SUMMARY: Property investors copping one in the neck – intense focus from regulators and FSI to cool the property market.
Property investors must be wondering why a red bullseye suddenly appeared smack over their heart. Attacks are coming from everywhere.
Two more financial watchdog heavyweights said this week that they wanted to tighten the screws on real estate investors and those lending to them.
Inquiries have been launched and “please explain” notices issued to the lending industry, specifically covering real estate lending product favourites, such as interest-only loans, investor loans and high loan-to-valuation ratios with a view to putting pressure on lenders regarding their use.
The announcements came just 48 hours after the David Murray-chaired Financial Systems Inquiry recommended many changes aimed specifically at taking heat out of the investment property market.
Out of the FSI, property investors now need to fear a potential ban on borrowing in super and potential capital restrictions being imposed on banks, which could limit loan supply.
Yesterday, in separate, though related, announcements, the Australian Prudential Regulatory Authority and the Australian Securities and Investments Commission also announced probes of lenders that could significantly impact on loans available for property investment.
ASIC will investigate interest-only loans as part of a review that “follows concerns by regulators about higher-risk lending, following strong house price growth in Sydney and Melbourne”.
The statement said 42.5% of new loans being issued were now interest-only, with a fear that the potentially “unsuitable loans could see them (investors and home buyers) with unsustainable levels of debt”.
The corporate cop is suggesting that some lenders are failing to comply with “responsible lending” rules and is promising enforcement action where it finds lenders are falling short.
Interest-only loans are a favourite of property investors, largely because they allow for better cashflow, because they do not have also make principal repayments. The money saved on principal repayments can then, in many cases, be used to pay down non-deductible debt, such as home loans, faster than they would otherwise be able to.
APRA’s inquiry will focus on high loan-to-income loans, high loan-to-valuation ratios, interest-only loans to owner occupiers and loans with longer loan terms.
Any lender growing their investor loan books at faster than 10% will come up particular scrutiny, as they believe it is indicative of the lender targeting investors.
And they want banks to use certain minimum requirements when determining “serviceability” for loans, including increasing the minimum interest rate buffers on loans, particularly for investors. These include a minimum interest rate for servicing of 7%, or 2% above the loan product rate.
If necessary, APRA has indicated it will consider lifting capital holding requirements for lenders.
While the inquiries are aimed more broadly at curtailing the heat in some sectors of the property market, in explanatory notes, both regulators acknowledged the inquiries were predominantly aimed more pointedly at the investment market.
Add this to a swathe of concerns and direct recommendations from the FSI and you’ve got the screws being turned on property investors.
Under recommendation 8 (of 44 direct recommendations), the FSI would like to see the ban on self-managed super fund borrowing reintroduced. More accurately, the “exception” to the rules that allow SMSFs to borrow to buy assets, largely property.
I’ve written recently that this was a strong likelihood (19/11/14) and it was right up there. These limited recourse borrowing arrangements (LRBAs) are growing rapidly in demand, though my fear has long been that it is property developers pushing the demand buttons with inexperienced investors and SMSF newbies, or those who previously didn’t own a SMSF at all.
My biggest fear is that it could have been one of those announcements that was instantaneous – the government banned the practice immediately at the very launch of the FSI, which would have caused a lot of damage to investors who were part-way through transactions, as outlined in my 19 November column.
However, it looks like the government is going to seek feedback, on all recommendations, until 31 March, meaning SMSFs appear to have some breathing space. The government could take some time to announce changes after that.
For investors more broadly, the FSI has serious concerns about the banking system. It was, after all, an investigation into the financial system.
But this, again, could add further headwinds to real estate investors. The first part of the report is dedicated to trying to reduce the risks of banks getting it wrong, with recommendations talking to the capital adequacy of banks.
This could also impact on investors in banking stocks, with more money being tied up as, effectively, reserve capital instead of being invested elsewhere, including as property loans. Anything that reduces the availability of loans takes heat out of a property market.
Recommendations to remove franking credits would also hit banking investors.
While not a specific recommendation, FSI suggests the case for continuing with imputation credits is “less clear” now than in the past. Banks are famous payers of high, fully franked, dividends. Any removal of dividend franking, which cannot be passed through to investors by mutual societies, would impact on bank share prices.
Investors in general
While the FSI was not a tax review, it does make much mention of “distortions” in the tax system when it comes to investment.
The fact that interest and coupons (from bonds) are taxed at double the rate of capital gains tax (largely from property and shares) and encourages “leveraged and speculative” investment.
(Put it that way and the CGT discount and speculation could also be one reason why Australian property prices didn’t crash like the rest of the western world in the GFC, much to the horror of some who expected it would.)
There has been plenty of talk about limiting any negative-gearing tax losses to just the income earned. But removing the halving of tax on gains would throw a spanner in the works of crunching the numbers on a long-term investment.
Also, as above, the suggestion of removing franking credits also distorts capital markets, David Murray said.
There are also considerable discussion around making corporate bonds a better investment, including a recommendation to reduce disclosure requirements for large corporates issuing simple bonds. The suggestion to remove the halving of CGT would also make corporate bonds a more attractive investment.
Outside of the headline-grabbers such as deleting LRBAs from existence and changes to franking credit laws, superannuation rated second on the list of importance.
The final report recommended reporting on the income stream associated with super savings be mandated on super funds (as I raised on 12/11/14).
But it stopped short of saying government should make annuities compulsory for a part of a person’s super savings when the income stream is turned on.
The FSI wants to see product innovation in the world of retirement income, suggesting super funds come up with default income stream options, which people would be encouraged, rather than forced, into.
Investors as consumers
If the FOFA on, FOFA off, FOFA back on, changes haven’t been unsettling enough for the financial services industry, Murray’s report wants far bigger protections in place for consumers.
These include level commissions being standard for life insurance products to stop churn and that advisers should meet higher education standards and a broadly enhanced register of financial advisers for consumers to research should be imposed. The register would include who ultimately owns, or licences, the adviser so that institutional ownership would be transparent.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.