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SMSF property spruikers on borrowed time

Most of the one million SMSF members have not read their 70 page trust deed, but every deed says something like: The Trustees must ensure that each investment strategy is appropriate at all times for Members of the Fund. The thousands of people attending property seminars aimed directly at SMSFs have additional risks to consider that are rarely, if ever, mentioned during the presentations. ASIC is watching how the industry’s gatekeepers behave.

For example, is it appropriate to use high leverage to invest in a single, illiquid asset worth many times more than the SMSF itself? Or in pension phase, how will minimum pension payments be met if the property is untenanted? And where will the money come from for major repairs if all the funds are in the property?

It was welcome that Peter Kell, ASIC Commissioner in charge of the SMSF taskforce, recently spoke at the CPA Conference, and attempted to clarify the requirements for property purchased through an SMSF. To quote him:

“In the past you may have seen ASIC comment that we do not regulate direct property investment. This is the case except where the investment is made through an SMSF. Let me be very clear – a person requires an AFS licence if they recommend that an existing or proposed member of an SMSF purchase a property through their SMSF. This is because the vehicle through which the underlying investment is made is an SMSF and an interest in an SMSF is a financial product.”

Then he issued this request (my underlining): “Where you see examples of unlicensed SMSF advice, please let us know.”

So we should give Peter and ASIC our stories.

Attending an SMSF property seminar

There are many property companies and real estate agents running seminars targeting SMSFs. The property agents issue emails to people who have visited one of their displays or responded to an advertisement. To quote from an email from one of the largest real estate companies in Australia:

Worried you won't have enough when you retire? Find out how you can utilise your existing superannuation to buy your next investment property. The presentation will provide insight into SMSFs and how they can help you create a brighter future for you and your family. According to the ATO’s most recent SMSF bulletin, 3,000 SMSFs are being established every month, that’s 100 daily and around 4 every hour!”

The seminar is held in the offices of the real estate company, and each session is packed. On the night I attend, extra lounge chairs are brought into the room, and it is standing room only at the back (near the bar). The clients are of all ages, including some surprisingly young couples. The real estate agent welcomes the crowd, says he will talk about some specific properties later, and then introduces the main speaker. We are told it’s an amazing presentation that will blow us all away.

The main speaker is from an SMSF administrator. He’s got quite a patter. First he tells us, “Those in the front row may need an umbrella. I tend to spit a lot”. I look at the real estate man to see if he is cringing in embarrassment, but he thinks it’s very funny. Then we’re told some surprising statistics. We don’t need much super to buy a $1 million property. 72% of SMSFs plan to buy property at some stage, and 92% of them plan to borrow. 86% of people prefer property to equities. In the near future, $500 billion will move into property from SMSFs, and one-third of all property will be bought by an SMSF. He tells us he has a telescope that can see into 2020, when we will be printing human organs to put into the body. And this telescope tells him there will be $3 trillion in super and the market capitalisation of the ASX will be only $2 trillion. The balance must find a home. In fact, the government introduced borrowing in super to encourage purchases of property. So this is going to be an LRBA night. That’s Limited Resource Borrowing Arrangement, because that’s how SMSFs buy property.

We are told there is a financial planner at the back of the room who any of us can talk to later.

The presentation makes the following points:

1. Using property, you can take control, diversify and stop managed funds and market fluctuations affecting your families (sic) financial future.

In fact, it couldn’t be less diversified. Residential property is one single, illiquid investment. How is it diversified? Because the rent covers the interest expense on the loan, leaving money for other assets. Oh, that’s fine then.

2. There’s an ability to use leverage in super that cannot be accessed through ‘normal’ superannuation.

What is this, ‘abnormal superannuation’? It is possible to leverage into other assets in super, although maybe not to the extent possible in property.

3. Use your limited super as a deposit.

The transaction example uses $140,000 of superannuation (“maybe take it out of an industry fund”) to buy a property for $500,000. Then when you sell it for $1 million ten years later when you are ‘only’ 55, you will be in pension phase where there is no capital gains tax. No mention that it might not suit you to enter a ‘transition to retirement’ pension for other reasons, or that for many in the room, the pension age is 60 and not 55.

