04 Jul 2024 Podcast: Deep Dive – Borrowing In A Trust
In this episode, Evelyn dives into the world of buying properties and borrowing through trusts in Australia.
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Discover how trusts can provide benefits like asset protection, tax planning, and succession planning.
Plus, don’t miss the announcement of our upcoming webinars for first-time home buyers and seasoned investors.
Get insider insights from a recent Westpac roundtable on interest rates, and learn the essentials of different trust types and their impact on borrowing capacity.
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You Have My Interest is brought to you by Everlend, a mortgage and finance broking firm built for the purpose of educating and empowering you to make informed financial decisions tailored to your wealth goals. Find out more and book in your free initial consultation at https://www.everlend.com.au/
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Podcast Audio Transcript
(00:02.26) Testing my mic, yep, cool, we’re good.
(00:19.988) Hello, everyone. Welcome to today’s deep dive episode on trust borrowings or buying properties in a trust and borrowing through a trust. This is one that I’ve been wanting to do for a while because we do work with a lot of investors and it is a very common scenario that we see investors utilize. And I’m going to go into obviously the reasons around that. We also work with a lot of property developers who are always buying properties in trusts.
So it is really good to know the intricacies and the ins and outs of what a trust is, why you would consider that strategy in terms of either a proposed property purchase strategy or why you would consider borrowing that way. So we’re going to go into that in detail. Today is also the end of financial year. So we have let’s just skip that bit. We don’t need to talk about that.
(01:14.004) As always, before we jump into today’s episode, I do want to go through a couple of updates that I think are really worth sharing with you all. So number one is we have just released the tickets for our first home buyer and our investment property webinars, which are going to be held on the 16th of July and the 24th of July. So the first week will be exclusively for first home buyers. The second week will be exclusively for people that are wanting to invest, whether it be your first investment property or your fifth investment property or who are looking at maximising their equity and purchasing another property.
So those webinars are available. The links are available through Eventbrite. If you do want to attend one event, it is $39 for one, or if you want to attend both, it’s $59 for both. And last year when we did these events, we had some really, really awesome feedback. It is probably one that even if you are still a while away from buying, I always get a lot of really positive feedback from first-term buyers who are starting out the process and just wanting to know.
what to do and what to get started and give you the ability to ask all those FAQ style questions. And it is available Australia wide and that’s why we’ve done a webinar because we do help clients all over Australia and some even into in different countries. So jump onto either our Instagram, LinkedIn, Facebook or Eventbrite and you will find the links to those events there to be able to purchase tickets. The tickets will actually close the day of the event. So you do have a bit of time to get ready for that.
The second update I wanted to give you all is I actually had a really, really good roundtable session with Westpac earlier in the week. One of the things that I’m, I guess, very privileged, I guess, in our business is we often do get invited to sit in on discussions with the heads of these banks. So we had an opportunity to do that on Wednesday with Westpac and they sort of just gave us a bit of a lowdown on what they’re seeing in the market, what they’re seeing economically wise and also what they’re seeing in the lending space and that sort of thing as well.
So we talked about interest rates and the general consensus from them is that we will definitely not see any cuts this year, but also that we may potentially have a rate rise. Now, obviously that is everyone is coming up with their own consensus, but that is purely just from Westpac’s consensus. So.
(03:35.572) It’ll be interesting to see what happens, but I just thought it might be a good little nugget for you guys to listen before this podcast. So let’s jump into buying in a trust. We’re going to go through a bit of an introduction on what a trust is, what the different types of trusts are and why you would consider buying in a trust. We will then also go through some of the lending requirements and some of the common sort of pitfalls, I guess, that may catch people out.
So if you do have any questions about trusts, please feel free to send them through to me. I’m gonna go through, I’ll try and keep this as structured for you guys as possible so that we can keep it really nice and high level. We’re not gonna go into super, super intricate details in terms of names of lenders and all of that sort of thing. I just wanna keep it high level. And then if this is something that is a particular scenario that you think may be something that you’re considering or you already have properties and trusts, more than happy to have one -on -one conversations with anyone.
So let’s go through, and I just want to do one disclaimer because we are talking about trusts. Before we dive in, please note that this podcast provides general information only and does not constitute financial or tax advice. We recommend consulting with a qualified accountant or tax advisor for specific advice tailored to your circumstances. So let’s start off with what is a trust. A trust is effectively a relationship in which one party known as the trustee holds the legal title to the property for another party known as the beneficiary. So you will often see that when you have a trust structure,
(05:26.836) So you’ll often see that when you have a trust structure, there will be a…
(05:35.739) Okay, how am I going to say this?
