30 September 2022

Completion of this Newsletter was Delayed Due to My Accident

Many thanks to all the people who sent me their best wishes recently. I returned home from rehab on 20 September and my mobility is steadily improving. 

Work from Home Traps in Real Estate Investment Trusts (Reits)

Covid greatly expanded working from home. What was initially thought to be a temporary measure has become long term for many, while others continue to work between office and home. Basically, this depends on type of employment: see below. This new reality is causing some tenants in capital city buildings to reduce their future demand for office space. As leases reach renewal option date, we can expect tenants to reduce the amount of space they are prepared to rent in future. If there is too much space, there will also be downward pressure on rents and in turn this leads to weaker valuations on buildings, reducing in turn the value of REITs. It will not appear suddenly because existing leases have a variety of terms but there will be a long-term impact.

 It is worthwhile examining the lessons of the past. In the 1980s, demand for CBD property triggered investment demand. Properties in Melbourne CBD were well let at good rentals which went up with inflation. Investors who geared into CBD properties via property trusts and property syndicates viewed them as attractive investments. This led to massive new building creating vast amounts of space in tall new buildings which became available for leasing as the economy was entering the downturn which Treasurer Paul Keating labelled “the recession Australia had to have”. Older buildings lost tenants as the owners of the new tall towers, desperate to fill them, offered huge incentives to move to far more attractive spaces. Other tenants’ businesses failed due to the impact of the recession. Melbourne CBD ended up with a surplus of office space for the next 20 years. This time the impact on the demand for office space has a different cause, but the result will be similar in that falling demand for space leads to long term lower rental income reducing property value. 

The Ambitious Get Back to the Office ASAP

Since the end of lock- downs it has become apparent that tenants with jobs in areas like investment banking, property, corporate advisory high-end legal and finance have quickly returned to the office. These are the jobs that require significant expertise/education, usually involve long hours and lots of time away from home on business. Buildings which house these jobs have returned to full occupancy and the tendency for these types of professionals to crowd together is even more pronounced.

By contrast, the more administrative, back off, more commoditized jobs are conducted in less expensive CBD and non-CBD locations which are struggling to get to pre-Covid-19 levels.

There appears to be a widening pay gap between what have been termed “greedy jobs” and jobs which are being conducted from home.

If two people are equally productive and one is seen in the office and the other isn’t, who do you believe is more likely to be given more responsibility or a pay rise? Engagement and productivity cannot be demonstrated adequately from home.

The Hidden Reason For Australian Superannuation Policy 

In the early 1980s Australia had a huge and worsening foreign debt problem. We also had high inflation which was added to by wage blow outs. Prime Minister Hawke, elected in early 1983, recognized that in order to counteract the growing foreign debt problem Australians had to save more, and allow businesses to invest more in equipment and restrict wage rises. A need for a national superannuation policy was born out of the alarming growth in foreign debt, but was sold to the union movement via the process known as ‘The Accord’ which was an agreement to restrict wage growth in return for compulsory superannuation. The compulsory superannuation was planned to increase from 4 percent per annum (3 percent in small businesses) to eventually grow to 12 percent. Currently it is 10.5 percent. The amount of savings in Australian superannuation took off and accelerated as the percentage of compulsory employer contributions increased. Concern over the amount of Australian foreign debt disappeared as our ‘national propensity to save’ accelerated. These days the debate is about how much saving/superannuation is necessary to retire. Behind the scenes Treasury advice to government is to maintain generous limits in order to have the huge savings within the superannuation system to counteract foreign debt. The debate as to how much superannuation is necessary to fund retirement mis understands the underlying purpose of Australia’s superannuation system.

Private school fees are increasingly being paid by retired grand parents many of whom have more savings than they will ever spend on their personal lifestyle.

Russia Has Badly Miscalculated the Invasion of Ukraine

Thus far the invasion has demonstrated that Russia badly miscalculated both the resistance of Ukraine and the reaction of western nations in imposing unprecedented sanctions. Whereas the Russian Army apparently believed that it would easily enter Kyiv and be welcomed by crowds throwing flowers at its soldiers, it met stiff resistance from day one and its initial invading force was revealed to be short of supplies. A 70-kilometre column of invading Russian units became stalled as Ukraine’s forces targeted its fuel tankers, food ran out and it had to withdraw with great difficulty. Vladimir Putin then redefined his “special operations” objectives and shifted the point of Russia’s invasion east to the Donbas.

