(03) 9020 2905PORTFOLIO POINT: My geared property rule for SMSFs trustees – if you’re not doing it outside super, don’t do it inside your SMSF.
With stock markets swan diving back into the pool of schizophrenia in recent weeks, expect the sales pitch volume for other asset classes to be turned up.
The “safety of cash”, the “low volatility of bonds” will be catch cries that you’re sure to see, if you haven’t already, from manufacturers and providers.
The psychological damage of the 20% fall in Australian equities in recent months will be considerable. And many will have had their fingers burnt and be wary of returning.
And when it comes to a sales pitch, we mustn’t forget the “fourth” asset class of property.
Property tends to be, by its nature, more volatile than fixed interest, but less volatile than shares. That said, the bigger and harder fall of real estate investment trusts (REITs) over equities during the 2007-2009 crash can be difficult to reconcile with that claim.
No matter which way you look at it, direct residential property is a favourite of Australian investors. Sure, it has its down times. But as far as crashes go, they aren’t as frequent or as quick. And they seem a little easier to predict.
The residential property “crash” of the late 80s and early 90s was, in comparison to stock market falls, pretty tame. The two biggest markets of Sydney and Melbourne fell about 20% and 10% respectively. It took years to recover, but you’d have to go back decades to get a comparable property price crash to what’s happened in equities in recent years.
(You can, of course, find great examples overseas, including Japan since the mid-80s and Northern America even now.)
My bias
As the author of two books on property investment (The Power of Property, 2006 and Investing in Real Estate For Dummies, 2008), I’m a paid-up, card-carrying fan of property investment. And I think gearing is an important, if not almost essential, part of the property investment process.
And like any property proponent, there are types/styles of property I would and wouldn’t recommend. Two of those golden rules are that I would never recommend high-density housing anywhere (because the land value is usually tiny) and I wouldn’t buy property investments outside of major metropolitan capitals.
I’m also wary of nicely wrapped “property solutions”. It’s not that they can’t work. I just come at them from a position of high scepticism – it sounds too easy because someone is probably making a meal of you. And it won’t be MasterChef. However, usually, it’s because they’re breaking my rules of the previous paragraph.
The great super gearing rule changes
Since September 2007, purchasing geared property in your super fund has become, firstly, possible, and secondly, a lot more appealing.
SMSFs have always been able to buy residential property (with certain restrictions, such as not buying from related parties), but the 2007 changes, which were refined in 2010, meant that geared property was now a reality for SMSFs.
Then the GFC struck. It meant virtually no-one was interested in geared anything inside super. Of equal importance, there were few product providers that were prepared to lend money into the sector. Many who started in the sector vanished in the credit crisis of 2008 when funding sources dried up.
The lending rules are different
Gearing strategies inside super for directly held assets are complex. You are required to have a standalone trust (variously referred to as a “bare trust” or a “debt instalment trust”) that holds the asset on behalf of the SMSF until the final instalment (that is, the loan) is repaid.
As I wrote in a column last September (click here, 29/9/10), you can be your own lender through either cash or equity against another property. And property gearing strategies could potentially see your super fund pay no tax (for that column, click here 20/10/10).
The offers on the table
Any brief search of the internet will show you that the offers to help with property gearing inside SMSFs are flourishing.
Increasingly, product manufacturers are now providing gift-wrapped opportunities for people to have geared property inside their super fund. And it’s from that today’s warning is issued.
SMSF property gearing is not like buying a regular investment property. There are similarities, but the rules are very, very different. You can’t just walk into a bank and get a loan based on your own income and balance sheet and then take your SMSF trust deed off to buy a property.
The way the asset has to be held through specific purpose trusts, which are not cheap to set up. And there are dozens of traps for the uninitiated just in the SMSF side of the equation.
And the consequences of getting it wrong could be, arguably, even more disastrous than getting it wrong outside of super.
If you don’t do it outside super, don’t do it inside
Directly held residential property investment is a complex enough strategy. It’s not like owning shares, where the management is taken on by someone else. With shares, your decision, outside of research, is largely when to buy or sell.
You are the manager when it comes to property management. You might hire someone to do the tenant vetting and rent collection for you, but you are still in charge of the investment itself, including the hiring and firing of those managers.
It takes a few years for newcomers to get used to property investment. I’d argue it takes at least five years before you are comfortable with the ups and downs of property management, cash flow issues, interest rates, costs and the tax implications, to name only the major areas.
For those comfortable with regular, personal-name property gearing, the allure of recreating geared property returns inside super has to be appealing. But I think that property investing inside a SMSF, particularly where gearing is involved, should start with a solid understanding of property investment outside of super.
There is likely to be a considerable push of SMSF property solutions in the coming months.
Any fears or concerns over your recent bath in the stockmarket should not be replaced with blind faith in a “SMSF geared property solution” plonked in front of you.
One of the reasons you are reading this column is partly because you enjoy making investment decisions yourselves.
If you do not currently have a solid understanding of property investment outside of super, don’t succumb to sales pitches about how great SMSF geared property can be. One steep learning curve is enough. Don’t try to climb two Everests at once.
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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 advised to consult your financial adviser.
Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.