18 January 2022

The Impact of Anticipated Interest Rate Increases

There was a huge rush for intending sellers to get their houses to market before the close of 2021 because the market expects the Reserve Bank to raise interest rates several times in the coming year. The Reserve Bank has modified its language, backing away from the previous no rate increase before 2023 advice. Bank fixed term rates have begun edging up, reflecting banks having to pay more for medium to longer term deposits in wholesale markets. The United States Federal Reserve has begun money tightening by allowing bonds to mature rather than rolling them over, thereby taking some liquidity out of the financial system. This flows on globally, meaning that our banks are having to pay more for the money that they lend.

Stock markets have begun to ease and there are as yet slight indications as to the impact on Australian housing prices. With the probability of 2022 being a year of low population, due to Covid continuing to limit immigration, the fear of several interest rate increases is likely to lead to a weaker housing market. We have short memories and those who bought houses in the past few years have enjoyed falling interest rates on home purchases to the lowest point in the memory of most Australians. Having reached an historic bottom in early 2021 there is only one direction rates can go—and that is up. Coupled with this are tougher lending restrictions imposed on banks by the bank regulator, APRA. I predict that housing prices will weaken this coming year while the share market return since 1 July 2021 is flat. 

Housing Investment Compared to Shares

Housing prices have increased dramatically in major markets in the past year buoyed by historically low interest rates. Shares have also had a strong run since April 2020. This is likely to change as interest rates have passed the bottom of the cycle. The share market has experienced recent volatility but there remain substantial reasons why investing in shares is better than residential rental property when considered on a long-term basis. I am unaware of any of Australia’s billionaires investing in large portfolios of residential rental properties and there are obvious reasons why. Accountants love their clients buying residential rental properties because they add to accounting practices annual accounting fees whereas ownership of units in a listed REIT (real estate investment trust) which owns quality commercial trust is simple to own, usually produce better income return and produces very little extra work for accountants. This should not be taken as endorsement of REITs as proper analysis is required.

1.     There are higher acquisition costs for houses than for shares due to stamp duty and conveyancing.

2.     Depending on state locations there is land tax on rental property but no equivalent tax on shares.

3.     The selling cost of property is much greater than for shares due to agent’s commission, advertising cost and conveyancing.

4.      In the case of rental houses the landlord has to pay the outgoings including municipal and water authority rates, maintenance insurance, agents letting fees and property management charges. In commercial leases it is normal to pass outgoings cost to the tenant.

5.     The value of shares is apparent in the stock market on an ongoing basis, but you only know the value of a property on the day that you sell it.

6.     Bad tenancy is a significant risk and the damage can be costly to repair. It poses additional cost in delay in reletting. Naturally there is risk of bad management of public companies but careful stock selection and a reasonably balanced portfolio makes this risk manageable.

7.     Shares are far more flexible. Part of a share holding is easily sold to meet a sudden expense. With a property it is an all or nothing decision.

Both markets suffer fluctuations, particularly when interest rates surge or there are economic shocks. 

One of the issues often overlooked is that the quality and location of our long-term homes is generally substantially superior to that of rental houses. Real estate statistics are seriously misleading because they lump rental housing with owner occupied homes and the latter are generally much better maintained. Housing statistics also misrepresent capital improvements as capital growth. A huge proportion of the more valuable properties in choice locations have had extensive renovations and extensions but major improvements are much less common in rental property.

High rise rental units usually give poor capital growth and when bought off the plan are frequently worth considerably less than the contracted purchase price on completion. Free standing houses with their own land content generally have better capital growth than high rise units which for many have proved o be wealth traps.

For dental and veterinary practice owners the two best real estate investments are usually their forever home and their practice premises. Occupation of premises allows them to have long term benefit of their extensive fit outs including plumbing, wiring and radiation shielding the value of most of which is lost if forced to move to new premises.

There may be exceptions for practices enjoying modest rents in country towns. Other types of business may still benefit from long term occupancy of owned premise but most don’t have as much dedicated plumbing and wiring as dental practices. 

Wesfarmers Buying Greencross?

Giant conglomerate Wesfarmers which owns Bunnings, Officeworks, Target, K Mart and a few other businesses is reportedly one of the few potential buyers left in the sale process. Wesfarmers, which has beaten off Woolworths in the race for pharmacy business API and appears certain to finalize that deal, is most likely to be interested in the Pet Barn part of Greencross operations. While Wesfarmers has a great deal of retailing experience and appears to be hungry for further acquisitions in the retail space it has no experience of running a business akin to the vet practices side of Greencross. One wonders how it will deal with the massive vet staffing issues and the vulnerability of the veterinary practice network to competition from new veterinary start up practices. Any natural advantages corporates have through purchasing power is more than negated by their disadvantage in competing with owner operated practices which build up long term relationships with pet owners. This has been well demonstrated by practice start ups quickly growing past a million of fees when competing with major corporate practices.

The current private equity owners of Greencross appear to see an opportunity in the Covid related surge in pet ownership to sell out at what will likely be the peak in pet ownership as more people return to the workplace from working at home.

If Wesfarmers succeeds in buying Greencross it may well separate and sell off the veterinary practice part of the business and run the Pet Barn business in conjunction with API. That would be consistent with Wesfarmers purchase of the Coles business where it reinvigorated then stripped out the supermarkets business but retained other elements.

Buying a Dental Practice

Those looking to buy a dental practice need to read “What Dentists Buying Practices Need to Know” from September/October edition of Australasian Dental Practice. The article covers vital information which accountants and valuers advising prospective purchasers are invariably incapable of advising. Reprinted at grahammiddleton.com

Preparing a Dental Practice for Sale 

Read article in November/December Australasian Dental Practice, coming soon. Read in conjunction with “What dentists buying practices need to know” from September/October edition of Australasian Dental Practice, reprinted at grahammiddleton.com. For further information, see Financial Success for Dentists. 

What About Vets? 

Recent sales of profitable city-based multiple vet practices have yielded prices not believed possible a couple of years ago. The prices offered by the large corporates have made these practices unbuyable by younger vets barring those with substantial family support. They have two options. 

1.     Gain experience in the country and seek to purchase a country practice in due course. Country practice has enabled many vets to develop comprehensive surgical skills and can be very profitable. Or

2.     Open a practice in the city. Preferably this should be close to a large corporately owned veterinary practice, as the corporates have substantial staffing problems and as a result shed a lot of clients. I am aware of instances where a start up practice has grown quickly to a two-vet size operation and there is little that the corporates can do about it.

3.     One of the keys to success is to keep as much surgery as possible in-house, including having a visiting surgeon. Once a case is referred to a corporately owned specialist practice it is common for the client to be permanently lost.

Warren Buffet

For powerful insights into long term investing read Warren Buffet’s letter to Berkshire Hathaway shareholders of 27/2/2021. For greater understanding, read in conjunction with his previous and much longer annual letter: his annual letters are easily available via Berkshire Hathaway’s website.

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 financialsuccessfordentists@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.

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.

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.

I wish all readers their families and staff a Happy 2022. 

Best wishes to all 

Graham Middleton