(05:42.292) So when you have a trust structure, you can either have a corporate or an individual trustee. And what a corporate trustee relationship looks like is ABC Proprietary Limited as trustee for the ABC Trust. If it’s an individual trustee, it would be Evelyn Clark as trustee for the ABC Trust. So that effectively means that
(06:41.524) I’m wondering how to best say this, so it’s nice and simple.
(07:01.492) So that is effectively what the trust trustee relationship looks like. But then you also have beneficiaries to the trusts who are usually individuals. So if you have a family trust, for example, your family trust may have a… So if you have a family trust, for example, what that might mean is that all of the individuals in your family are individual beneficiaries to the trust, but the property is actually held in the trustee entity so that…
Is that correct? Trustee holds the legal title for the new Trustee.
However, the asset is actually held under the name of the trust. And therefore it allows you to, probably one of the most common reasons that people look at trusts is it allows you to then distribute profits or use asset protection. It allows you to then distribute profits. my God, this is really hard. It allows you to then distribute profits to those individuals.
It allows you to then distribute profits to those individual beneficiaries as you see fit based on the way that the trust deed has been set up and structured. So you can see already that it is a little bit more of a complicated process, but it does have a lot of benefits. Now, the most common reasons that we see people utilize trusts is probably three.
Number one is asset protection. Number two would be tax minimization or I guess overall tax planning. And then the third one would be succession planning. So we’ll go through each of those. We’ll also go through the different types of trusts. So your different types of trusts typically tend to be discretionary trusts, which could be a family trust, a unit trust structure, or the other one would be a self -managed superfund, which also has its own trust structure.
To some degree, you can also look at hybrid trusts, but we hardly ever see those. The most common that we see is discretionary trusts, self -managed superfund, and some unit trust structures as well, depending on how the advice has been given.
(09:14.484) So in terms of looking at number one reasons to use a trust is asset protection. What that effectively refers to is the assets that are held in the trust are not legally owned by the beneficiaries, so the individuals. So if we think about that family trust scenario, if you have a family trust that owns an investment property, but then the beneficiaries are mom, dad, brother, sister, the asset is not legally owned by the beneficiaries, meaning that the…
(09:45.076) meaning that the assets held in the trust are protected from the liability.
(15:38.654) When you’re borrowing through a trust. And so that can obviously number one, make it give you less options in terms of which lenders will lend to you. But also you may have slightly lower loan to value ratios or higher interest rates depending on how the banks treat the asset. Tax implications. So this is, I would just say, obviously consult with your accountant and make sure you do get an accountant that understands property trust structures in a lot of depth, but you don’t want to get this wrong.
And also if you’re looking at land tax, land tax is higher. I’m not sure about all of the states, but I know in Victoria land tax is higher when you’ve owned property in a trust. And the last one I would say is potential loss of control. So this is just saying that the individuals may feel like they don’t have as much decision-making process because it does have to be based on the way that the trust deed has been set up as to who has the control in terms of making those decisions.
(16:48.702) Okay, so let’s go through some of the lending guidelines now in terms of borrowing through a trust. So the first thing to note is that as we mentioned, there are many different types of trusts. And what that also means is lenders have different rules around what trusts they can and can’t lend to as well. So for example, one of the biggest things that we see is there are less lenders that will allow you to borrow through a trust that has a corporate trustee, then you will through a trust that has an individual trustee.
Now with the corporate trustee, the biggest thing there is generally the banks want to see that that is not a trading entity, it is an entity that has been set up purely for the purposes of purchasing a residential or an investment property. So what that effectively means that if there is a corporate trustee that is trading, so AKA it’s associated with the trading business, banks are now going to start to look at that through a commercial lens, which is going to make higher interest rates and also mean that you potentially will have far less lending options to choose from and maybe slightly shorter loan terms as well, just depending on the lender’s parameters around that.
So looking at, let’s go through discretionary trusts. So looking at family trusts in particular, which is a type of discretionary trust, I would say this is probably one of the most common that we see. Generally, family trusts are set up to hold a family’s assets or business assets. So for the benefit of providing the asset protection and the tax planning for the family members. And then the income and the assets from the trust can be distributed to the beneficiaries, which are the family members as the trustee.
So if you intend to borrow through a family trust, this is probably gonna give you the most amount of borrowing options. And as I said earlier, having a personal trustee as opposed to a corporate trustee will give you more lending options, but it is a slightly weaker asset protection structure. So having a corporate trustee does give you the maximum amount of asset protection. So particularly when we say business owners who want to set up a trust to have their assets held in a trust so that their businesses are protected and the assets are protected from their business. Generally they will have a corporate trustee or a company trustee as opposed to an individual trustee.
