Commercial investors likely to benefit under new tax regime

The network said the findings reflected the commercial sector’s lower capital growth profile and stronger income characteristics in contrast to residential property.

It said that assets delivering capital growth below 4.5 per cent per annum, including commercial property, were likely to face a lower effective tax rate under the new system, assuming inflation of 2.5 per cent per annum.

According to Knight Frank’s analysis of historic investment returns over the past 30 years, private office investors would have benefited from an inflation-indexed capital gains tax (CGT) regime 77 per cent of the time since 2000, assuming a 10-year hold period.

When it came to retail assets, the network said investors would have been better off 80 per cent of the time, while investors in industrial assets would have benefited more 71 per cent of the time.

By contrast, for established homes, after-tax returns have generally been stronger under the existing 50 per cent discount.

Capital returns for houses were treated favourably under the former regime 69 per cent of the time, while the indexation regime would have been better only 20 per cent of the time.

In light of the findings, Knight Frank chief economist Ben Burston said the tax changes were likely to attract more private capital to commercial property, prompting a potential reallocation of investment across asset classes.

“These reforms are likely to meaningfully tilt the playing field in favour of commercial property.”

“Commercial assets tend to deliver the majority of returns through income rather than capital growth, so they are better aligned with an inflation-indexed CGT regime.”

According to Burnston, the new method for calculating CGT liability favoured income-driven investment over other assets offering lower income, but potential for higher capital growth.

While Knight Frank found that total investment returns across all major asset classes were relatively similar in the past 30 years, the most important data was whether the returns came from income or capital growth.

Across the office, retail, and industrial sectors, most returns, 70 per cent to 80 per cent, have typically been derived from income, with yields within the commercial market averaging around 5.5 per cent over the past decade.

Meanwhile, data showed investors of established homes tended to buy houses on lower yields of 3 to 4 per cent in most capitals, instead focusing on the potential for growth in values.

Around 60 to 70 per cent of total returns for apartments and units were derived from capital growth.

Burston said that, despite total returns being similar across asset classes, differences in return composition translated into significant differences in after-tax outcomes.

“Under inflation indexation, return composition matters. Indexation taxes only real capital gains-growth in value above inflation.”

Burston said that for commercial property, where capital growth had generally run at, or just above inflation in the long term, the real gain subject to tax was small, decreasing the CGT liability and the effective tax rate on capital gains.

“For residential investors, whose returns have largely been built on capital growth well above the inflation rate, the shift is more consequential.”

“The real gain has tended to be much larger, increasing the CGT liability and the effective tax rate on capital gains.”

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