital values fall.  This indicates that holding property during these rare periods of value fall is a sound strategy for recovery in time.
  3. Periods of growth are much longer than periods of downturn.

Whilst we often say (correctly) that past performance is no guarantee of future performance, long term data series are valuable to isolate long term trends and value.

Capital growth potential is based on income growth potential and other measurable factors – commercial properties are often valued on the basis of the potential (and actual) rental return being achieved. Other relevant factors include economic activity, interest rates, and the commercial success of the area surrounding the property.

Each Natgen investment offer will explain the above characteristics of the investment and outline how you can benefit from diversification through this investment.

We look forward to providing you with further detail on the above matters in the near future.

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2023 – a time to rethink our assumptions in changing times

Let me take this opportunity to wish you a happy 2023, whatever the year brings for us all.

After a huge 2022, we sat down to consider what 2023 was likely to bring for Natgen, our investors and the world at large.

The world in 2023

When discerning the strategic direction for Natgen and our investment offers, we believe it vital to investigate the broad trends shaping the world and the economies in which we operate. ‘Strategic foresight’ seems to be the best way to make sense of our ever changing environment, and thus how ‘we the people’ will respond to the changes.

We have identified a number of these trends, which are outlined at the end of this letter.  Whether these trends please us or otherwise, we think it useful to catalogue them for consideration in our future strategic decision-making.

The Australian economic environment and Natgen’s response

Overlaid upon these trends, we have the Australian economic environment, which directly impacts commercial property value and performance.

Asset price movements

With the impacts of the 2022 interest rate rises still washing through the economy, the process of repricing some of the top-priced assets has begun, with prices moderating to more understandable levels. I hasten to add that we at Natgen have always resisted the temptation to join the race to the top of asset prices, preferring to acquire assets at values which we consider to be more durable over time.  For example, when many convenience shopping centres were trading at yields between 4.75% and 5.75%, our acquisitions averaged yields of 7% or higher. Thus, the margin above the prevailing interest rates (the spread) is much higher.

Whilst we expect some price moderation, there remain a number of factors which lead us to the expectation that price drops will be contained. One of these factors which I mentioned in my last letter is the sharply rising replacement value of commercial property assets due to the major increases in building costs which have been experienced across the Australian markets.

Natgen acquisition themes in 2023

Over the course of 2023, Natgen will be concentrating acquisitions activity on the following:

  • Demonstrably high population growth areas, such as South-East Queensland.  We have shied away from our ‘home patch’ in the past, due to a period of unrealistic pricing for assets within our preferred categories.  We expect pricing to adjust during 2023 to a point where we feel that long term value has been restored.
  • Strong regional locations, with strong economic growth credentials.  We prefer regional areas with industrial/business growth expectations, rather than simply expecting population growth, as this measure can be more variable over time.
  • Non-CBD Offices.  This market segment is more specialised and requires understanding of the economic drivers of particular locations and businesses, but the long-term value propositions can be compelling.
  • Convenience Retailing.  A long term Natgen favourite.  Since we entered this market some years ago, market activity increased dramatically and value option in this space reduced.  However we see 2023 as potentially providing a return to value.
  • Property types which address the long term trends outlined above.  This is a deliberately broad category, but long term trends will be an important consideration within our decision-making framework.  Of course, short to medium term economics will also be critical in these decisions.

A pause in acquisitions activity

We believe that asset prices are still undergoing a normalisation process, so we have taken the decision to delay our next acquisition until we have a better understanding of where the economy and the market will equalise.  We believe that this is in the best interests of our investors, both existing and future.

We are keeping a very close eye on the market and will move as soon as we see value, in accordance with acquisition themes for the year.

An increase in development focus

This pause has allowed us to increase our focus on one area of the commercial property where we see current opportunity – development of industrial assets in high growth areas, such the South East Queensland.

With precipitous rises in building costs now generally behind us, projects can now again be costed with reasonable certainty and the economics of the demand side of the market are also reasonably stable.  On these bases, we are currently undertaking due diligence on a number of sites for Natgen development trusts and hope to have at least one development trust offer available within a month.

We are further strengthening our development credentials with the formation of a separate company to seek out and assess development projects for inclusion in a Natgen development trust.  This company will undertake the preliminary work and incur the costs of the original ‘work-up’ of a project, eventually providing the project to Natgen if and when it is proven as a viable project.  This company will be a subsidiary of the Natgen Group.

Another Natgen asset offer

We have also seeing demand within our investor base for a highly liquid cash and cash securities trust, where our investors can earn competitive cash interest rates whilst having their money available for withdrawal at short notice.

