The Super Suck
There’s a sucker born every minute, or so the saying goes. A fool and his money are soon parted, or so the saying goes. The borrower is the slave to the lender, or so the saying goes.
The New Con
Sadly the latest con doing the rounds (that I call ‘The Super Suck’) involves all of the above: suckers, fools and borrowers. The results are typical with one party making large sums of money at the expense of the other.
Specifically, the latest scam involves property developers (again) selling over-priced real estate to a new batch of unsophisticated mum and dad investors. Okay – nothing new there. But the current twist is to incorporate a self managed superannuation fund – a retirement savings investment vehicle that is experiencing something of an explosion of growth.
SMSFs
It is estimated that in June 2013 there more than 500,000 self managed superannuation funds (SMSFs) operating, with the number swelling by an additional 100 new funds being created every day. Money under management in those funds is reported to be $5.5b, and growing.
In case you don’t know, back in the early 1990’s the Hawke-Keating government mandated compulsory superannuation contributions for Australian employees, and by doing so gave birth to a captive retirement savings industry that is simply massive, and is legislated (via compulsory contributions) to grow larger into perpetuity.
And as investors accumulate more retirement savings, and as many realised they’d rather control their own financial destinies than pay an adviser (the GFC killed off the myth that financial advisers were the smartest guys in the room), the idea of creating your own self managed superannuation fund has become more and more popular.
The last hurdle was needing $100k+ in retirement savings to make the cost-to-benefit of establishing and maintaining a SMSF worth it, but this has been removed with the advent of service providers who will create a SMSF for you for free, provided you agree to use them to manage your compliance requirements.
The New Borrower
Until a few years ago it was not possible for a SMSF to borrow money.
Telstra Instalment Warrants changed all that (a story for another day), and soon thereafter some clever highly-paid people figured out an elaborate new way using multiple trusts that allowed SMSFs to borrow, subject to adhering to a few extra rules.
Fast forward a few years and today lending to SMSFs is more accepted, meaning the billions of dollars of retirement savings can now be leveraged into billions and billions of dollars of investment capital.
Naturally, it was only a matter of time before unscrupulous property developers latched on to this new capital stream and began hawking their wares, marketing to a new batch of suckers.
The New Fool
While some external consultation or advice may sometimes be sought, normally it is the members of a SMSF who decide what the fund will invest in. As such, a SMSF will only be as sophisticated as the collective financial intelligence of its members.
As you would expect, in instances where the members are unsophisticated it is easy to believe the marketing hype and be duped into making financially dumb investment decisions with their retirement savings.
The pitch goes something like this… as property values in Australia double every 7 to 10 years (not true, but sounds good), you should be using the safety of bricks and mortar to grow your retirement savings by purchasing quality property in quality areas.
It’s the perfect storm… access to new capital, lack of financial intelligence, the Australian love affair with property, slick marketing… and the trusted go between.
The Trusted Go Between
In the absence of knowing what to do, SMSF members may seek expert advice about the merits of borrowing and buying property.
Usually the developer will be able to recommend a suitably qualified ‘independent’ person, or else the member may have been invited to attend a seminar run by an adviser explaining how to buy property in their SMSF.
Unfortunately though, often this so-called trusted independent adviser is really a glorified salesperson who receives a commission (usually between 10% and 20% of the sales price) for introducing the seller to the developer / closing the deal.
On a $500,000 sale this commission could be as much as $50,000 to $100,000! Who pays for this? The developer? Oh no. It is incorporated into the sales price so one way or another, it is the buyer paying the fee.
This raises the learning point:
If you are planning to buy an off the plan property in your SMSF, negotiate with the developer direct and ask that the commission they would otherwise pay an adviser be rebated off the purchase price.
The Stench
Although the wider Aussie property market has enjoyed recent price growth, this is not to say all properties have appreciated in value.
Indeed, negative equity (defined as when the debt associated with the property is greater than its value) has been reported in the new apartment submarket.
For instance, I noticed the Sydney Morning Herald ran a story on the 18th July claiming some SMSF investors had lost up to 75% of their investment sum within two years of purchase. Ouch!
The Faulty Product
You should remember that the underlying property being sold is a marketing re-badge of an old theme.
Ten years ago the same property was marketed as a smart investment because the tenant and the taxman paid off your investment property. Be aware though that such property, characterised as being negatively geared, is designed to make a loss (hence the taxman reference as the loss reduces your tax).
Those familiar with my teachings will better associate this kind of property as ‘possible-gain; certain-loss’ real estate, and be able to characterise it is high-risk because property prices do not always appreciate.
I just don’t understand how a product designed to lose money in one instance is now a smart investment within a SMSF, which is already concessionally taxed so that any tax benefit from the income loss is reduced.
For instance, if you had net rental income loss of $10,000 and paid 30% personal income tax then you would get a tax deduction of $3,000. But a SMSF paying 15% tax would only get a deduction of $1,500, or even possibly nil if that fund was in pension phase.
