Four Principles of Corporate Finance that apply to Strata

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… and how every owners corporation and strata manager in Australia can benefit from understanding the implications of each!

Opportunity Cost

Remember the old Aspirin ads? “Two and a quarter times faster”. Well, 2 ¼ faster than what?

It’s the same with money in general and funding in strata in particular.

The money that owners pay in levies is not free – the cost of this money is whatever the next best thing you could do with it might be. That is, the cost of the lost opportunity of using that cash elsewhere.

If you could have repaid your credit card with the levy money, then the cost of your money is about 20%pa. If you could have invested in shares, then it’s the lost opportunity of making that investment. If you take it from a term deposit, then in the current market, it’s about 2%pa.

All money has an “opportunity cost”, i.e. a benefit, profit or value of something that must be given up to acquire or achieve something else. Since every resource (land, money, time, etc.) can be put to alternative uses, every action, choice or decision has an associated opportunity cost.

ROI

Return On Investment (ROI) is the single most important financial concept to apply in strata. Many people take completely the wrong approach when thinking about strata capital works – they want cheap, they think about each project as an expense.

But it’s not about the dollars, it’s about the return on those dollars. Replace your mental notion of “expense” with the concept and philosophy of “investment”. If you think “expense” then your mind is naturally drawn to “cheap” and there’s a reason why “cheap” and “nasty” are usually in the same sentence.

When you think “investment” your mind is automatically drawn to thinking about getting a return on that investment.

What will your emotional return be if you choose the cheap and nasty $50,000 quote instead of the quality $55,000 quote?  Or if you choose the $100,000 quick fix over the $150,000 value investment?

Optimising Equity and Debt

For the first-timer this sounds a bit odd, so we’ll just go straight into it:  equity is expensive, debt is cheap.

If debt is (in comparison) cheap, then why not use 100% debt? The reason is obvious but worth spelling out:  debit is risky. Borrow from anyone, for any purpose – mortgage, credit card, personal loan and the like – and things will get very difficult if you can’t repay it. Each dollar of debt adds to financial risk.

Fortunately, there’s a solution. It’s to optimise the level of debt and equity – find the right mix where the cost is less than if you had 100% equity, but the financial risk of the debt is not too onerous. An interesting observation is that there are many situations where this optimal amount is 80% debt and 20% equity, for example, when buying a house, but that’s a story for another day.

Tax

We all know about death and taxes, but for some owners in strata (and sometimes even their managers) it’s as if they think taxes don’t exist.

The important calculation in any financial decision is the effect of taxation and it’s the after-tax cost which is important.

There are four relevant taxes in strata:  income tax for the owner, income tax for the corporation, capital gains tax and GST.

It’s the impact on owners’ cash flows after tax that is critical to a good economic decision in strata.

It’s time we all got smart about the economics of strata schemes, so if you’re an owner or a strata manager looking at alternative (and smarter) ways to fund your next capital works project, contact the team at Lannock today!

Get In Touch

Applying for a strata loan is fast and easy – contact the Lannock team on 1300 851 585 or strata@lannock.com.au to find out more about why borrowing might be suitable for your owners corporation.