I INTRODUCTION TO THE LEGAL FRAMEWORK
i Ownership of real estate
Freehold Title is by far the most common form of ownership for real estate in Australia. Houses, apartments, commercial buildings, farms and vacant land are examples of real estate with freehold title.
Freehold Title means that the owner (and their beneficiaries) owns the real estate outright in perpetuity. The owner is free to mortgage the real estate to secure a loan, to lease the real estate to anyone, to gift the real estate, to leave the real estate by will, and to sell the real estate. The owner is free to build, add to and demolish, subject to planning permits.
Strata Title is the other common form of ownership. It is found in medium density and high-rise buildings where self-contained parts of the building – strata apartments (also known as home units or ‘lots’ in a strata plan) have a separate title. Apartments, townhouses, strata offices, strata shops and strata industrial units are examples of real estate with strata title.
Strata Title gives the owner the same rights as the owner of freehold title real estate, excepting that decisions upon the building, such as repairs and maintenance, are made collectively by all the owners of the building, and common levies are raised for insurance, repairs and maintenance.
Some specialised forms of ownership in Australia are: Crown Leases which is leasehold title found in farms and rural properties; Community Title which is found in residential developments ranging from low density to high density, and retirement villages; Maritime and Foreshore Leases of 99 years for land near waterways; Company Title which is found in older residential apartment buildings; and Native Title which is found in pastoral and mining leasehold land.
ii System of registration
Ownership of real estate is transparent in Australia. There is a record of the name of the legal owner of the real estate in the Land Titles Registry located in each State and Territory in Australia. Not only is the legal owner recorded, but also easements and covenants affecting the land, mortgages which are secured by the land, claims of interest (Caveats) made upon the land, and leases of the land. The price paid to purchase property and the rental payable on the lease are transparent, but not the amount owed under a mortgage security.
The recordings are made on a Certificate of Title. A separate Certificate of Title exists for every parcel of real estate in Australia. This idea originated from Robert Torrens who in 1858 introduced the system of transferring title to property by means of the registration of a Transfer of title on a Certificate of Title. This system is known as ‘Torrens Title’ and is used for all forms of ownership of real estate in Australia.
Legislation in Australia confers statutory protection, known as ‘indefeasibility of title’ upon the person who is recorded as owner on the Certificate of Title at the Land Titles Registry. The sole exception is if the transfer is fraudulent. In practice, this means there is a state guarantee of good title given to a purchaser when they purchase a property.
iii Choice of Law
There is no choice of law available in Australia when it comes to dealing with real estate.
The law which applies to dealings with real estate is the law of the State or Territory in Australia in which the real estate is situated. The exception is if the real estate is owned by the Commonwealth of Australia, in which case the Commonwealth Law (Federal Law) applies.
II OVERVIEW OF REAL ESTATE ACTIVITY
These figures from the Australian Bureau of Statistics paint the picture of a buoyant real estate market:
- The total value of residential dwellings in Australia was $6,726,783.5m at the end of the June quarter 2017.
- The mean price of residential dwellings in Australia rose $12,100 to $679,100 at the end of the June quarter 2017 and was up by 10.2% in the year to June 2017.*
- The number of residential dwellings in Australia rose by 40,000 to 9,906,100 in the June quarter 2017.
- Seasonally adjusted, approvals for private houses rose 6.2%, and approvals for other private sector dwellings (mainly apartments) rose 37.6% in the year to October 2017.
- Seasonally adjusted, capital expenditure on commercial buildings and structures rose 2.4% in the year to September 2017.
- Lending to investors is falling, while lending to owner occupiers is rising, partly as a result of an interest rate premium being charged to investors compared with owner occupiers, and partly as a result of lending policy favouring owner occupiers.
* Price increases for residential real estate varied considerably around Australia. The three capital cities which exceeded the mean price increase of 10.2% for the year to June 2017 are: Sydney – 13.8%, Melbourne – 13.8%, Hobart – 12.4%. The other capital cities were more subdued: Canberra – 7.9%, Adelaide - 5%, Brisbane – 3%, Perth – minus 3.1%, and Darwin – minus 4.9%.