Natgen Liquidity Trust CF22 has been structured to provide this style of investment and will be launched for investment in the coming months.

The year ahead

2023 has kicked off as a year of general uncertainty, given recent stock market movements and copious forecasts of downturn and possibly recession.

It is in this environment that we see the value of commercial property investment being particularly important, with attributes including:

  • An inflation hedge;
  • Income generation;
  • Growth options; and
  • STABILITY!

We at Natgen will continue to focus on long term value across all your properties and will continue to manage these assets with a single-minded focus on their value to the investor.

Brett and I, and the whole Natgen team, wish you well for 2023 and beyond.

Regards

Steven Goakes

 

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Why is it smart to diversify your portfolio to include commercial property investment trusts?

The central tenet of portfolio theory of investment is that various asset classes exhibit varying attributes which, when combined, provide a lower volatility for a given rate of return than the individual investments in the portfolio.  This is a concept of a diversified portfolio, as developed by Harry Markowitz in the 1950’s and  quantified by William Sharpe in his Capital Asset Pricing Model (CAPM), eventually leading to him winning the 1990 Nobel Prize for Economics for his work.

Commercial property investment trusts – such as Natgen trusts – can provide valuable diversification benefits within an investment portfolio, due to the nature of commercial property as an asset class.

Commercial property investment trusts invest in:

  • Office buildings;
  • Industrial facilities and warehouses;
  • Retail shopping centres; and/or
  • And mixed use properties, perhaps including some residential component.

Commercial property investment trusts exhibit some unique and valuable characteristics which provide diversity from other asset classes, such as shares, fixed interest investments, and even residential properties.

These characteristics include the following:

Higher Income Yields – the income earned from commercial property can be generally higher than other assets classes, which is particularly valuable where investors are relying on the income yield of their investments for living expenses.

Stability and Consistency of Income – due to the relatively long lease terms applying to commercial property.  Lease terms ranging from 3 years up 10 years or more provide consistent and predictable income streams over time.

Income growth – the longer leases of commercial properties usually allow for the rent to increase in every year of the lease, thus increasing the return on investment as the lease progresses.

Capital growth potential is based on income growth potential and other measurable factors – commercial properties are often valued on the basis of the potential (and actual) rental return being achieved. Other relevant factors include economic activity, interest rates, and the commercial success of the area surrounding the property.

Low volatility – commercial property is considered a lower-volatility asset class, compared with, say, listed equities.  This stability can be used to form the basis of a well-diversified portfolio.  The illiquid nature of the investment and the relatively high transactions costs are factors which actually add to this stability.

Ability to collectively invest – the ability to own commercial property within investment structures, such as commercial property investment trusts, allows investors to hold part of a larger asset and to benefit from professional management of both the asset and the investment vehicle, which will also be subject to annual audit.

Ability to collectively borrow on non-recourse terms – this can be a major advantage to investors seeking to gear their investment portfolio, but limit their debt exposure to the particular investment and not to spread it across their portfolio.

Focussed, professional management of the investment and assets – commercial property investment trust managers, such as Natgen, provide a wealth of experience and expertise in the management of the investment and the assets.  Quality of management if a significant point of difference and investors should ensure that their manager is fully licenced, has a track record, and appoints industry leaders to assist with valuation, due diligence and compliance.

Each Natgen investment offer will explain the above characteristics of the investment and outline how you can benefit from diversification through this investment.

We look forward to providing you with further detail on the above matters in the near future.

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June 2022 Interest Rates – the latest Natgen perspective

Since Natgen last wrote on the future of interest rate policy and market movements (approximately 6 months ago), the economic landscape is hardly recognisable.

The world of November 2021 has now endured:

  • the rampant spread of the Omicron strain of Covid-19 which, whilst generally less severe, is the most virulent strain.  This has resulted in mass infections (thankfully following mass vaccinations) and the resultant labour shortages globally;
  • the lock-down of China (and thus its productive capacity) seeking to eliminate Omicron;
  • the Russian invasion of Ukraine, disrupting exports from this important European supplier and massively changing the trading relationship of Europe (and beyond) with Russia, at least in the near term; and
  • devastating floods in South East Queensland and Northern New South Wales, disrupting important fresh food supplies to much of the eastern seaboard of Australia.

The result of the above has been the halting of the expected post-Covid worldwide (and local) resupply and recovery.  And, in fact, the deepening of supply-side economic disruption to unprecedented levels.