One surprising aspect was the failure of the Russian air force to gain air supremacy over Ukraine. Much of Russia’s military equipment has been inferior to that anticipated. Meanwhile Ukraine is making effective use of its own resources and increasingly of arms supplied from the West, chiefly from the US and Britain. The training and battle preparedness of the Russian Army and Air Force has been shown to be lacking. It is evident that following the Russian annexation of Crimea in 2014 Ukraine recognized that Russia would seek to control the whole of Ukraine. Ukraine’s army and air force have been preparing to meet the Russian invasion for the past 8 years. While battlefield losses are subject to exaggeration British and US intelligence is likely to be accurate given modern satellite surveillance allied with NATO surveillance aircraft looking and listening from just outside of Ukraine’s border with NATO states. It is apparent that Russia has suffered substantial combat losses and that Western Artillery which outranges Russian guns, particularly the HIMARS rocket system, is becoming a battle changer as Russian supply dumps deep behind the front line are being targeted.

Despite Russian claims to the contrary, the sanctions and the war are biting deep into the Russian economy while the economic impact of the war is being felt globally to various degrees. Claims by Russia that its economy is not suffering are nonsensical.

Russian Tactics 

The Russian army appears to have learned little since World War 2 when it relied on vast numbers of barely trained soldiers, T34 tanks and artillery to overwhelm German forces. Germany was fighting on multiple fronts on land, sea and air and simply did not have the numbers or equipment to hold back the Russian Army despite some estimates putting casualties 7 to 1 in the German army’s favor. Told that the latest German tanks were superior to the Russian T34s, Stalin is reported to have remarked that “quantity has a beauty of its own.” German Tiger tanks were few and the crude but effective T34s were produced in tens of thousands. Russians were fighting for their homeland and were well aware of the enormity of the atrocities committed during Germany’s advance into Russia; their training was scant, and their commanders relied upon mass rather than clever tactics.

Today their motivation is lacking. Many did not realize that Ukraine would bitterly contest their advance and the number of Russian casualties has come as a massive shock. Since Russian annexation of Crimea in 2014, Ukraine has lived with the probability of a further invasion and its army has prepared accordingly. Although much less populous than Russia, Ukraine has the ability to inflict enormous cost and casualties on Russia. The extent of Western sanctions against Russia and of supply of arms to Ukraine were not expected by Russia. The Russian army seems not to have practiced modern day combined arms tactics on formation exercises.

NATO, which came into existence to counter the Russian-dominated Warsaw pact, has continued to expect that the main threat to Western Europe would emanate from Russia, and sees the opportunity to cause a significant reduction in the long-term threat by supplying Ukraine with the weapons necessary to counter the Russian Army, including training of substantial numbers of Ukraine soldiers in their use. From a strategic perspective this is the cheapest way to weaken the Russian Army such that its threat to frontline NATO member countries is substantially diminished if not rendered impotent.

BHP Takeover Offer for Oz Minerals

This looked like stage one of the takeover playbook. First BHP made an offer to make a strategic acquisition. In turn the Oz Minerals board refused the offer as being well below what it considers true value to be. If the playbook continues as expected BHP may come back with an enriched offer large enough to force the Oz Minerals Board to give serious consideration at risk of being condemned by shareholders if it rejects an offer well above its recent share price. It might then extract a further small sweetener but would be expected to fall to BHP which has the balance sheet strength to make an unconditional offer not dependent on a massive capital raising. With interest rates rising alternative bidders are unlikely to emerge. BHP can be patient.

From BHP’s perspective it will enable BHP to mine a number of deposits of copper in the same province of South Australia leading to substantial synergy benefits in its production. Oz Minerals also has other forward looking mineral assets elsewhere which will fit into BHPs long term strategy.

I hold BHP and Oz Minerals shares in our family superannuation fund.

Crypto Chill to Close Exchanges 

In a recent week, $US190 Million (approximately $273 million) was stolen from a cryptocurrency cross-bridge called Nomad, and Australian-founded exchange Zipmex filed for bankruptcy protection in Singapore. McGrath Nicol, head of advisory Matt Fehon said that the industry is now talking of the start of a 40 to 50 percent rationalization, as reported in the Australian Financial Review, 9 August 2022. That’s a polite way of predicting a lot more failures, closures and amalgamations.

 A lot of people have made quick money out of crypto, but the losers are many and it is likely that the meltdown will continue.

Recently self-proclaimed “crypto king” Fred Schebesta admitted to having taken a substantial loss in the collapse of a stablecoin called Luna after earlier saying he had sold out despite earlier advocating its value. (Australian Financial Review, 9 August 2022)

This highlights problems with the largely unregulated mass of crypto products and talked up by promotors. In this environment hordes of gullible ‘investors’ are skinned.

