Proposed SMSF Change Could Cause A Property Price Correction
Just a quick heads up about a potential game changer that, if it happens, will negatively impact the property market – particularly new real estate sold off-the-plan.
Financial System Inquiry
You’re probably a very busy person, so you might not know about the major review of Australia’s financial system (called the Financial System Inquiry), that wrapped up Sunday night.
My plan is to read all 350 pages of their report over my Christmas holidays so I can provide you with a ‘what property investors need to know summary’, but out of the gate one significant recommendation I noticed was Recommendation #8:
“Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.”
This is significant and if it happens, will be a big game changer!
The SMSF Borrowing Boom
Between 2008 and 2014 the value of real properties owned by self managed superannuation funds (SMSFs) is reported to have increased from $40b to over $100b.
That’s a heck of a lot of new money pumped into the property market, and I bet a lot of it found its way into the coffers of developers selling off the plan property.
The economic gain resulting from this construction Renaissance was significant, and helped cushion the effect of the mining boom ending.
However, should the SMSF borrowing tap be turned off, a supply glut could emerge of projects underway but not pre-sold. If the number of buyers dries up, developers could dump their excess stock at cost to preserve their working capital.
The Potential Knock On Effect
A potential knock on effect of that happening is that projects pre-sold may be valued for less at completion, therefore forcing owners to contribute more money to fund the shortfall.
In the worst case scenario, this double whammy is the sort of spark that could cause a significant slip in property prices across the board!
That said, my guess is that there won’t be a drastic windback of the SMSF borrowing rules because there are some well funded lobby groups that will be campaigning against any change.
But, just in case there is, you need to be aware of what’s been recommended so you can reconsider your property portfolio and investment position accordingly.
If you’d like to flesh this concept out in more detail post a question or comment below.
All the best,
– Steve McKnight
P.S. If you want to read the report for yourself you can download it here. Give the report up to two minutes to download as the report is quite large.
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Would this only affect areas where there is a lot of development happening? What about areas where there is a lot less development happening (eg. parts of Sydney).
If demand is there and there are developers in the area trying to dump stock would i have an effect?
In the first instance the effect would be contained to capital cities, but the impact on confidence would be contagious and would spread to all areas.
The ‘missing ingredient’ for a substantial price shift is a sudden reason for many sellers to exit, but at the same time, few buyers to want to purchase.
We saw this in the US from 2008 – 2010, and also in certain areas in Aus when the mining boom ended and workers were retrenched and moved away (e.g. Blackwater, etc.)
– Steve
Good article and message Steve – however, lets be realistic with the continued scare campaign against SMSFs. The amount of questions I am getting from SMSFs members around this proposal is significant with the worry ‘what about my existing loan’ or ‘I bought off the plan, will this impact my settlement’ – they are all valid questions. However, in reality, this is a proposal only and will take many years to be implemented – if implemented at all. After all, the current federal government promised no major changes to Super and this will be another election promise broken – so donot expect this change implemented in the next 2 years under the current government.
A straight out ban is wrong in my opinion and I will continue to lobby against the change- SMSFs are regulated by the ATO and ASIC – lets all get together and regulate unlicensed advice by property spruikers and help ASIC prosecute them and lets the remaining Australians with a SMSF Strategy have the opportunity to borrow to invest – after all the majority of SMSF loans are for commercial, small business people are not stupid — they know what they are doing.
Look forward to hearing other people opinions also.
Cheers Ivan
Hi Ivan,
Thanks for posting your thoughts.
I doubt a total restriction on borrowing would be implemented day one, but perhaps a gradual phase in will be considered.
Remember that the original idea of a SMSF was that it should not borrow at all, and that because of T2 warrants a concession was made, which was then exploited by some clever legal people into the current situation.
My own thoughts on the matter are that SMSFs should not leverage to acquire property at all, although I agree this is an extreme view. I hold it because of what I saw in the US and the impact to retirement incomes when their property market deflated quickly.
Yes, I understand this is a different market and a different dynamic, but it can still happen.
Perhaps a middle ground strategy would be to limit SMSF borrowing to <50%LVR.