(19:16.19) Now, one thing to look at here in terms of the structure is who actually owns the property. So who is on the title of the property and then who are the borrowers. So on the title of the property will be the trustee. So for example, that example that we gave earlier, ABC Proprietary Limited as trustee for the ABC Trust, ABC Proprietary Limited would be the name on the title of the property. So when you sign the contract of sale, they would be the ones signing the contract of sale. And then the director of that company would be the ones that actually wrote their signature.
(19:51.952) Now, when you have a company trustee, one of the benefits that you do get is that if you change the directorship of the company, that means you can effectively be changing the ownership of the asset without incurring stamp duty. So that’s one of the reasons that we say people do it. Now, the borrowers are generally, in this case, the company’s director, the borrowers are generally the individual trustee or the directors of the corporate trustee. So, I’m gonna get rid of many of them.
(20:27.454) And so what that means is the person that are, the people that are signing the loan contracts and are required to make the repayments outside of the, no not that. So what that means is the person that’s effectively signing the loan contracts and whose name the loan will be in will be the corporate trustee, but also the directors will be providing personal guarantees for the borrowings associated to the trust.
(20:55.614) You will generally find that if you are borrowing under this type of arrangement, you’ll have the most lending options available and you will get residential interest rates. The biggest thing from a borrowing capacity perspective when we’re looking at borrowing through a trust is generally your borrowing capacity is a little bit more limited. And the reason is you can’t apply negative gearing to a trust. And that is because the trust already accounts for negative gearing to an extent by accounting for the investment property related expenses as part of the, as part of the…
It already accounts for the investment property expenses in the profit and loss statement before you get the net profit from the trust that’s then distributed. So that even includes the interest and borrowing costs. And then once the money is distributed through the trust to the individual parties and then it’ll flow through into the individual tax returns, that is basically then treated as taxable income.
So you can’t apportion negative gearing to the debt inside the trust which usually gives investment property buyers a higher borrowing capacity than if they were buying an owner occupied property because the lenders effectively add back a negatively geared portion of the lending. So it increases your ability to borrow. So when you’re borrowing in a trust, you lose that ability. Now there are a very, very, very small number of lenders that do still give negative gearing in the trust.
There is one that I was very surprised to hear about but 99 % of lenders weren’t apportioned negative gearing in a trust. So you have to be aware of that. How borrowing in a trust does increase your borrowing capacity though, is because typically when you have assets that are owned in a trust, the lenders will effectively look at those trusts and the assets and liabilities associated with them as their own individual entity. And they don’t bring that into the individual’s borrowing capacity. So if I have a, let’s say I’ve got my own occupied property,
(23:02.622) and that’s owned in my individual name. And now I want to switch that to investment property and I wanna upgrade my home and buy another owner occupied property. So that investment, that now investment property is still gonna be in my personal name, but I wanna go out and buy another owner occupied property. And let’s say I also own an investment property in my family trust.
That investment property in my family trust, so long as we can provide an accountant letter confirming that it is trading profitably or that it is purely set up as an asset protection entity or an entity that holds residential property and does not trade, then the banks can basically exclude that from my borrowing capacity assessment. Obviously that means I’m not using any rental income that is coming through that property, but I’m not expensing any loans.
And generally you will find that that combination will create a higher borrowing capacity now when I go and look at my owner occupied lending in my individual name, then it would if I had to bring all of that additional income and borrowings into the equation under the trust. So that is one reason why it can give you higher borrowing capacity.
And then what that effectively means for investment property buyers or people that want to really sort of expand their investment property portfolio and buy multiple properties in trusts is each of those entities can be excluded once they’re already in place, they can be excluded from that future borrowing capacity. So you can effectively, if you do it right and you start it at the right time, you can effectively set up individual or trusts for individual properties. And each time you go to buy another property in a trust, it’s like it’s treated as a new application where none of those other ones exist.
So you sort of don’t run out of borrowing capacity as quickly as you would if you were just going through your individual name. Now, you’re obviously going to have to have a higher amount of borrowing capacity to begin with going through the trust. But it does really give you that ability to expand that property portfolio quickly.
So let’s also look at, so some of that we might have to put at the beginning, I think, in terms of the benefits because, yeah, if we can take that section where I was explaining about the benefits of buying in a trust and move that, sorry, yeah, if we can take the section where I’ve talked about how borrowing capacity works in the trust, and if that can be moved to the section when I go through benefits, that would be amazing. And then what I’m gonna do after I speak about discretionary trusts,
(25:29.598) we’re now going to go through the rest of the trust. So the next one is unit trusts. So now let’s talk about unit trusts. So unit trusts are different to discretionary trust. This is a less common structure that I see, but effectively with a unit trust, it acts like a company where the trust property is divided into a number of shares called units. And then there are unit holders to the unit trust.
