Ask Us Anything: Silvagni Case and Suppression Orders + Arnott's $45M Debt Facility

0:28I'm Adam Schwab. to purchase more properties with major debt. My question is, how do they get finance from the banks at that level, which they can't service from their day job? I understand banks are loathe to include rental income in their assessing of the capability of the borrower to service the loans. That's an interesting question. I'm actually not sure how someone will be getting finance, because banks have, in one sense, become a lot stricter when they're talking about lending based on basically multiples of income, which is just a three to four, maybe five times income. But they've actually, we know that we think they're way too lenient on LVRs, up to 95 % now for principal residence.

1:11But I haven't actually heard of banks lending so generously to investment property buyers. Have you heard of this phenomenon? I haven't. I mean, it's obvious why banks don't like to include rental income in capacity to pay because that is the ultimate Ponzi scheme, right? Like banks are heavily leveraged to residential property in Australia. And if all of a sudden the bottom starts falling out, then not only will you lose your rental income, but if it was your ability to pay for your own property was based on that in your own mortgage, that will create a vicious cycle. So I understand why they do that.

1:50Now, I haven't heard about this. I'm not really familiar with this at all, frankly. So let's just change this question a little bit. Do you think it's a good idea to be, A, buying investment properties if you're sort of caught mid-20s, like early 30s, you've got your first job, and maybe you haven't bought a principal place of residence. What's your views on buying investment properties at a youngish age as opposed to buying shares or or crypto or whatever. From what I've seen, there's two reasons that people under, let's say, 35 buy investment properties before they've bought a primary residence.

2:27The first is they can't afford a primary residence where they want to live. That's especially common in Sydney. And so maybe you can afford to buy an investment property for a million dollars, an apartment or something. But where you want to live costs$4 million because it's Sydney. And so there's no way to facilitate that. So they want to get into the property market, they just can't get in with their primary residence. So that would be reason one. And reason two is this idea that you can use negative gearing, which if you're on the top tax rate, essentially means the ATO will subsidize 50 % of the losses that you're generating on property by operating it.

3:08And so that you can use negative gearing to create this, I don't want to call it a Ponzi scheme, but maybe it will say a highly leveraged house of cards where you buy your first investment property. It's going to lose money because the rent is not going to cover the operating costs, but the ATO is subsidizing half of that. And then that property goes up and then you borrow some more money against the equity in that property to buy the next investment property and do the same thing, which is great. everything, leverage is fantastic when markets are rising. It just looks pretty dreadful when markets start falling or when you lose your job and you lose the capacity to pay.

3:49And so my overarching view is I understand the first reason, like I understand that. The second reason I still fundamentally think given the enormous tax incentives that accrue to a primary residence, namely no capital gains tax ever being payable with any level of gain, it seems to me that most people where possible should skew heavily to kind of investing as much money in their primary residence as possible, keeping in mind that the mortgage that you pay on your primary residence, that is your house, cannot be offset from a tax point of view, whereas losses from an investment property can. So it's complicated and I think it's fundamentally tax related.

4:32And my, you know, as I would always say, and you would always say, be very careful with debt. Make sure you've got a big margin of safety. Yeah, that's right. I think the one exception, and we've talked about this before, I think Paul Clitherow wrote a great book. He was the famous host of the money program on Channel 9. He wrote a great book. It was like 25 years ago. And he made a really good point by saying - I read that book. That was the first personal finance book I ever read. By the way, Paul Clitheroe is still chairman of a business called InvestSmart, which is ASX listed, which bought the Intelligent Investor newsletter.

5:04And I think the assets of the Ellen Kohler newsletters, I think it currently owns that and a funds management business. Was that the Eureka Report potentially? I think that that's piled into there amongst other things. Which is a good business, a really actually good business. It was part of that. It was Business Spectator Eureka Report was all packaged at a Salton News Corp and a great transaction. That's right. Anyway, I sidetracked you, so I kept going about Paul Clothroy's book, which was called Money. That was the name of the book, wasn't it? I think it was called Money as well, which was the show he hosted.