It gets even better. If you don’t have enough money in super but you have equity in your house, you can borrow against your house and lend the money to your SMSF under an LRBA.

4. You can reduce the purchase price of the investment property by 40% using concessionally-taxed superannuation compared to after-tax salary for loan repayment.

The ‘reduced purchase price’ comes from the tax-effectiveness of superannuation, not property. Every investment is 40% lower on this basis, plus the fact that there is a $25,000 a year limit on concession contributions. That’s not much for a property deposit.

5. If you don’t have enough money for a deposit, four people can pool their money to fast track to wealth, allowing increased exposure to property assets.

So now someone with a really small amount in super, plus three of their friends, can leverage into property.

And on it goes. The numbers are wonderful. The money that buys the property does not incur any income tax, and there’s no capital gain on sale. Only an SMSF allows you to avoid tax like this, it is ‘below the tax line’. You would be ridiculous to buy property outside an SMSF, because for your $140,000 deposit, you need to earn $261,682. It’s so much cheaper in the SMSF. You save $514,429 over the life of the property investment.

The structure can be put together for a fee of $7,995 for the complete package of legal work setting up the SMSF, establishing the trust deed plus independent legal financial (sic) advice. When you check their website, where they promote their services to real estate agents, you see the ‘wholesale price’ is $5,000. The rest is the agent’s commission. In fact, allowing for referral fees and insurance premiums, an agent can earn $5,700 on an average SMSF package attached to a property.

It’s been quite a spiel, and the property agent is welcomed back to the microphone to offer a “grab bag of gold nuggets”. These are various property developments around Sydney. And at the end, the financial adviser offers his services to anyone who wants to talk about SMSF strategies.

What does the licencing process seek to achieve?

Is that what the licencing process intends, that as long as there is a licenced adviser in the room, everything is fine? To quote again from Peter Kell: a person requires an AFS licence if they recommend that an existing or proposed member of an SMSF purchase a property through their SMSF.” At what stage is the licence required and when does the financial advice begin?

It’s an irresistible combination for a marketing person based on four massive numbers: $4 trillion in residential housing, $1.5 trillion in superannuation, $500 billion in SMSFs and one million trustees, many of whom are far more comfortable with bricks and mortar than they are with shares and bonds. Throw in an ability to borrow in the SMSF and an industry that has never taken a backward step in seizing an opportunity, and residential property in self-managed super has become part of every real estate agent’s kit bag.

This regulatory environment is confusing many participants. The Mortgage and Finance Association of Australia (MFAA) recently launched a training programme to improve the skills of their brokers when dealing with SMSFs. The Property Investment Professionals of Australia (PIPA) recently said accountants, financial planners and mortgage brokers were tentative about who could legally lead SMSF trustees through the property investment process.

High-profile financial adviser and author, Noel Whittaker, is currently collecting stories about victims of property spruikers. He reports in his latest newsletter that just one firm of property marketers was making 22,000 cold calls a week. He has many stories of people losing money from property investments, and although not specifically targeted at SMSFs, no doubt this product is part of the spruiking.

When borrowing was allowed by SMSFs in 2007, did the regulators expect an industry to develop that encouraged leverage of four times the value of a superannuation balance? Superannuation has tax advantages to encourage people to save for the years when they cannot earn an income. Let's hope Australia does not have a property price fall anywhere near the size of countries like the United States and Ireland, or a lot of retail superannuation money will be lost.

At least the SMSF trust deed also has provisions to cover member insanity.

