I INTRODUCTION TO THE LEGAL FRAMEWORK
i Ownership of real estate
Freehold title is the most common form of ownership for real estate in Australia. Houses, apartments, commercial buildings, farms and vacant land are all owned with freehold title.
Freehold title means that the owner (and their beneficiaries) owns the real estate outright in perpetuity. The owner is free to sell, mortgage and lease the real estate without needing official permission. The owner can deal with the real estate as they choose, including by gifting or leaving the real estate by will. The owner is free to build, add to and demolish, provided the development controls allow and planning permits are obtained.
Strata title is a specialised form of freehold title. It is found in medium-density and high-rise buildings in which self-contained parts of the building known as 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 a share in what is known as the common property, which means the building, the foyer, the driveways, the garden, the lifts and the stairs. They participate in decisions concerning the common property, such as building insurance, repairs and maintenance, and pay strata levies for common property expenses.
Some specialised forms of ownership in Australia are:
- Crown leases, which are leasehold title found in farms and rural properties in remote areas;
- 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;
- long-term leasehold title, which applies to all real estate in Canberra; and
- native title, which is found in pastoral and mining leasehold land.
ii System of registration
Ownership of real estate is transparent in Australia. This is because the name of the legal owner of the real estate is recorded in the land titles registry. The land titles registry is a public 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 that are secured by the land, claims of interest (caveats) made upon the land and leases of the land. The owner, the transfer price and the rental payable on a registered lease are searchable on the public record.
Every parcel of real estate in Australia has its own certificate of title. This idea originated from Robert Torrens who in 1858 introduced the system of recording ownership of real estate in a register and on a certificate of title. This system is known as 'Torrens Title'. It 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 at the land titles registry. The sole exception is if the ownership was obtained by fraud. 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
The law that applies to dealings with real estate is the law of the state or territory in Australia in which the real estate is situated. A litigant cannot choose another law.
The exception is if the real estate is owned by the Commonwealth of Australia, in which case Commonwealth law (federal law) applies.
II OVERVIEW OF REAL ESTATE ACTIVITY
These figures from the Australian Bureau of Statistics paint the picture of a stable real estate market:
- The total value of residential dwellings in Australia was A$6.926 trillion as at the end of the June quarter 2018.
- The mean price of residential dwellings in Australia was A$686,200 as at the end of the June quarter 2018.
- Price increases for residential real estate vary considerably around Australia. The capital cities where prices rose over the year to June 2018 were: Hobart (+15.5 per cent), Canberra (+3.0 per cent), Melbourne (+2.3 per cent), Adelaide (+2.1 per cent) and Brisbane (+1.7 per cent). The capital cities where prices fell over the year to June 2018 were: Darwin (-6.1 per cent), Sydney (-3.9 per cent) and Perth (-0.9 per cent).
- The number of residential dwellings in Australia rose by 40,800 to 10,093,700 in the June quarter 2018.
- Seasonally adjusted, the total value of building approvals fell by 6.0 per cent in September 2018. The value of residential building fell 7.1 per cent, while the value of non-residential building fell 3.8 per cent.
- The restrictions on lending imposed by the Australian Prudential Regulatory Authority have led to a fall in lending to investors. Lending to owner-occupiers is rising. Factors favouring owner-occupiers include lower interest rates on loans, higher loan-to-valuation ratios and a tightening of tax depreciation for fixtures and fittings for investors.
III FOREIGN INVESTMENT
Australia is open to foreign investment in real estate in new residential housing (up to 50 per cent of an apartment development can be sold to foreign investors), and as a general rule, in residential development sites, commercial real estate and farms.
Investment in existing housing stock is restricted to Australian citizens and permanent residents. The 'existing house' policy is directed to increasing housing affordability for the average Australian, so that they are not crowded out or priced out of the housing market.
Foreign investors need approval from the Foreign Investment Review Board (FIRB). This is the foreign investment policy as explained by the FIRB:
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).
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.
Strict criminal and civil penalties may apply for breaches of the law, including disposal orders.
In 2016–17 the total number of applications approved by the FIRB was 14,357 for A$192.9 billion of proposed investment. Foreign investment applications are falling rapidly. In 2015–16, 41,445 applications were approved. Most approvals are for purchases of A$1 million or less in price, which indicates that the approvals were for the purchase of residential real estate.
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 or 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 forms for indirect investment are a listed real estate investment trust (REIT) or an unlisted property scheme or syndicate.
i Personal names
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 despite this exposure? The answer is that the family home has many tax advantages – the sale proceeds are completely exempt from capital gains tax, the home is exempt from 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 or transfer 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.
Real estate held in the name of a limited liability company protects the shareholders and directors of the company from legal claims. The exceptions are director liabilities for personal guarantees, payroll tax and environmental offences. Joint ownership of properties for investment is best in a company structure or a fixed trust structure.