5:33And he's a really sensible guy and it was a sensible book. And basically his main point was, and even made more since the time because property prices were much more. I think you get a property for five or six times household income. Now it's 13 times or whatever. But back then he said the beauty of buying a house, especially a principal residence, of course you get your tax holiday, day, but also it's a form of compulsory saving. So if you're taking out a mortgage, you're pumping your cash into reducing that mortgage, reducing the principal as well as interest. That is a great way to save when otherwise people are often far less disciplined about saving.

6:06So whilst I'm rather bearish about property in a lot of Australia, especially Sydney, I think I'm less bearish about property in Melbourne, which really hasn't gone anywhere for sort of five years, but certainly Sydney property, it's pretty hard to stomach. It's really the third most expensive property in the world after a couple of tax havens in Hong Kong, Monaco, and maybe Switzerland. So it's pretty hard to justify buying in Sydney, but certainly justify buying elsewhere. To your earlier point, I think if you can get a yield, which is effectively the rental you get from a tenant less your cost, if you can get a net yield, which is sort of rental less all those costs of probably 3%, I'm generally okay with property.

6:45If it's any less than 3%, which it generally is now outside most places, then I've got some issues because there's depreciation, essentially houses have to be rebuilt and apartments have sinking funds. So at the right place in the right time, property with leverage is an amazing way to build long-term wealth, but at the wrong time, it can be a sinkhole. So 3 % you're still going to be running negative because let's just use round numbers. If the interest rate is 5 % on the value of the property and you pay a 20 % deposit, that's the equivalent of just multiply the value of the property by 4%, right?

7:17That's the easiest way to do it. So a million dollar property, you'll be paying 4 % on the 800K, 4 % on the total, so 5 % on the 800K, so$40 ,000 a year. And you'll be getting a 3 % net yield, which is$30 ,000 a year. So the gap is$10 ,000, not tough maths. And that$10 ,000, you'll then say, oh, that's a loss associated with owning an investment property. And assuming you're on the top tax bracket, Let's round it to 50%. You'll go and make that an expense on your personal income tax statement and that will reduce your income by that$10 ,000, which effectively reduces your tax by$5 ,000. And that is why people love, love investment property because the government is subsidizing half your losses if you're a high income earner.

8:09Well, it's not just property. It's like most investments. No, you can't deduct the operating losses of most investments from your personal income tax. It is unique to property. Most operating losses are quarantined inside the entity that has made the losses until there is a gain made in that entity. And then the losses are offset against that future gain. So that's generally how it works in owning a business or a trading operation. But if you've got a business that's not a separate company though, so it's effectively you're trading under your own name, I think you cannot separate that. As a sole trader, you mean.

8:46As a sole trader. Yeah, that is true. Even with a company, obviously. Yeah, well, as a sole trader, you can. But, you know, this treatment of property is also the reason why, on a big tangent now, it is also the reason why people rightfully complain. or maybe I'll say people complain and rightfully note, it's up to you if you think it's a fair complaint, that negative gearing skews to advantage in high income earners because the higher your tax rate, the more beneficial negative gearing is for you. I think just on that example, the reason why I chose 3%, to be honest, a 3%, I doubt there's many properties yielding 3 % net because you probably have to yield 6 % gross.

9:25Not residential properties, that's for sure. Yeah, that's what I'm talking about. So I think it's a pretty high bar now. But there are definitely times where you can yield 5%, 6 % on residential properties, which gives you a 3 % net. The reason why I chose that is when you think about two things. One, as you pay down the mortgage, that interest rate burden becomes less. So you're paying it down progressively. And secondly, your rent should increase. Like a good property. So at the same time, you've got consistent costs. But I've factored into that sort of gross versus net. So I think for me, the minimum, if you can get 3 % plus, I think residential investment, property investment makes sense.

9:58Any less than that, I find it a little hard to stomach. You're basically speculating on the bigger idiot theory that somebody will pay a higher price than you in two, three, four, five years' time. So as you know, I'm generally bearish on property. Let's take a more common example that a high-income owner might do. Buy a property for two and a half mil, pay half a mil off the loan, and then they'll pay also some stamp duty, 5 % stamp duty on that property as well. So pay all of that. Now they've got a$2 million loan. The gap between the yield, the net yield and the interest they're paying is probably 3%.