As major economies and their central bankers tighten rules surrounding crypto and as interchange points get caught up in anti-money laundering regulations crypto promotors are increasingly concentrated in cyber space platforms operating through unregulated tax havens. Those trying to convert crypto profits to national currencies via crypto exchanges are also targets for tax collectors

Recently Coinbase lost $US 1.1Billion in three months.

What will future economic historians say?

Future economic historians will look back on the period from early 2010s onward when the greatest frauds, Ponzi schemes and financial collapses since the Great Depression occurred with the ballooning of thousands of crypto coins and the collapse of many, bringing down crypto exchanges. There is a continuing massive wealth transfer from those who unwisely believed crypto hype to those able to milk them of their wealth acting through unregulated fronts in tax and regulatory havens. 

Listed Investment Companies 

LICs with separate management companies charging high fees were heavily promoted and claimed superior returns, but few outperformed the main stock market indexes which would require them to outperform the market by their own fees. I have long avoided LICs if the management structure is separated from investors ownership of the underlying assets because they have unacceptable management expense ratios (MERs). They are an expensive alternative to managed funds, which in turn have much greater expense ratios than exchange traded funds (ETFs), the largest of which have very low management expense ratios (MERs). A key step is to check the MER before investing. If it is obscured, best avoid that investment medium.  A large ETF with a very low MER, code IVV, is based on the largest 500 companies listed on the New York Stock exchange and the NASDAQ. Many of these are international in scope and offer a medium which provides widespread international diversification of investment. Their values fluctuate with global economic conditions. It is a question of timing. While nobody rings bells at the top or at the bottom of stock markets it is apparent that as at 25 September, interest rates will increase further and markets will be weaker for a bit longer. I have a buy order for IVV at a discount to current price. Nonetheless, it is essential that readers do their own research and access advice as necessary.

International Diversification 

Substantial companies listed on the Australian Securities Exchange have extensive overseas operations which in some cases dwarf their Australian activity. For example, CSL with huge North American and European businesses or global investment/infrastructure investor and manager Macquarie Group are mainly international in scope.  BHP and Rio Tinto are huge international resource companies, as is Woodside with huge petroleum assets while further down the market scale ARB is increasingly international in its operations as is Xero. There are lots more. Before succumbing to the international diversification mantra for you super fund it is prudent to check the weighting of existing stocks with significant international business arms. You may be more internationally diversified than you realized.

Queensland Government Kills Investment in Rental Housing by Interstate Owners 

Queensland has legislated to incorporate the value of interstate (non-Queensland) property into the formula for applying Queensland property tax on Queensland investment properties. The move has made selling new investment units off the plan to interstate investors near impossible and will chill new developments. Interstate owners of Queensland rental properties have begun dumping them onto the market. New laws further favoring the interests of tenants over landlords in both Queensland and Victoria will also lead to an increase in the shortage of residential rental accommodation long term.

Residential rental property has long been a low yield investment with attendant risk. I have long disregarded it as an investment choice.

Initial approaches by Treasurer Chalmers to seek investment in social housing development by large superannuation funds were quickly dismissed as funds indicated that they have a duty to invest to the best advantage of fund members.

Integrity Commission Labor and Liberal Are Likely to Deal Greens out of the Decision 

Both major parties are concerned that the proposed federal integrity commission will be used by the Greens and independents, neither of which are likely to be able to form a government, to attack and further degrade the major parties. There is no support in either Labor or the Coalition for the substantial widening of the scope of the proposed commission. They regard the commission as an existential threat if its powers are too far reaching. The government and the opposition are likely to join together to force the legislation through the senate, and in doing so further demonstrate the limitations on the power of the Greens. The two major parties with their lowest primary vote percentages ever cannot afford to be seen to give into the Greens. With Labor only achieving 32.8 percent of the primary vote, its re-election without having to hope to form a minority government may hinge on being seen not to be bowing to the Greens. The Coalition are also likely to prefer to deal with the government on key issues rather than have them altered by Greens and minorities in the Senate. With present conditions Labor and the Coalition have a mutual interest in minimizing the Senate vote of the Greens.

Financial Success for Dentists 

Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:

·      Understand key practice valuation criteria.

·      Learn how some dentists inadvertently reduce the value of their practice by $500,000

·      Avoid long term errors when purchasing your practice.

There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.

I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.

A complete and comprehensive career guide for mature and aspiring dentists.

Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.

—Merv Saultry, Founder Dental Innovations Network 

To Obtain a Copy: 

·      Go to the Delany Foundation website at http://www.delanyfoundation.org.au

·      Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.

·      Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address

·      A copy of the book will be mailed directly to you

All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.

The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive. 

Please Pass On 

If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com

Independence And Disclosure

I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.  

General Advice 

I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. My website is now available at grahammiddleton.com.

Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.

Best wishes to all readers

Graham Middleton