Real estate investment companies pay tax at the rate of 30 cents in the A$1 if they are passive investors. If more than 20 cents in the A$1 of income is 'active' income, then the company may be treated as carrying on a business and the rate will be lower at 27.5 cents in the A$1. The tax paid is able to be distributed as a tax credit against the Australian tax payable by the shareholder. This is called a 'franking credit'.
Transacting is subject to full transfer taxes. Ownership interests are held as shareholdings.
The title to real estate held in a trust is usually held in the name of a trustee, which is usually a limited liability company. The trustee is usually able to deal with the real estate in its name, as owner.
There is no income tax payable by a trust because all of the profit is distributed to the trust beneficiaries annually. Tax is payable by the trust beneficiaries at rates according to their own tax position.
If the trust is a fixed trust, such as a unit trust or custodian trust, then the distributions made to the trust beneficiaries are fixed, according to the unit holdings.
If the trust is a discretionary trust, which beneficiaries receive the distributions and the amounts they receive are at the trustee's discretion. For this reason, a discretionary trust protects the trust assets if claims are made against beneficiaries personally.
Transacting units in a unit trust follows similar rules as transacting shares in a company. The rules are found in the unit trust deed.
Interests in a discretionary trust are not transacted because the trust 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 fixed trusts applies;
- in the names of the investors personally, as joint venturers. If so, it is an unincorporated joint venture and the commentary about personal names applies; or
- 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 REITs, are property schemes listed on a public market, such as the Australian Securities Exchange. They are easy to value, easy to sell and are subject to listing (disclosure) rules.
Unlisted property schemes provide less liquidity and are less transparent in terms of disclosures to investors.
In terms of taxation, the commentary upon unit trusts applies.
V REAL ESTATE OWNERSHIP
Planning rules provide the legal framework for the way that land can be used and developed in Australia.
Planning rules are strictly enforced. Illegal development will be subject to use prohibition orders and demolition orders. 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 (general, low density, medium density and high density), rural, business, general commercial, 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.
For built structures, 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, civil engineers and lawyers.
Local authorities (local councils) determine applications for development permits or approvals, except for state significant applications, which are determined by the state planning authorities.
Each state has an environmental planning authority that 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 found in localities where heavy industry or intensive agriculture are present, 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 clearance is an important part of the conveyancing process because the contract for the sale and purchase of land will normally preclude the purchaser from making any claim against the seller. The purchaser should request that the contract be made conditional upon the issue of an environmental clearance certificate, at the vendor's cost.
If a property is purchased as an investment, then an asbestos clearance may be appropriate if the improvements were built pre-1980s. Asbestos might be found in loose-fill asbestos insulation in the roof cavities of houses, asbestos lagging around pipes, asbestos roofing and in electrical boards.
Transfer tax, also known as stamp duty, is levied on the transfer of real estate in Australia. It is payable by a purchaser either within a fixed period of time after the contract is entered into, or on completion of the contract, depending on the state.
The rate of duty is 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 and to the purchase of new houses and apartments. Stamp duty surcharges apply to foreign purchasers in New South Wales, Victoria and Queensland.
This is a snapshot of the current duty payable:
- New South Wales – for an A$800,000 property, the stamp duty payable is A$31,490. An 8 per cent surcharge is payable by foreign purchasers of residential property, which adds another A$63,490. There is no surcharge for commercial property.
- Victoria – for an A$800,000 property, the stamp duty payable is A$43,070. A 7 per cent surcharge is payable by foreign purchasers of residential property, which adds another A$56,000.
- Queensland – for an A$800,000 property, the stamp duty payable is A$21,850. A 3 per cent surcharge is payable by foreign purchasers of residential property, which adds another A$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 ranking mortgage recorded on the title to the property. The reason is that in the event of default, the first mortgagee 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 three factors:
- The status of the borrower. Are they a resident or non-resident? Are they purchasing for owner-occupation or for investment?
- Loan serviceability. Australian lenders will only take into account Australian sourced income for meeting loan servicing requirements, and take into account only part of the rent to be received from the property.
- 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, what is the remaining term of the lease and the quality of the tenant?
The factors translate into whether or not loan finance is available, the loan-to-value ratio if approved, and the interest rate payable.
VI LEASES OF BUSINESS PREMISES
Commercial properties are often sold subject to lease. Evaluating the quality of the lease is essential. The main characteristics of leases of business premises in Australia are as follows:
Typical terms are two, three or five years, with an option to renew for the same term. Tenants with extensive fit outs, such as restaurants, food outlets, retail shops and cafes prefer five-year leases with at least one, if not two, options to renew for a further five years. The option to renew is exercised at the discretion of the tenant. Demolition clauses are included in leases of buildings that are intended for redevelopment, to enable the lease to be terminated early.
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, that the tenant requires. The tenant may negotiate a rent-free fit out period or a fit out allowance.