10:31And so they're paying$60 ,000 out of pocket on that$2 million loan every year. That$60 ,000 loss hits their personal income tax, reduces their income by 60K. That cuts$30 ,000 of tax off their tax bill. you can see the effect this has on the tax system and the effect that it probably has on investment property prices. This is why people talk so much about negative gearing. And if, for example, that$60 ,000 came off a lower income earner that was only on a 33 % tax rate, then obviously their discount would only be$20 ,000 on that, not$30 ,000. And so that is why it skews towards benefiting high income earners.

11:19But to answer the original question, I've got no idea about loans for construction. I think property, you know, is it a good or bad investment depends on the property and depends on long-term cycles. And should you be careful gearing up and then leveraging on top of leverage, which is effectively what lots of people are doing. So the person with the$2.5 million property, they've got a$2 million loan, then that property goes up to$4 million and they say, well, now, like, actually, I've got a lot of equity in this because I've only got a$2 million loan, but I've got a$4 million property. Wow, that's$2 million of equity.

11:52I'll borrow another$1 million against that equity from that property and invest that in the next property. And you end up with this house of cards where if they lose the ability to service or property prices fall, like that is catastrophic because actually in all, they might own$20 million of property, they might effectively only have four or five million dollars of equity in that property. And so it doesn't take much for that all house of cards to completely collapse. Yeah. And you hear people getting to 100 properties based on this literal strategy. And it can work if you're really smart the way you buy properties and you have a lot of luck with interest rates, probably dropping or staying static.

12:37You can maybe get worried that where you gets killed is if insurators go up. If you have a 1990 situation, insurators go to even 10%, let alone 17%, you're dead because the house of cards collapses pretty quickly. So it's really a leveraged bet on rates not going up and being able to continually find effectively inverted commerce undervalued property. So that's pretty hard. It's not impossible, but it's certainly not something I'd be suggesting. Or you just need property to keep going up 7 % to 10 % a year and doubling every 7 % to 10 years. And then what's the greatest Adam Schwab quote of all time?

13:06It is booms and bubbles make idiots seem smart. And that is absolutely a lot of what has happened in the property space over the last 20 years. On that note, we're going to question number two. Okay, this question comes in from Kelly. The National Reconstruction Fund recently provided a$45 million debt facility to Arnott's, which is owned by a large private equity fund. Do you guys think this is a good idea? So I'm not sure if you're familiar with this, but this is a couple of weeks ago. So there's the Australian government and it was Albanese and Jim Chalmers who started this$15 billion national reconstruction fund.

13:46This thing makes Breakthrough Victoria look like chump change. I'm shocked nobody's talked about this. So last week it gave a$45 million loan to Arnott's Own By KKR. Really the first time it's gotten any kind of press. What's your views on A, this loan and B, the fund itself? Because you are the Breakthrough Victoria king. Well, it has gotten press once previously, recently, well, in a similar kind of way. There's been obviously other press. But before it gave a loan to Arnott's, which is owned by KKR, obviously, as you just said, they also gave a loan to Paddy's Foods. Now, Paddy's is 4 and 20 pies and other stuff.

14:31And of course… Also owned by Private Equity. Also owned by, this one is owned by PAG Asia Capital. I happen to know the CEO of Paddy's Foods, although he doesn't really know that he knows me because I know in a non-business context, so I think he would be shocked to find out that I had this podcast. This National Reconstruction Fund, it started off post-COVID as we need to rebuild the Australian economy and make it more resilient and especially create a whole lot of sovereign capacity around key industries. So that's how it started. There are some very capable people on the board. So Ahmed Fahool's on the board, Kelly O'Dwyer, Daniel Petrie, who I think is terrific.

15:15Like there are very capable people on this board. The question is not like are they capable? The question is what should$15 billion of taxpayer money be used for? and my main issue with this is this feels like within the case of Arnott's and in the case of Paddy's Foods the Australian taxpayer through this reconstruction fund has become the lender of last resort because clearly Arnott's is in some kind of trouble. I think they run at losses this business a struggling business and I'm not sure it runs at losses this is private equity losses. They're running a heap of interest through. So I think the EBITDA, I suspect, is quite positive.