So, how has this impacted my interest rate propositions from November 2021?  The table below states the November 2021 proposition on the left with June 2022 insights to the right:

The assumption is that the next interest rate movements will be upwards.Yes – this has come to pass, but at a pace and extent that was broadly unexpected in November.
Governments and the banking/finance communities worldwide have a vested interest in keeping interest rate movements within a tolerable band for mortgage holders in particular.Whilst the general proposition remains true, other influences (inflationary pressures) are greatly impacting the ability of central banks to maintain this goal in the short term.
Our base case assumes a doubling of effective interest rates within the next interest rate cycle, meaning in increase over the coming years of approximately 2% per annum.The market is now pricing in a possible tripling of interest rates, however Reserve Bank indications are not going this far – more on this later.
The speed of interest rate increases is unable to be accurately determined, so we use the market rates for BBSY between 90 days and 10 years as an indication of the market view of the expected rate of rise in interest rates.The precipitous rate on interest rate rise bears no resemblance to the indicators as late as October / November 2021.
Our financial models for Natgen investment trusts assume a commencing interest rate above the current short term BBSY (bank bill swap rate) and provide an increase in this rate during the latter years of Natgen investment trusts based on advice from financiers, other market participants and Reserve Bank guidance.As part of our ongoing analysis of trust performance, we have remodelled each of the Natgen trusts in the light of recent interest rate data.  The interest rate ‘headroom’ which we allow in all Natgen trust cashflow is certainly now fully employed in the current environment.

Even within the last 3 months, Reserve Bank guidance has effectively done a 180 degree backflip, with ‘front loading’ of interest rate increases being dramatically opposed to previous guidance.

The response to this interest rate information may vary.This remains true. With the benefit of hindsight and better guidance from the Reserve Bank, the response may vary over time.

Market priced forward fixed rates as at 24 June 2021 and 2 June 2022:

(please note the difference in the Y-axis scale on these graphs)

So, we are now aware that short-term significantly higher interest rates are now a reality. Thus, we must ask the inevitable questions:

  1. How high and for how long?
  2. Was this foreseeable?
  3. What do we do about it?

    How high and how long?
    The answer to this question depends largely on two further questions:Is the inflation caused by supply-side disruption a spike or will it be more persistent?

    This largely depends when the supply constraints ease and the response of governments in the meantime.Australian inflation has been less than in other developed economies and high wages inflation at this stage has not been detected to any great degree, notwithstanding labour shortages and an unemployment rate in the high-3% range.Will the inflation spike be ‘baked in’ to the economy by some form of inflationary government policy response? Whilst Labor governments are reputed to be big spending in nature, the Treasurer has indicated that they have constraints on expenditure forced upon them by the current fiscal position of the federal government.  This indicates some level of restraint may be displayed in this regard.On the basis of their interpretation of the answers to these questions (and other considerations), our latest advice from the Commonwealth Bank is that the currently aggressive interest rate increases being experienced in the market (and edicted by the Reserve Bank) are likely to lessen the duration of the interest rate peak, but inevitably increase its magnitude.  The Commonwealth Bank is now factoring in a moderation of short term interest rates in late 2023.  This depends on the higher interest rates impacting inflation quickly without overshooting the economy into serious recession.In terms of how high, it remains difficult to determine.  Whilst global rates can be a guide, there are differences in the global interest rate markets which provide a cogent reason for variation.  For example, the Australian market – both home mortgage market and commercially – is by and large a variable rate market.  This means that interest rate variations have their economic impact more quickly than predominantly fixed rate markets.  (In the US, it is possible to take a home mortgage with a 30 year fixed rate.)

    Was this foreseeable?

    There is little doubt that increases in interest rates in the future were foreseeable, given the economic shocks being felt through the world economy.  Also, if for no other reason than an historically low emergency interest rate was unlikely to be maintained in the long term.

    What has surprised most – including us – is the timing and speed of the increases.  Of course, with the benefit of the data now available, there will be many who proclaim that they were fully aware of what was going to happen and when.  Unfortunately, none of these economics savants seem to have been employed by the Reserve Bank or other central banks.

    What do we do about it?

    Regardless on the circumstances, the remit of Natgen remains clear and unchanged. In the November article, I concluded by saying that Natgen will continue to take a risk-managed approach to interest rate decision making, with unitholder return and risk reduction as the central considerations.  In fact, these considerations remain central to decision making in relation to all our management obligations.

    Whilst the unusual speed of change in the interest rate environment has rendered some interest rate risk measures less effective (and much more expensive), there are still many management actions which impact performance regardless of interest rates.

    For example, we maintain a close watch on tenant payments and ensure that we become aware of any payment delinquencies.  Cashflow management is very important at all times.  Of course, we are also ensuring that rental reviews are carried out promptly and fully when due.  This provides regular and significant rental revenue increases, assisting to offset increased interest rate costs.