The rent is stated in the lease as either a gross rent (inclusive of outgoings) or a net rent (outgoings are added). Residential rents are always gross rents (by law). Office rents tend to be gross rents; industrial and retail rents tend to be net rents.
For these purposes, outgoings include council rates, water rates, strata levies, land tax, building insurance premiums, management fees, building repairs and maintenance. Outgoings do not include services such as electricity, gas, telecommunications, water usage, waste and garbage removal, which remain the tenant's responsibility.
Goods and services tax (GST) is payable on commercial rent (the current rate is 10 per cent). It is added to the rent. GST is remitted quarterly to the Australian Tax Office. No GST is payable on residential rents.
Some shopping centre leases contain turnover rent clauses. Turnover rent is payable in addition to normal rent, based on a percentage of the turnover.
Rent is usually paid monthly in advance. The annual outgoings are divided by 12 and are payable along with the rent, if the rent is a net rent.
Typically, rent is increased annually either by the 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 new rent from falling below the rent payable for the final year of the previous term.
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.
iv Security bond
A cash security or bank guarantee of three month's rent is typical for commercial leases. 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 retail bonds board. Personal guarantees are common, although their usefulness is limited either because a lawsuit is needed for collection or because the guarantor often becomes bankrupt if the business fails.
The use is specified in the lease either in specific terms such as a cafe, or in general terms such as a warehouse or office. Usually, the use must be approved by the local planning authority. The use cannot be changed without the landlord's consent.
vi Assignment and subletting
The tenant has the right to assign the lease and to sublet the premises, with the landlord's consent. The landlord can require the incoming tenant to have suitable experience and financial resources.
vii 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 must remove their fit out, reinstate and repaint the premises.
The landlord is responsible to insure the building (except in strata properties, where the strata corporation insures), for public liability and for fittings. The tenant is responsible to insure for public liability, plate glass (if any) and worker's compensation.
ix Energy efficiency
Owners of commercial office space with a net lettable area exceeding 1,000 m2 must provide an up-to-date building energy efficiency certificate (BEEC) to tenants before leasing and to purchasers before selling the office space. The Commercial Building Disclosure (CBD) Program requires BEECs to contain a National Australian Built Environment Rating System 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' (Tax Clearance Certificate) from the Australian Taxation Office (ATO) if the sale price is A$750,000 or more. The requirement applies not only to foreign residents, but also to Australian residents. 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 per cent of the price and remit it to the ATO. The purpose is to protect the ATO's assessment for capital gains tax payable on sale. Capital gains tax calculations 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 capital gains tax 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 (if before 30 June 2019) they are selling their main residence.
ii Purchaser declarations for transfer duty, vacancy charge and land tax
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 or transferee declaration or statement is necessary to meet Commonwealth Reporting Requirements and to meet the State 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, contract date and settlement date;
- identity information of the vendor or transferor and purchaser or transferee, including name, address, date of birth (for individuals) and Australian Company Number or Australian Business Number (for non-individuals);
- if the purchaser or transferee is the trustee of a trust, information about the trust; and
- nationality and immigration details of the vendor or transferor and purchaser or 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.
From 9 May 2017, foreign persons who purchase residential real estate will be subject to an annual vacancy charge levied by the ATO where the property 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 or stamp duties purposes. The information collected is also used for imposition of the land tax surcharge for foreign owners of residential real estate.
The land tax surcharge for foreign person ownership is 2 per cent in New South Wales. In both Victoria and Queensland, the surcharge is 1.5 per cent 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 per cent on the land value in New South Wales, then the surcharge will mean that land tax is levied at the rate of 3.6 per cent 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 costs without correct apportionment, or have claimed travel costs that were for private travel purposes.
Also 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 affected are usually mechanical fixtures or those that 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 the extracts below from a paper presented by Guy Debelle (Deputy Governor, Reserve Bank of Australia) at a FINSIA Signature Event: The Regulators held in Melbourne on 15 November 2018:
Housing construction activity has been at a high level for some time now. Our forecast is for it to continue at this level for at least a year given the amount of work in the pipeline. Beyond that, we expect construction activity to decline from its peak. Off-the-plan apartment sales in the major east coast cities have declined since around mid 2017, with developers citing weaker demand from domestic investors, as well as from foreign buyers. One risk is that tighter lending standards could amplify the downturn in apartment markets if some buyers of off-the-plan apartments are unable to obtain finance.
Housing prices have fallen by almost 5 per cent from their late 2017 peak while the pace of housing credit growth has slowed over the past couple of years. The fall in housing prices is a combination of a number of other factors, including the very large increase in the supply of houses and apartments both now and in prospect. It also reflects a reduction in foreign demand, which has been affected by a tightening in the ability to shift money out of China and an increase in stamp duty in some states.
Tighter lending conditions have reduced how much some people can borrow, and this contributed to weaker demand for properties and so softer prices.
1 Anthony J Cordato is the principal at Cordato Partners Lawyers: Business, Property and Tourism Lawyers.