16:00Well, we can definitely say from the reporting that Arnott's is heavily indebted as a result. There's a lot of debt on their balance sheet. That's because this is a classic private equity lever up. I agree. Because it's an easy business to lever up. But the thing with a lot of debt is that it makes it harder to borrow more debt because Because people are nervous about – the new lender is nervous about ever seeing a return because they're worried about the existing lenders getting paid. And so it definitely makes it hard. $45 million is a drop in the ocean of a$15 billion national reconstruction fund, which has made – I think I've been quite supportive of a lot of the high-tech investments that they've made.

16:43They have invested in things that maybe were not particularly suitable for private capital, but are important to Australia from a technology point of view. But I just don't quite, you know, I don't want to castigate this decision on this board because there's not enough information that's in the public domain. But I think if they're going to make this kind of loan, they should provide much more detail, virtually like investment notes about why did we decide to do this and what are our expectations? Because if the answer is Arnott's employs 4 ,000 people and they've got five factories and they told us they're going to fire 1 ,000 Australians unless we lend them$45 million as a shakedown, that would be a bad reason to give them$45 million of a loan.

17:26And it would also be interesting to know why couldn't Arnott's, which is owned by one of the most reputable private equity businesses on planet Earth, why couldn't they go and borrow this$45 million from somewhere else? private capital is crazy at the moment, right? There's answers to all this and the answer is they could and they largely did. So this, they had, I think it was a well over a billion financing package and the fund would have helped with probably credibility and getting, I guess, maybe finalized in the package. But my understanding is this is a really small part of the package and the CEO of the fund said, we're getting a commercial return.

18:03I think it's only a 6 % yield, so it doesn't sound overly commercial to me, but they said they're getting commercial return and we're putting money to work and making money for taxpayers is what the claim was from the CEO of this fund. I've got much more of an issue with this than you, it sounds like. Can I tell you, I just can see some performance. So this is what was written in the Fin Review about their performance by Campbell Kwan and Sally Patton. So Sally writes a lot of retail stuff. It said, the business has been struggling under enormous debts. The$45 million from the NRF was part of a broader$1.75 billion debt financing, which is what you just said.

18:38Filings with the Australian Securities and Investment Commission show Arnott's has debts of more than$2 billion and he's paying annual interest that tops$100 million. Sales, so that's its capital stack essentially. Now we talk about performance. Sales hit$1.76 billion in the 12 months to August 3. That's pretty big sales. But profits, I'm going to call it reported profits, were negligible, just half a million in that time and a$34 million loss one year earlier. The reason I say reported is because there's lots of moving pieces in a private business owned by private equity in terms of reported profits and what's driving that.

19:19But that at least provides the only window that we're going to get into Arnott's performance. And there's probably a lot of interest in there as well. So I suspect there's a hundred plus easily, if not more of interest. So I think the EBITDA of this business is probably a couple hundred million bucks. So I suspect it's actually doing pretty well to okay. So my issue, I know you're right, the 45 million is immaterial to everything, but why a taxpayer, this is a criticism of Jim Chalmers and Albanese for doing this, why are we creating Soviet-style funds where we're picking winners? The job of government isn't to invest taxes.

19:52Taxpayer dollars are our dollars. This is money that taxpayers have earned and is being stolen by the government. Why is the government taking this money and investing it? We could invest it on our behalf in places if we wanted to. I don't want the government investing my money for me and hoping these idiots deliver a return because despite the fact they're not investors and not experts. You said they've got a decent board and I take your view on that. Well, I would really refute you on this because so you'll have lots of criticism for a few of these people on the board like people that were the national secretary of the Australian Workers Union but I want to emphasize the fundamental difference.

20:29These people are not idiots at all. They are smart people. I'm not saying they're all smart. I'm saying I want to invest my own money, but not some unionist investor for me. That's a separate issue. But like I agree with you on that. But I wouldn't disparage this board. Like this board is smart. They've been in business. They've been in serious investing. This is my fundamental difference here between this and Breakthrough Victoria. Like this is a highly capable board. And that is why – I think that's a false difference because you can fix – you can change a board. Like Breakthrough Victoria could have a – you could hire – So change it for a minute board.

21:01It'd still be terrible. I don't think simply because they've got good or bad people on the board makes this – this is as bad as breakthrough Victoria. Well, I think you're – I don't think it is. Maybe even worse given what they're doing. Like why are we lending to wealthy – as you say, wealthy private equity-backed business? They can easily cover this loan through 100 other places. They don't need the Australian government lowering their cost of capital. All right, but let's not conflate multiple different things. One is should these sort of things exist with taxpayer money? Two is what should they invest in?