    As always, we continue to seek value-add opportunities within managed properties, specifically directed toward revenue increments.

    As this very dynamic interest rate environment continues to unfold, we will keep you informed about what the market is forecasting, what the Reserve Bank is planning and our responses to each.

    Please feel welcome to reach out to us if you would like to discuss these matters in more detail.

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Interest Rates – a Natgen Perspective

By Natgen Managing Director, Steven Goakes

Speculation on the future of interest rate policy and market movements is a hot topic at the moment – both in the media and within financial circles.

We at Natgen have been watching these developments closely, given the fact that we have been following our interest rate risk management strategy for some time now.

The basic tenets of our strategy are as follows:

  • The assumption is that the next interest rate movements will be upwards.
  • Governments and the banking/finance communities worldwide have a vested interest in keeping interest rate movements within a tolerable band for mortgage holders in particular.
  • Our base case assumes a doubling of effective interest rates within the next interest rate cycle, meaning in increase over the coming years of approximately 2% per annum.
  • The speed of interest rate increases is unable to be accurately determined, so we use the market rates for BBSY between 90 days and 10 years as an indication of the market view of the expected rate of rise in interest rates.
  • Our financial models for Natgen investment trusts assume a commencing interest rate above the current short term BBSY (bank bill swap rate) and provide an increase in this rate during the latter years of Natgen investment trusts based on advice from financiers, other market participants and Reserve Bank guidance.
  • The response to this interest rate information may vary. For example, Natgen has chosen to fix the interest rate of the debt for the Kingsthorpe Central Shopping Centre for the term of the loan, whereas the interest rate for Rededge Goodna will remain variable in the short term, pending further market indications. Both these responses are based on our interpretation of available information and our consideration of the best outcomes for our unitholders in each individual case.

Current interest rate market indications

Following the most recent inflation figures, medium term fixed interest rates jumped significantly, indicating that the market is factoring in a series of increases earlier than previously expected.

The consensus view of bank economists is bringing interest rates increases forward from 2024 into 2023 and to some extent into the latter part of 2022. The Reserve Bank, on the other hand, is taking a somewhat more conservative approach. In its latest Statement on Monetary Policy (November 2021), the Reserve Bank has made observations about the international environment, domestic economic conditions and domestic financial conditions which are consistent with it’s conservative growth expectations on interest rates.

Whilst a multitude of factors are at play, my reading is that the RBA sees the current inflation spike as just that – a spike, which has been caused largely by supply constraints as global supply chains re-start following Covid-related shutdowns on all continents. The Delta strain further extended supply constraint conditions. However, as supply chains recover, the expectation is that the inflation spike will normalise and long term inflationary pressures will return to closer to pre-pandemic levels. Even widely-publicised labour market shortages are expected to have only moderate impacts in Australia, given our predominantly services based economy and reintroduction of foreign students and workers into the economy in 2022.

In the end, only time will tell whether the market response or RBA analysis is correct. Notwithstanding this uncertainty, we at Natgen will continue to take a risk-managed approach to interest rate decision making, with unitholder return and risk reduction as the central considerations.

Steven Goakes
Managing Director

 

For 2022 Natgen opportunities, please visit: https://natgen.com.au/investment-opportunity

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The End of an Epic Financial Year

As the end of the financial year approached, I spent some time looking back at the position of the world and this country at the beginning of the financial year. On 1 July 2020, the following was happening:

  1. The first wave COVID-19 disasters had swamped the UK, USA, Italy and many other countries;
  2. Fortress Australia was in place and our first wave had been controlled;
  3. A COVID-19 vaccine seemed a distant hope – perhaps for 2022 or 2023;
  4. The ASX was stuttering back after a March rout;
  5. Close to 3.5 million Australians were being supported by Jobkeeper, following the loss of somewhere between 1 and 2 million jobs;
  6. Property markets were flat;
  7. All Australian governments were putting on a united front (remember that!); and
  8. There was significant pessimism about near-term economic performance of the economy.

We were yet to face devastating second and third waves of the pandemic globally and the scary spectre of the removal of Jobkeeper support after September.

As astonishing as the pandemic was in its impact and consequences, the ‘snap back’ has been equally astonishing, with significant winners and losers along the way.

My hope for this coming year is that short-term survival behaviour gives way to long-term strategy and vision, both for individuals, corporations and countries.  Whilst they may appear at times to have been suspended, the fundamentals of economics, politics and the social contract have not gone away. We best recognise this sooner rather than later.

2021-2022 Financial Year: What’s next?

Since completing our latest investment trust Natgen Investment Trust KT21 at the beginning of May this year (only 2 months ago), we have been fielding constant queries about when and what is next for Natgen and it’s investors.