And so those unit holders can be companies or they can be individuals or it can be even another trust. And so what that effectively means is if you said, let’s say you had a unit trust with four unit holders, you can have people that are effectively investing in that unit trust structure in their choice of how they want to invest. They can be an individual or they can be a company.
So you could have multiple family, let’s say families that want to invest together and they set up a unit trust structure and you could have four families, and they could all have their own individual companies that are owning 25 % of the units in that unit trust. This generally is not as flexible of a structure in terms of borrowing capacity options with lenders.
(27:09.246) And we don’t tend to see this being as much of a common structure, particularly if you’ve got one family unit that wants to own multiple properties in trusts. It’s generally something that we see with non -family members or people that are purchasing with multiple, like multiple different families are purchasing together. And then let’s talk about self -managed superfund trusts.
So with self -managed superfunds, when you purchase a property in your self -managed superfund, and I did actually do a full episode on this in details, if you wanna go back and listen to that one, you can. But when you’re buying a property in a self -managed superfund, you need to set up an entity or the trust that effectively owns that asset or holds that asset on behalf of the SMSF. And the borrowing structure is typically set up so that you’ve got a property holding entity, and then you’ve got an entity that borrows the money. The loan is. what we call a limited recourse borrowing arrangement, meaning that,
(28:14.302) meaning that there is no recourse to any of the other assets held in the SMSF. So it treats again that particular purchase or that particular property and the particular lending against that as its own separate entity, separate to the actual SMSF itself.
(28:38.366) Hopefully that’ll make sense.
(28:43.198) What are we up to in terms of time? 28 minutes. Okay cool, I think that’s a lot of information. Okay so…
(28:57.694) They’re the main things that I wanted to go through.
(29:09.406) So in terms of just summarizing a lot of what we’ve spoken about there, we’ve gone through what is a trust, the different types of trusts, the benefits associated with borrowing in a trust and why people would actually utilize a trust, some of the disadvantages to it too. And one disadvantage that I didn’t mention is when you do set up lending in a trust, because of the guarantees required, which means you generally need to get independent legal advice when you’re signing your loan documents as well and have that all certified and signed off.
It is far less common to people for people to refinance two different lenders through the trust. Typically you do sort of want to secure your lending with someone that you will keep that loan with for a while. It’s far less common for people to jump around lenders under a trust because of the additional cost involved and because of the restrictive appetite of the lenders.
And once you’ve got, let’s say, you know, 10 different property trusts, there aren’t going to be always lenders that, that doesn’t make sense, 10 different property trusts. There will be less lenders that you would be considering because some of those are going to take 10 properties into consideration in your borrowing capacity, whereas some are going to exclude all of those.
And again, that’s probably one of the reasons that we see the, no, we didn’t talk about property developers. Yeah.
(30:40.35) Sorry.
(30:48.478) So I guess my final tips if you are looking to purchase property in a trust is to number one, find the right professionals to help you. So you definitely need a good accountant and a lawyer and obviously a mortgage broker that understands the structure as well. In terms of looking at the, I don’t really do that.
(31:24.99) So I’ll just say find the right professionals. And that would definitely be my biggest piece of advice. So it’s going to be a lot harder if you don’t set it up correctly in the first place and then need to unwind a structure, then it will be to get it right. So make sure you do speak with those people upfront. You may even wanna work with a financial planner if that’s something that you’re considering as well. So as you can see, there are a lot of different reasons that people do borrow money and do purchase properties in trusts.
It doesn’t just have to be to build out an investment property portfolio. You know, one of the ones that we haven’t really spoken about is property developers. And the reasons that they’re obviously putting their individual projects in trust is because they treat all of those individual projects as their own business in its own right, where you will buy the property under the trust structure. And then the profits from the profits from that project can then be distributed accordingly. But each individual project will be set up in its own individual trust.
And so that is again, one of the reasons that you need to be working with lenders that will be able to exclude what’s happening in those other trusts from your future borrowing capacity potential, because it can take them two to three years to actually, you know, finalise and realise the returns on that property development itself. And that’s where working with, you need an accountant that’s going to be able to provide those accountant letters to confirm that that is, you know, either trading in its own right or it’s not trading because it’s being held for property because it’s been set up for property holding purposes only. And then obviously working with a lender that’s gonna be able to accept that as well. And then you’ve got things right down to…
No, we’ll get rid of that. So I hope that has been helpful. I know it is a little bit more complex than looking at just borrowing money through your individual names, but definitely for the property investors out there or people that are looking at setting up trusts for future, let’s say estate planning potential.
As I said, I just highly recommend that you find the right professionals to work with that you’re really comfortable with in terms of going through that. And please don’t ever hesitate to reach out if you do have any questions. I hope that’s been helpful and I look forward to speaking to you all next week.
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