III FOREIGN INVESTMENT
Australia is open to foreign investment in real estate in new residential housing (up to 50% of an apartment development can be sold to foreign investors), commercial real estate and farms.
Investment in existing housing stock is restricted to Australian citizens, permanent residents and holders of student visas. The ‘existing house’ policy is directed to housing affordability for the average Australian – that they are not crowded out or priced out of the housing market.
This is the foreign investment policy as explained by the Foreign Investment Review Board:
Under Australia’s foreign investment framework, foreign persons generally need to apply for foreign investment approval before purchasing residential real estate in Australia.
Foreign investment applications are considered in light of the overarching principle that the proposed investment should increase Australia’s housing stock (by creating at least one new additional dwelling).
Strict criminal and civil penalties may apply for breaches of the law, including disposal orders.
Foreign persons may be required to notify and receive a no objections notification before acquiring an interest in commercial land in Australia. Different rules apply depending on whether the land is vacant or not, whether the proposed acquisition falls into the category of sensitive commercial land that is not vacant, and the value of the proposed acquisition.
Proposed direct interests in an agribusiness generally require approval where the value of the investment is more than $55 million, with an exemption applying to investors from Australia’s trade agreement partners and a $0 threshold applying to Foreign Government investors.
In 2015-16 the Foreign Investment Review Board approved 41,000 purchases of residential real estate by foreigners nationwide, with 44% in Victoria and 33% in New South Wales. For various reasons, this represents a high water mark and foreign purchases have declined. Most approvals are for purchases of $1 million or less in price, which indicates that the properties purchased are mostly strata apartments.
IV STRUCTURING THE INVESTMENT
Investors in real estate in Australia have a wide choice of structures and investment vehicles in which to make their investment.
The most popular forms for direct investment are: personal name, a company, a trust, and a joint venture. Each have their relative advantages in terms of asset protection, taxation treatment, ease of transacting, disclosure and sharing ownership.
The most popular form for indirect investment is a property scheme, which can be a listed real estate investment trust (REIT) or an unlisted property scheme.
i Personal Name
Real Estate held in a personal name is exposed to creditors and others who make legal claims.
Why is it that most Australians own their family home in their own names with this exposure? The answer is that the family home has many tax exemptions – the sales proceeds are completely exempt from capital gains tax, the home is exempt from annual land tax, and no inheritance tax is payable on death. Investment property has no such tax exemptions.
Transacting is subject to full transfer taxes (known as stamp duty) no matter if it is a family home or an investment property. If ownership is shared, the names of all owners are recorded on the title.
ii Company
Real Estate held in the name of a limited liability company protects the shareholders and directors of the company from legal claims against the property. The exceptions are director liabilities for personal guarantees, tax and environmental offences. Companies are useful for joint ownership of properties for investment.
Real estate investment companies pay tax at the rate of 30¢ in the $1. If more than 20¢ in the $1 of income is ‘active’ income, in which case the rate may be lower. The tax paid is able to be distributed as a tax credit against the Australian tax payable by the shareholder.
Transacting is subject to full transfer taxes, whether by the company or by the shareholder. The ownership interests are held as shareholdings.
iii Trust
Real Estate held in a trust is usually held in the name of a limited liability company which acts as the trustee of the trust. The trustee is usually able to deal with the real estate in its name, as if it were the owner. The trust protects the real estate assets against legal claims made against the trust beneficiaries personally.
There is no tax payable by a trust – because the income surplus is distributed to the beneficiaries annually. Tax is payable by the trust beneficiaries on the trust distributions according to their tax position.
If the trust is a unit trust, then the distributions made to the trust beneficiaries are fixed, according to the unit holdings. If the trust is a discretionary trust, then the distributions are made at the trustee’s discretion. If the trust is a custodian trust (a bare trust), then the trust beneficiary or beneficiaries are entitled to fixed distributions.