 

 

6 Comments
EricP56
December 13, 2013

Thanks Graham,
We geared and bought property with our SMSF but this only represents about 70% of our overall superannuation. We understand our need to diversify and not chuck all our eggs into one basket (property.... because we wanted to buy 2). We are now allocated about 70% property 20% shares with a 10% cash buffer.
It was important for us to work with a firm that holds an AFSL license with ASIC and could give written advice. We went to a few seminars prior but quickly realised we were just dealing with 'glorified real estate agents' talking about superannuation and retirement.
I think ASIC and the ATO should restrict ALL property investment implementation to companies that are directly licensed with them... as real estate agents (most spruikers) are not licensed under ASIC to give investment advice. AND YET THEY DO.
Read the headlines and calls to action from the top 'SMSF Property' search in Google and they 'advise you to buy property with your SMSF'... THIS IS ILLEGAL, why is ASIC not doing anything..?

To even suggest to someone that SMSF is right for them, let alone recommend direct property investment is 2 pieces of advice.
1. an SMSF may not suit them
2. property may not be the best investment for them
Yet this is plastered all through 'SMSF' searches in Google: Buy Property with an SMSF NOW!!!

The most alarming thing that my wife and I noticed last week is a lot of spruikers are now offering FREE SMSF set up (**If you buy a property from them).

We lost a lot of money outside of super from an IP 'negative-gearing-is-like-magic' spruiker. We made sure we got licensed advice before we proceeded inside of super.

Chris
April 29, 2013

A great article Graham. I recently attended a similar seminar. Many of the statements you refer to in your article were also made at this seminar. The clear intent of the seminar was to encourage people to purchase property via an SMSF without any discussion or information whether an SMSF may or many not be appropriate for an individual.

On Andrew Bloore's comment, I believe he misses the point. Yes, a Bank will conduct a series of checks to ensure that trust documents are all in order, however, they will not provide advice to a client on the appropriateness of an SMSF for that individual.

Alun Stevens
April 22, 2013

Wayne, Thanks for your very sensible comments. As you say 5% of a big number is a big number. In this case ~$25bn. There is also no doubt that the current invested base is not indicative of the interest for new money. The hard stats are not yet out, but anecdotal information suggests that the percentage of geared property for new SMSFs is higher and that this is being driven by the amount of promotion taking place.

I suspect that this is in part a reason for ASIC's interest.

The other issue is the exposure to property may be higher because it is not clear, to me at least, that the gross asset value is known because it may well be the net asset value (ie property value minus loan outstanding) that is being reported.

We have to be a little careful when generalising because the SMSF portfolio may in fact be only part of the investor's overall asset pool and may well hold all that person's property investments because it is tax advantageous. Nonetheless, it is difficult to justify single asset exposures of say $500,000 for an account that will not reach this total value for many years. It is extremely risky.

The promoters appear to be pushing the tax advantaged status of geared property investments via SMSFs with little regard to the overriding superannuation requirements or prudent risk management. It all appears to be about how much tax can be saved - ie an appeal to greed.

It also appears that a number of the promoters of these arrangements are not licensed and probably have no interest in retirement planning at all. It is about selling a property, getting a commish and moving on. The comment that Graham reported in the article that the investor could get their money out of an industry fund and jump into this is an example of quite dangerous advice (that is probably quite common because it has in fact been noticed by the industry funds that are on the other end of this). It would be a quite inappropriate comment for a licensed adviser to make as a generality and is essentially illegal for someone without a license. But it happened.

Wayne Slager
April 22, 2013

Great comments all round gents. However, the percentage of smsf's actually investing in residential property would appear to be very low but our collective experience is that 'property in smsf' is being promoted relentlessly and that seminars are packed with punters ready to listen to a plethora of spruikers. Is it just a beat up with all the marketing failing to convince trustees to buy?

I'm concentrating on the residential component as this is where spruikers are most active and there's also a general sense that much of the commercial property has either been purchased from a related party (so no new acquisition) or commercial property buyers are usually more astute and have greater investment and business acumen.

Either way, 5% of a huge number is still a large number. However, we're not talking about a small risk to all funds but a potentially large risk to many, many individual funds. Let's remember that we're talking about people and, for most, their life's savings. It's very, very personal. Therefore, maybe the percentages mean less than the principle.