– Steve
Would you please explain this in plain English :
“Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.”
Thanks
Cheers
thecrest
I believe this is saying that the general rule is to not allow super funds to borrow for investment purposes. This has been relaxed for self managed super funds, which allowed someone managing their own super via property investment. The proposal is to remove this exception, closing the gap on what you can and can’t do with your super in an SMSF.
What is interesting whether these recommendations go ahead or not, is that Steve is rightly pointing out that market forces driven by policy change can and do have dramatic impact upon the trigger points of any market. i.e. fear and greed.
$100b is a big part of the equation that has driven the Sydney and Melbourne investment property markets sky high and to put a dampener on it by withdrawing the ability to leverage this seemingly unstoppable surge, just might be what is required to find the release valve and bring everyone back to earth.
Once the market turns it affects all markets @ryan via the spillover affect. One does need to keep a keen eye out on game changers like this. Good reporting.
Thanks for your input Greg.
– Steve
Nice summary Steve,
The change won’t instantaneously remove the huge amount of funds already invested, but like you say it will ‘turn off the tap’ and any developments in the pipeline that expected to pitch their product to SMSF may be in trouble.
I don’t believe in a total ban on lending in a SMSF, because standard super contributions will never be enough to support someone through their retirement. Leverage is a great way to build a self-sufficient retirement nest egg, so long as it’s done responsibly. As you mention, ‘responsibly’ may mean 50% LVR.
I guess we’d also expect to see a ‘rush’ of people purchasing in their SMSF prior to the change being implemented (similar to the effects of the First Home Buyers grant)?
Cheers,
Simon
Thanks Simon. Leverage is still possible without borrowing, for instance via the use of certain managed investment products. But at least in that case the amount of the loss is restricted to the sum invested, rather than the deposit + debt.
I appreciate your input.
– Steve
Super is the biggest scam.
Its not enough to provide for the majority who have been led to believe its going to provide for them in retirement.
Leverage is the natural answer so I don’t see leverage being removed but increased.
There will always be law changes and we will keep adapting but unless more money goes in and returns go up there will never be enough.
My biggest worry is that law changes complicate issues thus the majority of people will seek the easy way out and continue to pay someone to care for their money.
Colin,
The only way more money will get into Super, well enough to cover retirement, is for employees to be forced to contribute more.
We need to foster a mindset that it is normal to contribute above the minimum, and the earlier the better.
– Steve
Thank you for the heads up Steve,
Various articles I have read recently on the Financial System Inquiry seems to suggest panic buying in the market will begin to occur in anticipation of the banning. Which is a typical reaction seen in share trading, it this occurs the potential hype created may generate a spike of market activity that will take a few years to slow down. It all depends on how quickly the government adopts these recommendations, if they do at all!! Regardless if the buying frenzy does kick in it will fast track the market overheating. So make sure you keep checking the temperature in the water before you put your toe in!!
This is an excellent point.
There may be a rush to the door to get in before any wind back unfolds, but this will be a near term marketing push that could very easily unwind afterwards should there be a sharp rise in sales (caused by developers dumping stock).
– Steve
Thanks very much Steve, I’m a bit of a novice but can I ask with respect to investing in the Perth property market which poses the greater risk between apartments and houses? Is one necessarily a safer bet if you can call it that in terms of rental income and capital growth over the next 5 to 10 years and what are the key considerations before investing in either?
Apartments, without doubt Tatenda. They generally provide up to 200 basis points higher in income, but tend to under-perform on capital appreciation compared to houses.
Make sure you grab a copy of my free book (just pay postage) so you can understand more about how to structure your plan for financial freedom. You’ll appreciate the guidance.
– Steve
Fantastic, thanks a lot Steve! I’ll be sure to do that, so glad I joined this forum! With the potential price correction though would you advise waiting over the next 12 months or so to see how the proposed legislation pans out and the effect on the market? Also how can I identify which areas around Perth would make for a better investment in the long run? There are so many developments going up everywhere to choose from.
Hi Steve this is worrying for all property owners. What is the timeframe would you say this is going to be over.
Hey Dee,
How’s Mackay?
