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.