Transacting units in a unit trust follows the same rules as transacting shares in a company, namely that the requirements of the Unit Trust Deed must be followed.
Interests in a discretionary trust are not transacted because the beneficiaries have no fixed entitlements, only an entitlement to be considered for a distribution.
Transacting interests in a custodian trust follows the same rules as transacting interests in a personal name.
iv Joint Venture
Real estate held in a joint venture can be held in any one of three ways –
- In the name of a company. If so, it is an incorporated joint venture and the commentary about companies and unit trusts applies.
- In the names of the investors personally – the joint venturers. If so, it is an unincorporated joint venture and the commentary about personal names applies.
- In the name of a nominee company. If so, it is an unincorporated joint venture and the commentary upon custodian trusts applies.
v Property Scheme
This description is provided by the Australian Securities and Investments Commission:
A property scheme, also known as a property fund or property syndicate, is an investment where you, and other investors, buy 'units' in an investment operated by a professional investment manager. The scheme's money is invested in property assets which may include commercial, retail, industrial or other property sector assets.
The investment manager selects and buys investment properties and is responsible for maintenance, administration, rental collection and improvements to the properties.
Your money usually stays in the property scheme until it ends, when the properties are sold and the net proceeds are distributed to investors.
You may be able to withdraw your money early but there may be penalties. If the scheme is listed, you may be able to sell your units on the public market.
Depending on the type of property fund you invest in, you might get a regular income (distributions), usually quarterly or half-yearly, and a capital gain on your original investment, if the value of the scheme's underlying investment assets increases.
Some property schemes invest in property development, which means there are extra construction and development risks.
Listed property schemes, known as property trusts or real estate investment trusts (REITs), are property schemes listed on a public market, such as the Australian Securities Exchange (ASX). They are easy to value, easy to sell and are subject to listing (disclosure) rules.
Unlisted property schemes give less liquidity for their units, and are less transparent in terms of disclosures to investors.
In terms of taxation, the commentary upon unit trusts applies, because that is their structure.
V REAL ESTATE OWNERSHIP
i Planning
Town planning schemes, land zoning and development controls provide the legal framework for the way that land can be used in Australia.
Planning rules are strictly enforced. Illegal development will be subject to use prohibition orders and demolition. For that reason, checking planning and building compliance is a vital part of the conveyancing process for the purchase of property.
Common land zonings are: Residential (low density, medium density and high density), Rural, Business, General Commercial, Tourist, Industrial, Mixed Zoning and Environmental. Each zoning has rules for exempt development which does not need a permit, complying and permissible development which needs a permit, and prohibited development.
Checking building compliance is an important part of the conveyancing process when purchasing real estate in Australia.
Complying with the planning rules to develop a property in Australia requires expert assistance from specialists such as town planners, traffic consultants, environmental consultants, land surveyors and lawyers.
Local authorities (Local Councils) determine applications for development permits or approvals, except for state significant applications which are determined by the State Departments of Planning.
ii Environmental
Each State has an Environmental Planning Authority which regulates the investigation and clean-up of contaminated land to prevent pollution and safeguard community wellbeing. The planning and development process determines what remediation is necessary to make contaminated land suitable for use.
Examples of contaminated land are land which is in a locality where heavy industry or intensive agriculture is found, or individual sites that have been used for chemical storage, such as petroleum service stations, and sites with asbestos materials in buildings or in the soil.
If a property is purchased for development, especially for residential development, obtaining an Environmental Impact Statement is an important part of the conveyancing process because the Contract for the Sale and Purchase of Land will normally contractually preclude the purchaser from making any claim against the seller. If there is contamination, the purchaser should request that completion of the Contract be made conditional upon the issue of an Environmental Clearance Certificate.
