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SMSF borrowing and residential property

I made a personal submission to the Financial System Inquiry, based on several articles written for Cuffelinks, on the subject linked here: Should SMSFs be allowed to borrow?

My conclusion was:

"Leverage increases risk, and when this is widespread across an asset class, financial crises can be exaggerated by forced sellers. The best example is margin lending, where banks have the right to force investors to sell assets to maintain margin ratios. In troubled times, assets look for buyers but everybody is trying to preserve liquidity.

Given so much leverage in our system outside of superannuation, do we need to add more potential risk and volatility into the system generally, and superannuation in particular? Our retirement savings are supposed to reduce the future drain on pension payments, and an investor who loses money from a poor leveraged investment may become a long-term drain on public resources.

Property differs from shares as it is usually a single indivisible asset, which cannot readily be sold brick by brick. The sole purpose of superannuation, and the reason it is given favourable tax treatment, is to fund a retirement, and to do this, it must generate income. Leveraged investments usually carry an interest cost, and unless the revenue exceeds this cost, there is a net cash outflow. What happens when interest rates rise, or the property has a long vacancy period, or a major repair is required? What if the SMSF trustee loses their job and is not making other contributions to super? The SMSF trustee may be forced to sell the apartment at the worst time in the property cycle.

This paper has demonstrated:

  • the dramatic downside of leveraged returns in a falling market
  • the low net yields generated by many residential properties when all costs are considered
  • the spruiking techniques some agents use to target SMSFs
  • the role that superannuation plays in funding a retirement.

Many highly leveraged SMSFs would lose all their own equity if there is a decent residential property price correction. Anyone who doubts the potential problems should attend a property seminar aimed at SMSFs and listen to the techniques used."

And as if to emphasise the point that SMSFs will be targeted for property, this leaflet arrived unrequested in a direct mail drop to everyone in my suburb on 'How to retire a millionaire without breaking a sweat' (sic - it should be 'breaking into a sweat'). Thank goodness the Reserve Bank Governor, Glenn Stevens, issued a warning this week that house prices can fall as well as rise.

SMSF property brochure

SMSF property brochure


Martin Mulcare
September 14, 2014

There is no doubt that too many inappropriate people are taking inappropriate advice to establish sub-optimal SMSFs. There is also no doubt that it will end in tears for many people. When ex-rugby league players are promoting SMSFs on Sydney radio we should all be alarmed!

Ian Kredulis
September 15, 2014

Agreed Martin. There are two forces at play here. On the 'provider' side, there is too much easy revenue available to not flog LRBA property via SMSFs. It really is money for jam. There are a whole range of entities with snouts firmly placed in the LRBA-via-SMSF trough.

On the demand side, there is only one word needed to convert a fence-sitter into a hot prospect: "Tax". Most Australians might not understand complex investment-speak but they get tax; "the less I pay the better off I am". And that's all LRBA property spruikers need to keep the sales pipeline full.

Ian Kredulis
September 12, 2014

How have LRBA assets within SMSFs hit $8.7bn (ATO estimate as at 30 June 2014)? Here's my experience. A few weeks ago I took a call not long after getting home from work. The voice (a mature sounding gentleman) barely allowed me to say 'Hello' before launching into a question: how would I like to pay up much less tax?

Hmm. Having a pretty good idea where this was going I played along. Did this have anything to do with property investing? Possibly said the cold caller. SMSFs? Maybe. He seemed very keen to establish my age & income, and that of my wife (pre-qualifying perhaps?). After some basic chat about how much tax we pay (way too much according to the caller) he asked for contact details & informed that a colleague would call soon to arrange a free 'consultation' to discuss wealth opportunities.

In short order I took a call from a female who identified herself as representing a "diversified" financial services entity committed to helping hard-working Australian families like ours get ahead. The vehicle of choice for their wealth strategy? Residential property. Held within a SMSF. Did we have one? Did we know of the myriad of tax advantages available by using an SMSF?

The caller's remit was clearly to dangle enough shiny baubles in front of me to get an appointment with a 'Consultant'. Was this Consultant a Financial Planner I asked. No, but he could assist with "coordinating" all aspects of the plan (which I assumed meant setting up an SMSF & arranging the LRBA facility).

I set up an appointment for a week hence, put the phone down and within 10 minutes on Google had established this cold calling company as being a mortgage broker. It was a corporate credit representative of another entity holding an Australian Credit License. Not licensed to provide financial product advice under an AFSL its website nonetheless suggested that it could facilitate the provision of various service providers including realty managers, conveyancers, accountants, financial planners and lawyers.

Having done my own due diligence I called back to cancel the appointment. Many others however would have been paid a home visit by their 'Consultant'. Many of these people might now have a brand new SMSF awaiting the purchase of a property under the LRBA rules. For some, the desire to avoid 'paying too much tax' may come at a much higher price.

September 10, 2014

I agree - no debt allowed in SMSF's whatsoever.

There should also be a maximum annual limit on withdrawals so the fund is not used to repay mortgages etc outside super..

Ben Smythe
September 09, 2014

I must admit that I have sat on the fence with this issue for a while - on the pro side, leverage is a legitimate wealth accumulation consideration and on the negative side in the wrong hands it can be a disaster.

The Government's reluctance to restrict the proliferation of overnight "SMSF property" experts has now drawn me to the side of banning SMSF borrowing going forward. While the numbers are still relatively small, it is too concerning watching these property spruikers double as personal superannuation advisers. Their "structures" are set up predominately to advantage themselves, and if the SMSF members make money then that is a bonus.

The damage that will be done/is being down to SMSFs as a legitimate retirement savings vehicle also needs to be taken in to consideration as the whole SMSF industry will be "tarred with the same brush" as more SMSF members lose their savings.

Warren Bird
September 06, 2014

I've said it on another thread, but have to say it again. The issue is not leverage, it's risk management. Every share is a leveraged asset and I can't see how you can rule out the fund borrowing to buy an unleveraged asset if you are prepared to let it invest in something that borrows within its own structure.

The reason most funds shouldn't be 'allowed' to borrow to buy a property is that it typically results in a highly concentrated portfolio - the geared property and little else, most likely. It's that concentration in an illiquid asset that makes it a risky strategy, not the borrowing.

Introduce suitable rules about concentration of risk and the question of borrowing for a property will become academic - and the real issue will be getting addressed.

September 05, 2014

I know of no other major country in the world other than Australia that allows retirements to borrow money to invest with the risk that retirement savings could be wiped out as a result.

It is playing Russian Roulette with one's retirement years by doing so.


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