What is old has been made new again, yet what was old didn’t work then and doesn’t work now!
The Conclusion
Forewarned is forearmed, or so the saying goes.
This article has been written as a warning about the perils of buying off-the-plan (negative geared) property within a SMSF.
I am not a lone voice. Recently the Financial System Inquiry’s observed:
“Leverage (or borrowing) should not be a core focus of SMSFs – or any superannuation fund – and is inconsistent with Australia’s retirement income policy”
A bad property investment can never be made good because of taxation benefits.
And now a joke to finish on that pokes fun at financial planners:
“Three financial planners went out hunting, and came across a large deer. The first financial planner fired, but missed, by a metre to the left. The second financial planner fired, but also missed, by a metre to the right. The third financial planner didn’t fire, but shouted in triumph, “We hit it! We hit it!””
Near enough is not good enough when it comes to your financial future.
I’d be interested to know your thoughts. Leave a comment below.
Comments
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Totally agree that there is no substitute for due diligence. A SMSF is simple an investment vehicle. Regardless of the investment vehicle, that is, personal name, company, trust or SMSF structure a poor investment is a poor investment. Too often though the strategy ( using SMSF’s to invest in real estate) becomes tainted by the association with spruikers selling certain types of property. If you ever find yourself in a large room of people being SOLD anything – then RUN. Make your own decisions. If you can’t do that you probably have no business running a SMSF. http://www.homeloanwarehouse.com.au
Great warning Steve. I have forwarded your link to others as it’s important to get the word out
Vassy
But I got good marks for economics in my accounting degree! Just because we disagree doesn’t mean you have to get all nasty about it! Steve
Great post !! Bit late for me though. Im just about to lose $100K of my SMSF after an investment with Custodian Land Syndicate managed by Custodian wealth builders or JLF. Yes the prospectus for Cunningham rise gave a 13% return over 3 years. Well, maybe Im going to get back 36% of my total investment in 6 years time!!! NO LEGAL COME BACK ON THESE PEOPLE!! How they stay in business still flogging house /land packages is unbelievable. John Fitzgeralds book and new edition ” seven steps to wealth” should be out soon , at my expense!!
Ouch!
What I find interesting is the 5K price spread that I’ve been quoted by SMSF “conversion specialists” and the finders fees offered for referrals. One estate agent even told me not to worry about the fee because it wasn’t real money, the SuperFund pays for it!
Good warning Steve. I think SMSF can be a good vehicle in some circumstances but not all. The numbers need to stack up, i.e. amount of equity available in SMSF (deposit) plus mortgage proceeds and rental income plus contributions need to be in sync.
Something I dont agree with you about is that negatively geared property is bad by design. I dont think that 95% of properties that are negatively geared are like that because they were designed to loose money but rather, the purchaser got the seller to the lowest price they could but it still had a purchase price that results in a purchaser needing to subsidise a tenant. This is so very often the case with well located property in capital cities. Not designed that way but rather purchase prices just being high and the landlord only getting back some of the monthly costs of holding.
But hang on… by definition ‘negative gearing’ implies a negative.
The negative is negative cash flow and hopefully positive growth.
If that’s what people want then I agree it’s not bad, but those wanting to make money need to know and understand the beast they are getting into bed with.
– Steve
Sure, it is a beast but the beast that can be positive cashflow properties can often be worse. At least the capital gain possibilities with most negatively geared property are a better bet. Lets face it, nobody wants to loose money and one sometimes makes these bets. To my mind a property in a good suburb and a capital has a better than even chance of yielding some capital gain whereas a property in some mining town in the middle of the outback with positive gearing has a far better chance of downside if the mine closed down (which is happening all over Australia at the moment).
Maybe… provided property prices keep going up.
Your theory wouldn’t have worked in the US or Europe though, where property prices halved even in many good areas. Let’s agree in our hope that never happens here.
Thanks for your valued contribution to the discussion.
– Steve
Steve thanks for your words flagging the unscrupulous who pray on the uneducated and unsophisticated investor. To me this is consistent with your mission to empower people to make the right investment decisions using their own analysis.
The issue is that these “bad guys” will sell to anybody through any investment structure- SMSF, trust, corporation or individual. It is just that people using SMSFs are the latest easy buck for them.
That having been said, I think you crossed the line with your comments about lending for SMSFs as this is a separate issue altogether. Used properly, finance in SMSFs can be used by those you have empowered to diligently invest in property to build a nest egg in many cases likely better than investing through retail super funds. Cashflow is king. If it puts money in your pocket from day 1 and have good prospects of capital growth you are a winner!
I do not agree that there should be a prohibition on lending through SMSFs. Quite frankly I think it is insulting for proficient (educated) property investors that the Murray report has made this recommendation.