If a property is purchased as an investment, then an asbestos clearance may be appropriate, for loose fill asbestos insulation in the roof cavities of houses, and for asbestos lagging around pipes, asbestos roofing and in electrical boards in commercial buildings.
iii Tax
Transfer tax, known as stamp duty in Australia, is levied on transfers of real estate in Australia. It is payable by a purchaser either within a fixed period after the Contract is entered into, or on completion of the Contract, depending on the State.
The rate of duty varies according to the price in the Contract for the Sale and Purchase of the real estate, unless it is a gift or a transfer between related parties, when the rate is according to the market value of the real estate.
The rate of duty varies between the States and Territories. Exemptions can apply to First Home Purchasers. Stamp duty surcharges apply to foreign purchasers in New South Wales, Victoria and Queensland.
This is a snapshot of the current stamp duties payable –
- New South Wales – For an $800,000 property, the stamp duty payable is $63,490. An 8% surcharge is payable by foreign purchasers of residential property which adds another $63,490. There is no surcharge for commercial property.
- Victoria – For an $800,000 property, the stamp duty payable is $43,070. A 7% surcharge is payable by foreign purchasers of residential property which adds another $56,000.
- Queensland - For an $800,000 property, the stamp duty payable is $21,850. A 3% surcharge is payable by foreign purchasers of residential property which adds another $24,000.
iv Finance and security
Australian Real Estate is acceptable security for loan finance. Lenders require ‘first mortgagee’ status, which is that their mortgage is the first mortgage recorded on the title to the property. The reason is that in the event of default, the lender has the right to sell the property in its capacity as mortgagee exercising its power of sale. This right is not restricted by subsequent mortgages or other interests recorded on the title to the property.
The availability of loan finance for Australian Real Estate is governed by two factors:
- The status of the borrower: Are they a resident or non-resident? Are they purchasing for owner-occupation or for investment?
- The nature of the property: Is it residential - a house or an apartment? Is it commercial – a hotel, retail, industrial or office? Is it agricultural – a farm or other rural property? If commercial, the remaining term of the lease and the quality of the tenant.
The factors translate into whether or not loan finance is available, the interest rate payable and the LVR (Loan-to-Value Ratio) that will apply.
VI LEASES OF BUSINESS PREMISES
Commercial properties are usually sold subject to lease. Evaluating the quality of the lease is essential The main characteristics of leases of business premises in Australia to look out for are:
Term Typical terms are 2, 3 or 5 years, with an option to renew for the same term. Tenants with extensive fit outs, such as restaurants, food outlets, retail shops, cafes, prefer 5 year leases with at least one, if not two, options to renew for a further 5 years. The option to renew is exercised at the discretion of the tenant. Demolition clauses are inserted into leases of buildings which are intended for redevelopment, which enable the lease to be terminated early.
Commencement If a tenant pre-commits to premises in the course of construction, then an Agreement for Lease is entered into as a precursor to the Lease. The Agreement for Lease often contains the specifications, such as services, air conditioning and configuration the tenant requires. If the premises are existing, the tenant may negotiate a rent-free fit out period before the lease term commences.
Rent The rent is stated in the lease as either a gross rent (inclusive of outgoings) or a net rent (outgoings are added). Office rents tend to be gross rents; industrial and retail rents tend to be net rents. For these purposes, outgoings includes Council Rates, Water Rates, Strata Levies, Land Tax, Building Insurance, Management fees, Building repairs and maintenance. Outgoings do not include services, such as electricity, gas, telecommunications, water usage, waste and other garbage removal, which remain the tenant’s responsibility.
Goods and Services Tax (GST) is payable on the rent (the current rate is 10%). It is added to the rent. GST is remitted quarterly to the Australian Tax Office.
Some shopping centre leases contain turnover rent clauses. Turnover rent is payable in addition to normal rent, based on a percentage of the rent.
Rent is usually paid monthly in advance. The annual outgoings are divided by 12 and are payable along with the rent.