I think we need to see what the government’s response is to the inquiry first. I’ll provide more updates depending on what they say and do.
Merry Christmas!
– Steve
Hi Steve
I certainly agree that permitting SMSFs to borrow to purchase investment property has increased demand and therefore contributed to the increase in property prices.
I am concerned however, that unless the recommendation is implemented very carefully it could cause a bubble as funds rush to make their investment before the ban kicks in. A similar thing happened in the UK in the late 1980’s when the government announced changes to personal tax relief on mortgage payments. Prices rose very rapidly as people flocked to purchase before the change. Afterwards there was a price crash ruining many as their investments went into “negative equity”
It would be better I think, instead of a complete ban on SMSFs borrowing to purchase investment property which could cause such a bubble, to require that the amount of the borrowing is to be limited – perhaps to 50% of the property’s value. This would have the advantage that funds would avoid becoming over leveraged. Also, the restriction could be introduced progressively to avoid a bubble arising.
Thanks Steve, very insightful indeed.
One thing bad about superannuation is the contributions would be better used to pay off a home loan. The savings in interest by paying off the home loan are greater after tax than the return from superannuation after tax and fees. This means the reality is that any Australian paying a home loan are worse of due to being forced by the government into paying superannuation funds. Part of the con is the government says its your employer that pays superannuation but it is a payment resulting from your work effort so it is the employee making the payment. People are retiring with mortgages so they use their superannuation to pay the mortgage and then go on the pension defeating the whole purpose of superannuation. This issue is not addressed by the Murray enquiry and someone needs to address it. To me superannuation is a high risk investment as its at the mercy of the whim of a government to take the money in a similar way that the Greek government confiscated bank savings when they had budget problems.
Interesting point. Thanks for making it.
– Steve
Interesting how powerful the word “could” can be in a sentence.
Like earth “could” be hit by a meteorite and wipe out humanity as we know it.
Yes this could happen, but realistically, will it?
For the SMSF borrowing tap to be turned off, the government of the day will need to make the deliberate decision to commit political suicide.
Somehow I doubt it.
Like with a $7 GP co-payment, or cutting off unemployment benefits for 6 months Peteinperth? Who knows with politicians. It should be remembered that borrowing in a SMSF was specifically prohibited prior to 2007. Now it is permissible, but with detailed compliance requirements.
This is a very good article:
http://www.smsfinstitute.com.au/smsf-borrowing-money.php
So is this (for those who like more detail):
http://www.consolidatedlawyers.com/assets/files/pdfs/SMSF-Borrowing.pdf
– Steve
Pete. Google “percentages of a Carrington event CME” …lol its eye opening but yes I agree, I think there would be a riot if Tony Abbott introduced something that drove down property prices 30% overnight.
This being said “Between 2008 and 2014 the value of real properties owned by self managed superannuation funds (SMSFs) is reported to have increased from $40b to over $100b”.
That initial $40b was worth around $65-70b just from capital growth alone so there was only about $30-35b in actual new investments……or roughly $6b a year.
Its still a lot and as investors we should be aware of it as it drives down yields…..but make inflation your bitch as capital growth rocks
Thank you for sharing your insights Steve… and for translating Recommendation #8 into simple terms!
I doubt the decline will be any thing like the figure stated in the article. Firstly the percentage of properties that are owned by super funds is simply too small. Secondly I cannot see that funds that currently own a property will be forced to sell. This will prevent forced sales that increase stock which triggers a decline in price. I see that the change if any, will be either additional restrictions or a ban on borrowing to purchase property via a SMSF..
The property I hold in my SMSF returns 13%, and I generated 100k in equity after purchase. Every year I know the return will slowly increase. I cannot say this about shares.
I do not know why SMSF’s would be barred from one of the best investment classes there is. I have a client who is a successful stock broker, when ask why he likes property he said “‘ Unlike shares or derivatives, it is real, you can touch it, you can fee see it and no matter what people are always going to want a roof over their heads.”
Government is concerned that some SMSF’s are falling prey to property sprukers, which is certainly true. However it is not just SMS’s who are in this basket, I see a large numbers of Mums and Dad’s getting burnt on a weekly basis.
