20 February 2022

Listed Property Trusts/REITs Will Fall if Interest Rates Rise 

Property trusts have long been traded on the basis of their income yield in relationship to long term bond yields. If interest rates rise, bond resale prices are discounted to increase their yield to purchasers. Traders in property trusts (REITS) will then only buy them at a reduced price to maintain a consistent yield in relation to long term government bonds. With overwhelming opinion in financial markets that interest rates will increase through the coming year bond resale prices are falling to provide increasing yields to buyers. We may expect the prices of property trusts and their close cousin Transurban to weaken. The interest effect is already visible in housing with sellers rushing to put properties on the market in the hope that buyers are not yet spooked by the high probability of interest rate increases. Interest rates have trended downward for several years and it is somewhat of a shock to relies that the cycle is turning. Current strong employment and a burst of inflation in the US make it inevitable that the US Federal Reserve is going to force up interest rates and the Reserve Bank of Australia is going to be forced to follow. We are witnessing its tactical withdrawal from the now untenable forecast that it would not raise interest rates before 2024.

I have recently sold Transurban and Waypoint because I expect both to fall in price during the coming year as interest rates rise. At this stage there is only a slight tweaking of term loans but there is strong evidence to indicate that there will be a series of increases over the next year with up to four small increases rather than one bigger leap.

I may consider repurchasing Transurban and Waypoint or other stocks with similar characteristics as the coming interest rate cycle is well advanced.

This year is election year with a pre -election budget due in March and a probable election date in May. Whichever side wins it will have to undertake fiscal tightening regardless as to what politicians say pre-election. 

End of Contact Tracing?

Contact tracing is reported as having been shelved in Victoria and probably elsewhere. Thankfully the worst of Covid appears to be past with falling numbers in ICU and a huge vaccination rate across Australia. International tourism is for double vaccinated visitors and state borders sans WA have opened. 

Owning One Good Dental Practice is More Effective Than Owning and Managing Several Small Practices!

In all of the more successful practice financials I have examined over many years the lions share of profit is earned in the owner’s personal surgery. Not only are the practice owners usually the most experienced dentists with the best hands the treatment they do is work for which they do not pay an employed or contracted dentist a significant percentage. Usually the owner produces significantly more work per hour than assistant dentists and this also means that the cost of the chairside assistant of an owner is significantly lower as a percentage of dental fees.

As an example a practice with three chairs, one is operated by the owner who produces $1million of dentistry per year including a proportion of high end but actually produces the lions share of income on traditional treatment which is quite profitable because of the speed of the owners hands. The two other chairs utilized by dental employees average $500,000 each per year. They are paid on the traditional formula of 40 percent of fees minus laboratory costs which works out at about 37 percent each but like the owner each utilize a fully equipped dental surgery and a full time DA/nurse. While the overall practice runs at a little above the average DEBDIT at say 60 percent some allowance has to be made for interest cost and actual equipment replacement. A cost accountant looking at the practice would quickly identify that the two assistant dentists have a much greater cost per dollar of dental fees than does the owner’s surgery and of course the owner is not paying another dentist to do the work done personally.  Stripped down the actual profit on the surgeries operated by the two assistants is quite low, possibly of the order of around 8 percent of fees generated, or about $80,000 from the two whereas the owner’s profit is around 60 percent of fees or about $600,000 or often higher. The actual numbers vary among practices. In this example a dentist wishing to replace their own profit would actually have to employ seven or eight assistant dentists to make the same profit and would in all probability be so absorbed in supervising them as to leave little or no room for their own production.

So too is the reward from owning multiple small practices conducted by dentists on a contractual basis. It can take quite a few small practices run in this way to equal the profit of one really good practice owned by a competent dentist.

Over many years I saw the actual financials of a multitude of dental practices or groups of practices but the recurring truth was that skilled dentists with the best outcomes were invariably owners of the practice in which they worked and regardless of the number of chairs staffed by assistant dentists the lions share of profit was earned in the owner’s surgery. 

Bank Profit Is Mainly Due to Near Free Money from The Reserve Bank of Australia but This Is Coming to an End!

During the December half year, the Commonwealth Bank had borrowings of $52 Billion from the Reserve Bank at a nominal 0.1 percent interest plus of course vast amounts of bank deposits at zero or negligible interest. Much of its half yearly interest cost of $2.25 Billion was paid in professional money markets. Interest income was $11.9 Billion! It was no wonder that it could hand out large housing loans of $500,000 upwards at 2 percent with a huge queue of borrowers clamoring for loans when its average interest charge was 5.3 times it's cost of money!

This will change dramatically when first the US Federal Reserve followed by Reserve Bank of Australia push up interest rates and further as the huge amount of Reserve Bank loans to the banks dry up in June 2024. That leads to two related questions:

1.     When do CBA and other banks raise interest costs on housing loans, and,

2.     When will our banks be forced to pay a meaningful interest rate to depositors to keep up their supply of money to lend?

Changes by June 2024

By June 2024 the financial landscape is going to be dramatically altered with much higher interest rates in Australia and abroad reducing significantly the amount of money that home buyers will be able to afford to borrow. Banks will be forced to raise interest on deposits to hold onto money. Listed property trusts (REITs) will likely have fallen in value to a point where their yield retains its relativity to long term government bonds. The price of stocks with similar characteristics are likely to behave similarly to REITs.

Superfunds Headed for Poor Year End Results 

Australian superannuation funds are headed for a poor result in the present financial year with many likely to end the year in negative territory due to the anticipated change in interest rates. In this environment it is smart to sell down interest rate sensitive stocks, continue to contribute cash to superfunds but wait for several interest rate increases before committing significant amounts to the market. Run this scenario past your advisers but be particularly wary of any advisers recommending that you make significant purchases of REITs, shares and ETFs based on equities at the present time. 

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. 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 

Graham Middleton