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Banks throw wrench in SMSF property plans

Anthony Fensom  |  22 Nov 2018Text size  Decrease  Increase  |  
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Leveraged borrowing by SMSFs for the purchase of property has become more expensive as the big four banks have withdrawn support for the practise, suggesting its end may be nigh.

In October, the nation’s biggest mortgage lender, the Commonwealth Bank (ASX: CBA) cancelled its SMSF lending product, SuperGear, citing the need to “become a simpler, better bank”.

This marked the end of the big four’s involvement in the sector, following July’s exit by Westpac, which said it aimed to “simplify and streamline” its product range. At this point, none of Australia's biggest banks are involved in SMSF lending.

AMP, Australia’s largest financial conglomerate, also ended such lending in October. Its chairman, David Murray, is viewed as one of the leading critics of SMSF property lending.

Under limited recourse borrowing arrangements, SMSFs are permitted to borrow or gear super funds into property and other assets, albeit with strict conditions. These include restricting such borrowing to enable the purchase of a single asset, or a collection of identical assets with the same market value, and such funds cannot be allowed to improve the acquired asset.


Each of Australia's major banks have halted support for geared SMSF lending

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SMSF borrowing to fund property investments via LRBAs swelled from $2.5 billion in 2012 to more than $25 billion in 2017, with an estimated one in 10 SMSF trustees accessing LRBAs.

Nevertheless, the SMSF sector points to its property investments only accounting for an estimated 6.9 per cent of total SMSF assets of around $700 billion.

Regulatory pressure

The Financial System Inquiry in 2014 recommended the government prohibit LRBAs, citing the need to “prevent the unnecessary build-up of risk” and ensure super remains a vehicle for retirement income “rather than a broader wealth management vehicle”.

The recommendation was rejected by the then Turnbull government. While noting anecdotal concerns, the Federal Government said it “does not consider the data sufficient to justify significant policy intervention”.

However, recent inquiries have put the pressure back onto LRBAs.

ASIC’s June 2018 report on SMSFs flagged concerns over “gearing through an SMSF to invest in property, which is being actively promoted by ‘property one-stop shops’…Our results suggest that, in many cases, this is likely to result in financial detriment to SMSF members”.

The Productivity Commission’s April 2018 draft report found that the relatively small number of SMSFs involved with LRBAs means “such borrowing is at present unlikely to pose a material systemic risk" – although it called for active monitoring of the sector.

Yet the recent Hayne royal commission has raised cases of inappropriate advice being provided concerning the establishment of SMSFs to purchase property. This included a case involving a “celebrity” financial adviser and the Fair Work Commissioner.

With the property market cooling in Sydney and Melbourne and growing concerns of a potential US recession as early as 2020, SMSFs that are heavily geared into a single property face the risk of both capital and income loss. Annual caps that restrict fund contributions could force a fire sale of distressed properties, critics warn.

While LRBAs remain valid for now, the opposition Labor Party has vowed to abolish such borrowings.

“A Shorten Labor Government will take the responsible decision and adopt the recommendation of the Financial System Inquiry to restore the prohibition on direct borrowing by superannuation funds on a prospective basis,” it said.

“This measure will prevent the unnecessary build-up of risk in Australia’s superannuation system, reduce future calls on the aged pension as a result of a less diversified superannuation system and make the financial system more resilient in the face of potential economic shocks”.

‘Valid strategy’

Yet some SMSF advisers suggest borrowing is still a legitimate strategy for trustees, providing the risks are managed.

"Use of borrowing in an SMSF is still a valid strategy for those with plenty of time to retirement, but who need to enhance the growth of their fund. Many professional immigrants, women with broken careers, self-employed with previously low contributions use this strategy, knowing it involves risk,” says Verante Financial Planning director, Liam Shorte.

"With large mortgages outside of super taking up too much of their salaries, many only have their super to build wealth and are willing to take a long-term leveraged investment to save for retirement. There is never a guarantee, but holding a good, well-researched property for 15 to 20 years is likely to provide decent returns as part of a diversified strategy."

Other benefits include the ability to pool super account balances with other family members to buy larger assets, tax concessions and the ability for business owners to buy a commercial or industrial property to lease back to the company.

However, downsides include a potential lack of diversification, higher set-up costs and rules including the need for any investment to be acquired on an “arms-length basis.”

SMSF borrowers can also expect to pay higher interest rates than other borrowers and face loan-to-value ratios requirements of 70 per cent or higher, with a diminishing number of lenders.

As the regulator ASIC warns: "Getting into a scheme is relatively easy compared to getting out. It is important to plan an exit strategy to minimise the costs and risks".

While leveraging remains an option, the clock appears to be ticking on a strategy that previously benefitted from rising property prices. SMSF borrowers have reason to be cautious, with the likelihood of further regulatory changes and potentially the end of LRBAs in 2019.

is a Morningstar contributor.

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