The real solution is to regulate people selling or offering advice about investing in property. Unbelievably, property investment advice is unregulated, and no licence is required.
I don’t think regulation necessarily protects people against bad advice. Look at CBA / Storm Financial.
The price slippage, if it happens, will be because of the excess stock that would have been bought by SMSFs now needing to be absorbed elsewhere.
As for the reasons why SMSFs shouldn’t be allowed to borrow, go to the horse’s mouth and read the report.
All the best,
– Steve
Keep in mind David…..13% is high but not amazing and is this including “sales costs” as well?.
Eg my 401k index fund here in the US is returning 17.5% over 5 years (22% over 3 years – http://www.bloomberg.com/quote/VPMAX:US ) but yes I agree investing in Australian property far safer and dependable…….
Hi Steve,
I notice you have said a tone of negative stuff about developers and super funds lately. Are you totally only in favour of second hand property at the moment. Not having a dig just curious.
In a way I sort of agree with you. I have never purchased anything with a bow on it and can’t see the merit or fun in doing that.
When purchasing certain types of property I feel like we really just become “consumers” of a “product” rather than investors. We become a little like people buying managed funds because they like the TV ad or the brochure.
The more we have done for us the less likely it is that any real profit will be returned. Total speculation. It is not really investing is it? Sure, it is pretty easy to rate available glossy properties from 1 to 10 (or apply whatever criteria you wish) and pick one. Is that investing though? I don’t think so? I am on the fence on that point. Some skill and some luck.
Leveraging others skills is a skill I suppose.
Investing is bloody hard work but totally amazing and rewarding when you solve a problem or create something. I feel like that’s what investing is. I am a broker but investor first. Last year I did some little stuff like build some homes for other people to live in that I am keeping and just finished one for me to live in. Bits and pieces. Direct, planned and deliberate.
I think we do a lot right in this country in relation to property and some things are so wrong. Stamp duty. Don’t get me started on that.
Grants for first home buyers. Lets encourage savers. Let’s incentivise saving rather than giving.
Deregulate Local Government control over small to medium development.
There is so much we could do. Really, the proper use of gearing by SMSF’s in not going to cause the sky to fall. Exit strategy is a more important point to consider.
We are never going to stop people buying poor investments property or otherwise.
Did you get a chance to read Macquarie Banks view on disinflation.(I will post it here as no doubt if I put a link in the blog will think its a spam comment.) Worth the read.
We have an outlook of weak and weaker commodity prices,the threat of another EU crisis looming with the Greek elections and uncertainty for financial market in the mid term.
My point being demand for direct investment in property seems like it will continue.
Australia’s recent inflation outcome showed some of the same trends which are evident globally. Disinflation, or declining inflation, is a pressing challenge for global policymakers. As the foundations underpinning global growth outside of the US begin to look shakier, deflationary concerns are spurring global central banks into action.
Concerns about weak global demand are rising
Concerns about the strength and durability of global demand have increased, and the International Monetary Fund (IMF) has downgraded its global growth forecasts. Weak global demand is manifesting in disinflationary trends in commodity and energy prices, with demand-side factors replacing supply-side influences in global markets. Global economic activity is uneven, and low levels of nominal income growth and ongoing structural challenges are being interpreted by investors as a sign of another year of sub-potential growth.
Demand-driven weakness in commodity and energy prices has fed through to lower inflationary outcomes, particularly for economies where demand is weak. Policymakers have had to respond as inflationary expectations begin to show signs of moderation. The eurozone is a case in point. The European Central Bank (ECB) has announced an additional quantitative easing program, as annual inflation has fallen to a 5-year low of 0.3%. In Sweden, the central bank recently cut rates to zero, as a high currency and falling commodity prices have led to deflation despite the Swedish economy being “relatively strong and economic activity … continuing to improve”.
Other central banks are also taking their own steps to address deflationary concerns. The Bank of Japan announced an almost two-thirds (approximately $US280 billion) increase in their quantitative easing measures. In New Zealand, while not anywhere near the zero lower bound that requires quantitative easing, the Reserve Bank of New Zealand (RBNZ) removed its forward guidance pointing to interest rate hikes after a third quarter of soft consumer price index (CPI) outcomes took annual inflation to the bottom of the RBNZ’s 1-3% target band.