So, do we wait until it becomes a larger problem before professional bodies take action and more dealer groups, practices and individual advisers take a public position?

In respect of smsf, what we understand the correct process to be is for accountants and planners to firstly determine whether smsf is, in fact, an appropriate strategy and structure for the client and ONLY THEN decide what assets should be involved.

Sadly, what we're seeing all too often is the opposite with smsf simply being used a populist, flavour of the month vehicle for spruikers, in cahoots with their unscrupulous associates (inc. some planners, mortgage brokers, etc), to flog their pots and pans.

Alun Stevens
April 22, 2013

Good article Graham. I suspect that your experiences at the seminar you attended are not particularly different from what is occurring at all the other seminars and this is the worry.

I agree that there is some confusion as to who can advise an SMSF trustee about investing in a particular property via an SMSF, but I don't think it is a significant confusion. Any advice to establish an SMSF, that it is the appropriate vehicle for a specific person, how it works and its pros and cons is obviously and quite specifically financial product advice requiring a license or authorisation under a license or an exemption via Corporations Regulations 7.1.29A (ie the accountants' exemption). Even if this advice is not specific to a particular person, it is general product advice and similarly requires licensing or authorisation.

Any advice to switch money into the SMSF from (say) an industry or corporate fund is personal financial product advice and requires a license or authorisation. The person giving the advice must also satisfy the specific requirements for dealing with superannuation switching as in RG84.

The selection of a specific property is the bit that is a little vague because the property is not a financial product nor is the mortgage and advice about them does not require a license or authorisation under one, but there are various state regulations about who is allowed to essentially 'deal' (in the AFSL sense) in property. The advice about the appropriate size of property, gearing levels, financing arrangements, risks, remedies etc are all in respect of an interest in an SMSF and financial product advice requiring a license or authorisation. If the assessment of the appropriateness of the property or the presentation of it to the client deals with tax, the person must also be authorised to give tax advice or have an exemption from the provisions. (As you would be aware, financial advisers will be losing their limited exemption for tax advice.)

The presentation you received would seem to satisfy the definition of general financial product advice (and there may well have been some personal advice as well on the sidelines). This means that the person presenting it would need to be licensed or authorised. It isn't good enough to have a licensed person in the room. ( I have personal experience of this in relation to providing seminars to people interested in trading shares or options. All the presenters were required to be authorised to provide general advice on securities and derivatives.) The presenter should also have disclosed his licensed/authorised status, the name of the licensee if he was only authorised, that he was providing general advice, that it might not suit everyone and that they should seek personal advice before proceeding.

The statistics presented are also rather misleading regarding the propensity of the SMSF market to invest in property and to borrow. The percentages given are much too high and probably given to convince attendees that gearing residential property is what everyone is doing so they can feel secure that they are not contemplating anything unusual. The statistics in the ASIC report (some their own and some from Investment Trends) show a much, much lower number - 14% to 18% if my memory serves me right. The ATO statistics on investment holdings also give the lie to these outrageously high numbers. Only 15% of assets by value are direct property and some two-thirds of that is business real property - ie residential property represents only some 5%.

Andrew Bloore
April 19, 2013

One thing that is often not explained is that the fund still needs to get a loan. Lenders to SMSF structures are more stringent that outside the fund. The loans must stack up in their own right. The fund must have the capacity to pay and very often the LVR rations are significantly less than can be gained externally to the fund. So the banks play a very big part in ensuring things are right. The structure and deeds are checked to allow the fund to lend by the banks lawyers the interest cover and normal credit is checked and importantly these loans are recourse only to the asset acquired. Independant valuations must be sort to satisfy the bank from a panel of valuers that the bank approves.

Like all these things clients if they are borrowing money add risk to the investment because of the debt, however, if done correctly the gains that are made, and we assume that the assets are purchased with the intent to make a gain, is kept in the fund for retirement purposes, unlike if the asset was acquired outside the fund.

Clearly sprukers are of concern but someone has to approve the loan as well. Caution yes but a balanced view is needed.

 

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