The constant (and truthful) response is that we are diligently seeking new opportunities for our investors which accord to the immutable principles of the Natgen Investment Philosophy. 

Markets are hot right now – some might say behaving irrationally. Experience tells us that value remains available in these times, but one must seek it out in a careful, sober and meticulous manner. It is a time where we get to demonstrate our values, for whilst it would be better for us (as a company) to take on as many new transactions as possible, this would not be in the best interests of our investors, who rely on us to provide thought leadership in terms of where value and growth can be found. Our long term survival and prosperity will come from demonstrating that we live our values and continue to put investor’s interests first. After all, this is the fundamental tenet of a fiduciary relationship – always has been, always will be.

Don’t worry – when we find value passing a transaction through our due diligence processes, you will be informed and be invited to participate. In every case, we ask you to challenge us to explain to you our underlying value proposition for the transaction. Our philosophy and processes ensure that we will have a good answer to that question.

Interest rates and their future impacts

The low interest rate environment that we currently enjoy has presented threats and opportunities across the economy. In particular, it has impacted prices of residential property substantially and commercial property also, but to a lesser extent.

But interest rates will not stay stagnant forever, and logic suggests that the next movements will be up. Thus, we are constantly focussing on interest rate risk management in all transactions we are considering. It is not sufficient to predict that rates will remain where they are for term of a trust. We at Natgen are seeking regular (at least monthly and often weekly) briefings from our preferred debt providers and adjusting our interest rate considerations accordingly.

Ultimately, no-one actually knows where or when rate movements will occur. What we can do, however, is take a well-informed, risk-managed position on interest rates and manage our portfolio and future transactions accordingly.

I wish you well for the year ahead.

Regards

Steven Goakes

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The top 8 benefits of commercial property investment vs residential property investment

When most people think of property investment, they tend to think of ‘negative gearing’ a residential home or apartment.

The “negative gearing industry” has been relentlessly promoting this for many years, and their messages are well known. 

Of course, negative gearing involves losing money on your investment property (ie. negative annual profit) in order to minimise tax on other income. Then, the investor hopes that the asset’s value grows to eventually give an overall positive return. 

As an alternative, commercial property investment exhibits some fundamental differences. To begin with, commercial property investments are generally structured to be positively geared – you make an income return on your investment funds.

What defines a ‘commercial property’? 

A commercial property includes: 

  • office buildings
  • warehouses
  • industrial buildings
  • mixed use buildings (retail/apartments etc.)
  • retail buildings.  

Potential advantages of commercial property investment include:

  1. Higher income yields – commercial properties generally show a greater level of income for a given property value, when compared to residential property.
  2. Capital growth potential is based on income growth potential and other measurable factors – commercial properties are often valued on the basis of the potential (and actual) rental return being achieved. Other relevant factors include economic activity, interest rates, and the commercial success of the area surrounding the property.
  3. Stability and consistency of income – longer leases. Whilst residential properties are typically held on short leases (often 12 months), commercial properties typically attract longer lease terms between three and 10 years, providing consistent and predictable income streams over time.
  4. Income growth – the longer leases of commercial properties usually allow for the rent to increase in every year of the lease, thus increasing the return on investment as the lease progresses.
  5. Maintenance – unlike residential investors, commercial investors have the potential to earn enhanced profit, with the lessee responsible for paying the cost of maintenance, rates and repairs on the property when the ongoing expenses are written into the commercial lease agreement. 
  6. Reliable tenants – we have all heard stories of “horror tenants” in houses and apartments. Tenants of commercial properties, on the other hand, are earning their income from the property. Therefore, it is in their interests to keep the property in good order and to maintain good relations with the landlord.
  7. Diversification – commercial property investment can provide diversification across different asset classes and geographic locations, allowing the investor to add further elements of diversification into their portfolio. By diversifying their portfolio and investing in a variety of commercial assets, from retail to industrial, investors are also protecting their income and managing risk in the event of an economic downturn. 
  8. Ability to collectively invest – the ability to own commercial property within investment structures, such as property managed investment trusts, allows investors to hold part of a larger asset and to benefit from professional management of both the asset and the investment vehicle, which will also be subject to annual audit.

 As with all investments, commercial property investment is also subject to investment risks which must be managed.  For example, the managers of the property must ensure that the property remains relevant to the leasing market which it serves.  From a financial perspective, gearing must be monitored and maintained at appropriate levels.

Natgen provides clients with well-considered, carefully measured commercial investment opportunities, accompanied by professional advice from our experienced leaders. If you’d like to be notified of future investment opportunities, request an Investor Information Pack or contact us directly at invest@natgen.com.au

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