Typically, rent increases annually by either CPI (Consumer Price Index) or by a fixed percentage, or by the higher of the two. Rent is reviewed to market at the commencement of the option term. The lease should contain a ‘ratchet’ clause which prevents the rent from falling below the rent for the final year of the previous term when the rent is reviewed to market.
A rent-free period is often negotiated for the first term, the length of which depends on the tightness of the rental market. It can be one month per year in a normal market.
Security Bond A cash security or bank guarantee of three months rent is typical. The amount can be increased every time the rent is reviewed. Cash bonds are held by the landlord, except retail premises bonds which are held by a rental bonds board. Personal guarantees are common, although their usefulness is limited because a law suit is needed for collection, or because the guarantors becomes bankrupt if the business fails.
Use The use is specified in the lease either in specific terms such as a café, or in general terms such as a warehouse. Usually, the use must be approved by the local planning authority. The use cannot be changed without the landlord’s consent.
Assignment and sub-letting The tenant has the right to assign the lease and to sub-let the premises, with the landlord’s consent. The landlord can require the incoming tenant to have suitable experience and financial resources.
Make Good At the end of the lease, the tenant is required to “make good”. This means that the tenant must hand back the premises in the condition and state of repair that it was handed over to them, fair wear and tear excepted. The tenant is to remove their fit out, and to paint the premises. The tenant is to de-contaminate if their use has caused contamination.
Insurance The landlord is responsible to insure the building (except in strata properties, where the strata corporation does so), and for public liability and for fittings. The tenant is responsible to insure for public liability, plate glass (if any) and worker’s compensation.
Energy Efficiency Owners of commercial office space with a net lettable area exceeding 1,000 square metres must provide an up-to-date Building Energy Efficiency Certificate (BEEC) and provide it to tenants before leasing and purchasers before selling the office space. The Commercial Building Disclosure (CBD) Program requires BEECs to contain a National Australian Built Environment Rating System (NABERS) Energy for offices rating and a CBD tenancy lighting assessment.
VII DEVELOPMENTS IN PRACTICE
i. Tax Clearance Certificates for Sale of Properties now required
All real estate vendors must obtain a Foreign resident capital gains withholding clearance certificate (a Tax Clearance Certificate) from the Australian Taxation Office (the ATO) if the sale price is $750,000 or more. Although the title indicates Foreign residents, the requirement applies to Australian residents, in fact to all vendors. The term resident means a resident for tax purposes.
The Tax Clearance Certificate is given to the purchaser on settlement of the sale, that is, when the price is paid. Without it the purchaser is under a legal obligation to withhold 12.5% of the price and remit it to the ATO. The purpose is to protect the ATO’s claim for capital gains tax payable on sale. Note: capital gains tax calculations are made differently - they are based on profit on sale, not a percentage of the sale price.
Australian resident vendors (for tax purposes) may apply for a Tax Clearance Certificate online, or in a paper form. Where there is more than one vendor, each vendor must lodge a separate application.
They are issued if the ATO is satisfied that the vendor has complied with their Australian tax obligations, that is, if a tax return has been filed within the past two years and there is no tax overdue. The ATO may issue a partial Tax Clearance Certificate to cover unpaid tax.
Foreign resident vendors may apply for a Variation to reduce or eliminate the withholding obligation. They must prove to the ATO that they will make a capital loss on sale; or a CGT roll-over applies; or they have carried-forward losses or tax losses; or the proceeds of sale available at settlement are insufficient after repayment of the mortgage or other security interest; or they are selling their main residence (if before 30 June 2019).
ii Purchaser declarations for transfer duty
All purchasers must complete a declaration when buying or acquiring property in Australia. A new form was introduced on 1 July 2017.
Information collected through the purchaser/transferee declaration/statement is necessary to meet Commonwealth Reporting Requirements and to meet the Revenue Office’s responsibilities to administer the Duties Act, including the identification of foreigners for purchaser surcharge duty and land tax.
