Scandal identifies a very interesting tax dodge

Sometimes it takes a whiff of scandal to alert you to a fantastic way to avoid paying a massive tax and perhaps also find a new option for investing your money.

In this case it was an ABC investigation into the Wollert community land lease property of listed Lifestyle Communities (ASX: LIC) which blasted the operator for a couple of things – charging rent to dead people and also charging exit fees which some saw as trapping residents by restricting their ability to be able to afford to move.

Those allegations and others will be sorted out in a court case between some members of the Wollert community and Lifestyle Communities to be heard before the Victorian Civil and Administrative Tribunal but it did pique my interest in one intriguing feature of the land lease model – the ability to quite legally step around the need to pay stamp duty when you “buy” a new property.

Stamp duty an ugly, inefficient tax

As most people know, stamp duty is a bloated, inefficient and frankly horrible tax that absolutely gums up transactions in the Australian property market and is often a very heavy load for buyers, who effectively pay it off over many years with compounding interest as part of their home loans.

The land lease model, which is very popular in the United States and some other international markets, totally avoids this tax because people buy houses but not the land they stand on, for which they pay rent to the land lease developer.

That rent also covers community facilities and land lease projects in Australia range from effectively mobile homes in caravan parks all of the way through to luxury retirement communities.

What being able to avoid that hefty stamp duty on purchases provides is the ability for a much cheaper entry point for buyers compared to an equivalent conventional property – offset to some extent by an obligation to pay rent – and some excellent returns for investors.

Because the land is leased, there are also no individual council rates to be paid, although the community as a whole would pay rates.

To give an idea of the scale of stamp duty in Victoria, on a $500,000 purchase you pay $21,970, rising to $110,000 for a $2 million property and so on, so avoiding paying that sort of massive impost up front is a massive benefit even if it is offset a little by needing to pay rent.

A much cheaper entry to the property market

Importantly though, what the land lease model offers is a much cheaper entry point into property ownership plus some shared community facilities.

That is a worthwhile aim in an era in which property prices have outstripped the affordability of many.

It is also a model that arguably competes quite well against many alternative retirement community models, which have long been controversial for entirely or largely stripping out the possibility of capital gains and for hefty fees and charges.

Investors betting heavily on land lease

Looking at it from the investor side for a moment, land lease communities have become a lot more popular, due to factors including significantly lower development costs and impressive long-term annual returns sometimes as high as 20% – well above the sort of returns being achieved by alternatives such as build to rent.

That has attracted some new established development players such as Stockland (ASX: SGP) and Mirvac (ASX: MGR) to a large roster of existing players which includes the listed Ingenia Communities (ASX: INA) and Lifestyle Communities (ASX: LIC).

Macquarie Asset Management announced plans in June to develop, own and operate land lease housing communities on the east coast, drawing on $1.9 billion of capital it has raised for its second opportunistic real estate fund.

Independent advice a good idea

Obviously, anybody considering buying into a land lease community should do plenty of due diligence and make certain that they are happy with the conditions of living there and the financial implications.

Independent legal and financial advice is always a great idea unless you have a strong understanding of what you are signing up for.

Some communities operate with exit fees, in which the operator shares varying proportions of the capital growth of the property (minus land), while others do not.

The legality of these exit fees will obviously be tested in the VCAT case as well.

However, on paper at least, it should be possible for the land lease model to produce great outcomes for both occupants and investors alike.

The only party left steaming will be the state governments who are missing out on their continual stamp duty turnover honey pot, although at least they collected one wad of stamp duty when the community land was bought in the first place.