How long will the Reserve Bank of Australia be able to hold steady?
Elevated concerns about global growth, weak global inflation and declines in commodity and energy prices are all key factors in the Reserve Bank of Australia’s (RBA’s) outlook for domestic growth and inflation. Following the release of the September quarter CPI data, the RBA will be updating their quarterly Statement on Monetary Policy forecasts. The risks are that the backdrop and September CPI outcome see the RBA echo the dovish turn taken by other central banks.
The September quarter CPI outcome is a key starting point. Headline inflation fell from the top of the target band down to 2.3%, confirming that the June quarter outcome was a near-term peak in the inflation cycle. While there were some one-off declines, such as the removal of the carbon price, the broader message from the underlying inflation outcome and a number of measures of domestic inflationary pressures was of a broader disinflationary trend.
Headline inflation outcomes are frequently subject to one-off impacts, such as the introduction of the goods and services tax, oil price spikes and tobacco excise increases. The underlying measures of inflation, which are designed to take out these impacts, are key considerations for the RBA’s decision-making. Underlying inflation moderated in the September quarter to just 2.2% on a 6-month ended, annualised basis. On a trimmed-mean basis, underlying inflation looks to have undershot the RBA’s August forecasts.
The domestic price measures, or non-tradable inflation, continued to moderate. Non-tradable inflation declined to 2.4%, and price rises over the past 6-months have been the softest since 2009. Weak domestic demand and rising spare capacity in the labour market are feeding through to low inflation.
While a number of factors point to a potential downgrade to the RBA’s already modest inflation profile, and subsequently a risk that the RBA takes a dovish policy stance, there is another factor which could complicate any reduction. The Australian dollar has fallen over the past month, falling from $US0.93 to $US0.88. This should flow through to a lift in the tradables component of the inflation basket. However, with weak global pricing pressure and disinflationary trends domestically, the risk lies with the RBA joining the chorus of central banks raising concerns about a weak growth, low inflation environment.
Crikey! That’s a long post, but well made for sure!
My thoughts are you pay a premium for new, and when you do the only profit you earn is from the market as a whole.
To me there are better ways of making money from property that are less speculative, but they do require more effort and skill.
All the best,
– Steve
Another one sided view here but sums the issue up very well. from ifa com au
“Lobbying by institutions and vested interests continue to impact policy recommendations,” said Mr Pinn, who also heads up a Sydney-based financial advice and accounting firm.
“SMSFs were barred from using margin loans and other debt finance to purchase equities [and] now the same vested interests want to ban properly structured debt finance in direct property.
“The common theme seems to be that SMSF trustees – mums and dads – are either too dumb or too sneaky to be trusted with managing their own money.”
Mr Pinn said institutions and other vested interests are opposed to LRBAs because they have an underlying agenda to direct funds into “buying instalment warrants, investing in geared equities where someone else controls the money or some other more costly structure”, all of which generate revenue for these interests.
I understand in Singapore you can use your superannuation fund to purchase your own home…….. now this makes perfect sense to me. It is your money being put aside for your future welfare, now I would have thought having a roof over your head was a good step towards a good retirement. I do not know of one asset class or investment vehicle that is not subject to pull back at certain times in the economic cycle. We hear so much talk about affordability for the first home buyer : well this is not going to go away because of the high costs for land, state & local government fees and infrastructure costs let alone the cost of materials to build now to meet all the complicated compliance issues. An early start of securing a roof over your head would be a good way to go I would think? A hell of a lot simplier than trusting in someone else to manage your money on the share market. Attend to survival needs first then take the next step for investing is my thinking. No doubt there are some holes in my view but it would be worth discussing.
Hi Steve if this changes what do you think will happen with existing unconditional off the plan contracts in place surley it won’t be retrospective leaving the buyer exposed or the developer suing if buyer cannot settle because of this change. As you can appreciate many apartment off the plan pre sales come from smsf buyers it would also put developments at risk? Does this mean we should stop selling property to smsf until there is more clarity.