(03) 9020 2905PORTFOLIO POINT: People can’t take their eyes off property. But the banks are reacting with typical glacial speed to the “new” rules for SMSFs. Have you considered being your own banker?
If, like Reserve Bank governor Glenn Stevens, you find the current bouyancy of Australia’s residential property market a little hard to fathom, be thankful there’s a big drag on a potential swathe of new demand.
You.
More than 2 ½ years after the rules were changed to allow Australia’s SMSFs to use gearing to invest, precious few trustees have taken the leap into leveraged property inside their DIY fund. And it’s not necessarily because they don’t want to. It’s usually because they can’t get the loan – banks are still suffering from inertia.
As we’re all too well aware, the rules that allowed super funds to gear were changed in September 2007. There was a period of shock, which lasted for about six months, where there were no lending institutions that had loan product available to meet the new requirements. Well, that’s not true. There were some, including Calliva and Babcock & Brown, who were soon the victims of “the sky falling in” (also known as the GFC).
The rule changes came at a time when property and equity prices were reaching a crescendo. The top of Australian property and global share markets came in the following quarter. And both asset classes fell for more than a year following.
To point out the bleeding obvious, it’s April 2010. Both property and shares bottomed more than a year ago now. The world has resumed spinning on its axis again. There’s no – at least not in Australia – threat of economic meltdown. Bills are being paid. The unemployment queues are stubbornly short.
But you might have more success and less pain pulling your own teeth than you’ll have getting a property loan for a SMSF through a major Australian bank. You can’t walk into a branch and ask for one – the tellers will laugh at you. The branch lending manager is likely to shrug his shoulders. Someone in the regional branch might know what you’re talking about, but they won’t know who to refer it to.
You’ll need patience. Or someone with experience. Or another way to skin the cat.
As property continues its resurgence, the lack of lending product is potentially costing SMSFs money. Banks are not marketing their SMSF-specific loan products/packages particularly well or widely. And those that do often have one or a number of the following: high valuation or establishment fees; compulsory bank custodianship (with their own fees); high interest rates; and inflexible loan structures.
Because the new regulations stipulate that loans for SMSFs be limited recourse – that is, they can only seek redress against the asset that was purchased – banks have tended to limit the ratio to which they will lend to around 60-75% for residential property.
SMSF trustees are, as a result, increasingly becoming their own banker for their SMSF gearing strategies.
Yes, YOU can be the lender to your super fund. Becoming your own banker can remove a whole lot of hurdles for investing in property through your SMSF.
It starts with you, as the trustee, having access to plenty of equity outside of super, presumably against your home or another property (although the money could feasibly come from another trust or company). Alternatively, access to plenty of cash that you don’t, for one reason or another, want to put into super as a non-concessional contribution. (Or access to so much money that you could take up both you and your partners non-concessional contributions and still have plenty left to spare for lend into your SMSF.)
For example, if you own your $1 million home outright and you have some income to service a loan, banks will usually consider lending up to 80% of the value of the property as a line-of-credit loan.
This money could, potentially, be lent to your SMSF for geared investments. (It could also be used by yourself to invest in non-super geared investments, but then you wouldn’ t have the tax advantages available to super funds.)
This will also give you access to home loan interest rates, which are usually going to be considerably lower than those offered commercially for SMSFs.
It will also give you more flexibility on the length of time the loan is in existence for. So long as your loan document allows it, your super fund can pay out the loan at the time of its choosing. It can also determine the amount of money that is lent.
It’s a path being turned to by more and more trustees, partly out of frustration at getting nowhere with the major banks, or being unhappy with the eventual terms that have been offered by them.
It’s not just a simple case, however, of sending a sum of money across to your SMSF bank account as a loan, then buying a property.
You still need to follow the new rules, as they relate to borrowing for SMSFs. And those rules include that the the asset be held in a bare trust (aka custodian trust or debt instalment trust), that there be proper loan documentation and that your SMSF trust is allowed to invest in geared assets – this is often a good time to update your trust deed.
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Do’s
- Make sure you trust deed allows you SMSF to borrow. If it doesn’t, update your deed to one that does allow gearing.
- Make sure you purchase the property inside a special purpose bare trust (also know as a debt instalment trust or a custodial trust)
- Have a properly documented loan agreement in place between the lender (you) and the SMSF.
- Ensure the loan is limited recourse.
- Make sure it is a new asset, if you’re purchasing residential property. Residential cannot be purchased from an existing related party.
Don’ts
- Don’t just transfer some money into your super fund and call it a “loan”. The loans need to be properly documented and the asset needs to be held on trust for the super fund.
- Don’t charge an interest rate that is too low or too high, as they will be seen as either gaining a benefit from your super fund before retirement or trying to put extra money into super.
- Don’t invest outside of your SMSF’s “investment strategy”. Take the opportunity to update your investment strategy to allow for geared investments.
- Don’t leave too little money in the fund. You will need to cover interest repayments, the other expenses of the fund (accounting, audit, insurance, etc).
- Don’t become a one-asset fund that holds a single property and no other investments. Super funds still need diversification.
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Make sure the interest rate you charge your super fund is realistic. Passing on the interest rate exactly as you are being charged by the bank that you are lending it from might would seem reasonable.
I’ve heard it argued that a small premium might also make sense, due to the higher risk (that is, if your bank is charging you 6.5% for the money, then you charge your super fund a premium, say 7%, because of the higher risk that is inherent in limited recourse lending).
But this is a grey area. The important point is that you shouldn’t charge a considerably higher, or lower, interest rate. If you charge your super fund a very high interest rate, then it could be charged that you are breaching the sole purpose test by trying to gain benefits for yourself prior to reaching a condition of release.
Charge yourself too little interest and they could be seen as defacto contributions, which could be a big problem if you’re already at your concessional and non-concessional limits, or it causes you to breach them.
Also don’t forget that your loan to the super fund is limited recourse. If the property investment turns bad, or needs to be sold at a bad time, then you, as the lender, can only seek redress over the actual asset that was lent for.
If a $400,000 property was bought with a $300,000 loan, but the property is later sold for only $200,000, then the lender (you) will only be able to get back a maximum of $200,000 on your $300,000 loan. Or so the theory goes.
More so than almost any other area, if you’re looking to go down the path of geared property in super, particularly with the industry in its infancy, seek professional advice from a financial adviser or SMSF law specialist, or both.
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We got an official update yesterday on Jeremy Cooper’s upcoming report in regards to the already reported “MySuper” plans. This plan would see all platforms and super managers being forced to offer a cut-down, no-advice, no-commission offer within what they currently do.
The recommendation springs from Cooper’s understanding that far too many people are disinterested or disengaged from their super. The point of the “MySuper” option within any fund would be that it would be cheap as chips. The MySuper option would also be likely to have the ability to be charged a fee-for-service, with no ongoing trail or percentage-based fees.
It might well save thousands of people from losing more in fees that they should. However, it still has the potential to legislate for indifference – far too much of which already exists within current options. More detail, please.
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Two short notes this week. First, thanks to those Eureka Report readers who joined us for the first Eureka Report superannuation webinars yesterday. We will be running a webinar on investing in property through your SMSF in May. Keep a lookout for the date. Second, this is my last column before I take a short break. My column will return on March 12.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.