SUMMARY: Is the end nigh for SMSF property gearing strategies?
If you’ve been considering making a geared property investment inside a SMSF for a while, I don’t know that I would be dithering for much longer.
It’s beginning to feel like the vice handle is being turned and squeezing SMSFs. The end could be in sight for this geared property investment opportunities for SMSFs. It wouldn’t be the first time a government has closed down an opportunity like this in super.
The mainstream media is increasingly running “element of concern” stories, citing senior industry participants’ fear that super is not the right place for gearing.
And there is an increasing incidence of anecdotes of Australians blowing up large sums of their superannuation savings – sometimes all – via geared superannuation property investments.
Weighty industry figures are chipping in. In recent weeks, this has included both Jeremy Cooper and David Murray, following his Financial System Inquiry.
Cooper, the chair of the former Labor Government’s Super System Review, now wants gearing in super terminated, though he admits it could be difficult to stop.
In his SSR report in 2010, Cooper recommended that the Federal Government run a review into super gearing two years after his report was tabled (as I outlined in this column, 22/12/10), which never happened (read here 12/12/2012).
He wasn’t a fan of it then, but his opinion seems to have hardened since. There’s enough leverage in the broader economy, he believes, without it being a part of superannuation.
Murray’s FSI interim report, tabled last month also has its cannons pointed at the super gearing. It quotes statistics showing exponential growth in the number of SMSFs entering geared property deals.
It’s jumped from 1.1% of funds to 3.7% of funds between 2008 and 2012. Data beyond that isn’t as reliable, but the FSI quotes an Investment Trends report that states that the number of SMSFs that are geared topped 38,000 by April this year. With the number of SMSFs at around 528,000 in March, that suggests that 7.2% are now gearing, which is rapid expansion.
In summing up, the FSI said that was seeking further views on the costs, benefits and trade-offs of “(restoring) the general prohibition on direct leverage of superannuation funds on a prospective basis”.
“The general prohibition on borrowing in superannuation was introduced for sound reasons. Although levels of direct leverage in the superannuation sector are low, they are increasing. Removing direct leverage in superannuation is consistent with the concept that superannuation tax concessions should apply to funds that have been saved and not borrowed. There are ample opportunities — and tax benefits — for individuals to borrow outside superannuation,” the report said.
Prior to September 2007, the opportunties to gear inside super were very limited. Essentially, you invest in the likes of self-funding instalment warrants, internally geared managed funds and partly paid shares (such as the three Telstra floats).
The rules changed in September 2007, just six weeks before the market topped out on November 1. Thankfully, the lifting of the borrowing prohibition caught the industry by surprise and there were very few products ready to go for the slide that great crash that followed.
After consideration, the rules were changed again in 2010, which was more of a clean up by the ATO. It was these changes that gave us “limited recourse borrowing arrangements” (LRBAs). And it wasn’t until after this time that lenders were really ready to re-enter this space.
Also, in the last two years, banks have developed processes and risk management strategies that have allowed for a considerable reduction in the premiums charged for making loans into the LRBA space.
Where the premium for a SMSF loan used to be more than 2%, banks are now doing them for rates similar to the standard variable loan rates, from which the discounts are then offered to clients.
The industry is a long way from being mature. But it is, at least, beyond its difficult birth and childhood.
The big risk threatening geared property in SMSFs as an investment, in my opinion, are rogue elements in the property sector.
Too many of the horror stories seem to lead back to property developers.
They are the ones offering huge commissions/kickbacks/payments (call it what you will) to financial advisers, accountants and salesmen to get their brand new properties off their hands.
The ones who are getting screwed are, predominantly, trustees who are relatively new to the SMSF game. Or, specifically, getting into geared property is the sole reason for starting a SMSF.
I’d bet a significant proportion of those doing their dough with a SMSF property have never owned property outside of their super fund.
As a result, they don’t necessarily understand the risks of geared property investment. And they literally don’t know what elements combined make a successful property investment (the most important of which is land scarcity).
As I’ve written before, ASIC is onto this. But there is a limit to what they can do, given that shutting down property developers, or banning sales of anything high-rise, or out-of-town, to SMSFs isn’t feasible and would penalise legitimate players.
The announcement by SPAA a few weeks ago (covered in this column on 6/8/14) is a small step in the right direction.
The problem will remain. Authorities can dress it up as a general “fear of gearing issue”. But if there weren’t any stories of people losing money, the case for fear would be difficult to push.
I’m getting the impression that the growth continues and stories of losses in SMSFs broaden, the opportunity will be removed for everybody for good.
If you think you know what you’re doing when it comes to property in a SMSF – if you’re not sure, see this column here (2/6/14) – then you might want to consider your options before you don’t have one.
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.