The information collected includes:
- Property details, including if it is residential or commercial, whether it is owner-occupied or an investment property.
- Transactional information, including the transfer price, contact date and settlement date.
- Identity information of the vendor/transferor and purchaser/transferee including name, address, date of birth (for individuals) and Australian Company Number / Australian Business Number (for non-individuals).
- If the purchaser/transferee is the trustee of a trust, information about the trust.
- Nationality and immigration details of the vendor/transferor and purchaser/transferee.
The Commonwealth Reporting Requirements relate to foreign investment. The information is provided to the ATO for the purpose of information-matching and ensuring compliance with the taxation laws of the Commonwealth. The ATO can impose a ‘vacancy fee’ on residential real estate that is left unoccupied for more than 183 days per year.
The Duties Act requirements are directed to raising revenue. The information collected is used to identify whether a foreign purchaser surcharge is payable for transfer tax/stamp duties purposes. The information collected is also used for imposition of the annual land tax surcharge for foreign owners of residential real estate.
The land tax surcharge for foreign person ownership is 2.0% in New South Wales. In both Victoria and Queensland, the surcharge is 1.5% and is known an absentee owner surcharge (known as a ‘ghost tax’) which is levied on unoccupied properties. For example, if land tax is levied at the rate of 1.6% on the land value in New South Wales, then the surcharge will mean that land tax is levied at the rate of 3.6% on residential land in foreign ownership.
iii Tax deductions for travel to visit investment real estate and some depreciation abolished
From 1 July 2017, the Government has disallowed deductions for travel expenses related to inspecting, maintaining or collecting rent for a residential rental property. This was an integrity measure taken to address concerns that many taxpayers have been claiming travel deductions without correctly apportioning costs, or have claimed travel costs that were for private travel purposes.
From 1 July 2017, the Government has limited plant and equipment depreciation deductions to outlays actually incurred by investors in residential real estate. Plant and equipment items are usually mechanical fixtures or those which can be ‘easily’ removed from a property such as dishwashers and ceiling fans. This was an integrity measure taken to address concerns that some plant and equipment items were being depreciated by successive investors in excess of their actual value.
VIII OUTLOOK AND CONCLUSIONS
The outlook and conclusions are well described in these extracts from a paper presented by Jonathan Kearns - Head of Financial Stability, Reserve Bank of Australia at a conference of Aus-China Property Developers, Investors & Financiers held at Sydney on 20 November 2017:
Purchases and financing by foreigner investors and banks have been prominent in the current commercial property cycle. We have seen this before and are well aware of the impact this can have on the cycle. The increased purchases of dwellings by foreign buyers, particularly for investment purposes, are a more recent phenomenon and so their impact on the housing cycle is less clear.
Conditions in the housing market have eased, particularly in Sydney where prices had experienced strong growth and are particularly high, possibly giving lending restrictions greater impact in Sydney. In Melbourne, conditions remain stronger than in other capital cities. On the other side of the country, and at the other end of the spectrum in terms of housing market conditions, the Perth housing market remains weak. Prices have fallen gradually over the past two to three years, with rents also falling as the rental vacancy rate has increased to its highest level since 1990.
Commercial office markets have been strongest in Sydney and Melbourne with low vacancy rates and rising prices. In contrast, conditions have been weaker in Perth where vacancy rates increased sharply with the downturn in the state economy from the decline in mining investment.
Purchases by foreign buyers do not, on the whole, reduce the supply of dwellings available to local residents and in fact may actually contribute to expansion of the housing stock. Foreign buyers in Australia for work or study would have been renting if they did not purchase. Other foreign buyers rent the property as an investment and so contribute to the rental stock. Also, there are some new developments that only proceed because they get high pre-sales from foreign buyers.
The strength of the Australian property market, and the participation by foreign buyers, has also enticed some foreign developers to Australia for specific projects, but overall they remain a small part of the market. Foreign banks also have a very small role in residential property lending in Australia.