21:29and three is can you trust the people making the decisions. I find them three totally different things. And so number three on this, my answer would be yes. That's why I'm much less fast. Well, I think number three is by far the least relevant question because it can change in a heartbeat. Well, but it's why I'm not – all right, but it's why I think if this would have come to break through Victoria, they might not have exactly realised what they were doing in providing this money. This board knows exactly what they were doing in providing this money. And it was a conscious, eyes-open decision.

22:00That's why I said I want to see what the investment notes are on why this money was provided, like what the justification was. I think the argument for a reconstruction fund post-COVID to build sovereign capacity in places where timelines are too long for private investment, I actually am supportive of that as a use of taxpayer money. Does this particular investment fit that bill? it feels difficult to understand why chocolate biscuits i'm being a bit extreme but why chocolate biscuits are a sovereign requirement for australia like having that on shore like they've got these seven different investment types and this foot falls on the agriculture type somehow i don't even know how it's even agriculture but that's what they claim uh it's actually manufacturing maybe they're a huge buyer of australian agriculture but the truth is they're going to be either way that all this does is reduce their cost of capital it just makes kkr a bit more kkr's investors who i'm sure are pretty much all non-australians by the way a bit more money.

22:54So it's literally Australian taxpayer helping out wealthy foreign private equity investors. And KKR is smart enough to get this good on KKR. This isn't a criticism of them at all. This is a criticism of the idiots running this government who are frittering away our tax dollars and giving it to billionaire Americans, which is exactly what's happening. Or your mates at Ivy League Unis, who are the LPs in this fund. I'm much less critical about this than I am at Breakthrough Victoria, but I do think - To me, they're one and the same. I don't know how you can differentiate the two well for the reasons i just outlined but i but i do think like with these with every investment that is being made using taxpayer money i think the transparency bar should be very high and lots of information should be provided it doesn't have to be commercial and confidence information lots of information should be provided about why this body felt that this was a good use of taxpayer money.

23:51And by the way, if it is, if there's something in there that's like, yeah, that's pretty smart. I'm all in favor of that. But, you know, generally speaking, I agree with you, like going and dishing out billions of dollars of taxpayer money to be spent investing or in this case lending to private enterprise, especially foreign private enterprises that are owned by very sophisticated foreign financiers, like at face value, you definitely want more of an explanation about what just happened there. You're far more generous, I think this is an absolute disgrace. But anyway, we move on to a super quick break, back in no time at all.

24:39And we're back, question number three, over to you, Mike. final question this week from chris the recent tom silvani case shown a light on the use of suppression orders especially in victoria which is known as the suppression order capital of the world there is now a move to reduce the ability for courts to allow these orders this seems fair to me but am i missing something uh what's your view on this uh my view actually you'd be shocked to hear so just a quick background so that obviously the tom silvani case was the the really sad case of of a young man who's being found guilty of rape uh obviously a house hearts go out to the victim and obviously that all families involved because it's a pretty horrid uh incident made probably made worse by the celebrity of the parents of the perpetrator i think had had it been just a regular person uh we we wouldn't have heard about it i suspect so that's obviously cast a whole new sort of light on it but so what happened was there was a very strong suppression order that basically media couldn't report.

25:41The media all knew what was happening. It was reported as a very high-profile family, the son of a high-profile family. And a lot of people knew. So a lot of people in sort of footy circles knew. But obviously, media couldn't report on it until basically last week where obviously he was found guilty and the suppression order was finally lifted. I actually am very supportive of these things. And we saw with the Tanner Bruin, an actual footballer, about a month ago, there was a suppression order on his matter. It was also a rape matter. And it was later found that the victim basically made up the whole thing.

26:15We don't know what happened there. But his name was completely cleared. And that was a fantastic thing that his name wasn't – it's been impacted later, but it wasn't dragged through the mud on what was a false claim. So I think the notion of suppression orders are great. I think they should be 100 % suppression orders until someone is found guilty. because if someone's found not guilty, they shouldn't have their lives ruined through speculation and the sort of tarring. Your name's tarred forever even if you're found not guilty. So I think they're a great thing. I think when someone is found guilty, it should come up.