On this point a draft of my submission to Mr Murray would read as follows:
I am writing to contest the observation that:
“If allowed to continue, growth in direct leverage by superannuation funds, although embryonic, may create vulnerabilities for the superannuation and financial systems.”
The general thrust of commentary appears to reference lending to purchase equities or equity derivatives. These investment instruments carry inherent volatility risk and it appears that the argument for a prohibition on superannuation leverage is largely based on borrowing for this type of investment.
It is suggested that basing leverage recommendations on a narrow view of investments such as equities is not optimal for the enquiry.
By way of contrast to equities, real estate as an investment is a much less volatile. Investment to buy property to rent is actually quite simple (some say to the extent that it is boring). Average Australians may understand real estate by borrowing to buy their own home. It is an asset class which is understood by lenders. It has established metrics to manage risks for lending through loan to value ratio and debt service ratios. With a long history of lending for real estate in Australia, arguably it is much more established. The Australian real estate market was relatively stable compared to other countries during the GFC. This was because for real estate in Australia there is a deficit of supply over demand, non-recourse lending is not usual and low deposit loans are not prolific. Australia can be proud that prudential local lending practices meant that this country did not follow the housing led GFC in the USA. It is prudential lending practices for optimum risk management not a moratorium for lending that should be bought to the attention of the enquiry.
Using a superannuation entity to borrow to invest in real estate is in essence no different to an individual investing in real estate. The lending risk management is handled by the same metrics lending to individuals (loan to value ratio and debt service ratio) but with tighter lending criteria to moderate the lending risk. The lender is in a position to measure wether the loan is a good business risk or not.
Thanks for your in-depth contribution.
Just remember that when the legislation for superannuation funds was released, borrowing was not allowed – period. It was seen as an unacceptable risk to take with retirements savings, which ought not to be leveraged in any way.
It is only because of Telstra instalments warrants that the loophole exists, although it has been exploited to be sure.
Perhaps those with the financial intelligence to understand the risk / reward can handle debt in SMSFs, but I have to think that it would be a better protection for all if leverage was simply not permitted in such vehicles.
– Steve
Hi Steve You are absolutely correct about this being a shocking scam. In fact a mate of mine just did it. He bought quite a nice unit in far north QLD for $650K. A quick check by me (after the deal was done unfortunately) of the rental for this type of property in its area shows he will be LUCKY to return around 2.4% on it – and then had deductions from that! Further, if you look where he bought, in the same development, there is a larger one selling for $415K. However an onsite “arms length adviser” (supplied by the developer) told him that the one he bought was a better buy. I asked my solicitor if there was an out & of course he said that my mate was offered a property & accepted it – no coercion there! All is legal – he has just lost money & will continue to loose it!!
This is the problem – what these shysters are doing is perfectly legal – they are just trading on the “one born every day” mantra & skinning them alive.
A further comment Steve about negative gearing. I have a modest portfolio of properties in very good areas. Initially there were negatively geared but as interest rates dropped & rentals rose most are now positive. One I have redevelopment in to two town houses through my own SMSF & sold one off retaining the other. My goal is to use negative gearing only as a method of purchasing properties in good areas where there will be (based on some pretty good research) capital gain & good rental returns.
One other point: Beware the spectre of depreciation! When you eventually sell all that smart depreciation you benefited from via tax relief comes back to bite you in capital gains!
Not quite right…
The technically correct response is that all that depreciation comes back as a balancing charge:
https://www.ato.gov.au/Business/Deductions-for-business/Capital-allowances-and-depreciating-assets/Uniform-capital-allowances/Disposing-of-a-depreciating-asset/
That is, the whole amount should be included in assessable income as a balancing charge, not as a capital gain. The only way around this is to sell the assets at written down value as a schedule to the contract. Beware.
Maybe I should write an article about this…
– Steve
Yes Steve, I suggest you write an article on that for sure
Steve, the issue is selling bad investments, not lending to SMSFs.
An SMSF is a structure like a family trust except with tax advantages. What you are saying is don’t lend to SMSFs. So to be consistent then you would also say don’t lend to family trusts which is not your intent I am sure.
It is the investment that is bad not the structure. The same guys can sell the same investment to anyone with access to cash – leveraged or not. SMSF or not.
Regulate the problem – the bad guys. Let those of us who know what we are doing have the freedom to invest our own money.
Not give it to some stranger to loose it!
But a family trust is not a specialised retirement vehicle.
It is the borrowing within a dedicated retirement vehicle that was not allowed in the first place.
The genie is out of the bottle now though, and I doubt it could ever be stuffed back in.
– Steve
The reason many people are using SMSF I believe is because they like property as an asset class and have never enjoyed handing over fees to super funds who do nothing for you at all (small generalization I know) and it also avoids having all your super cash tied up in shares. Thats my excuse anyway. I much prefer property for the long range but could never use all the equity in my super to invest in it until recently. I for one will always prefer property to shares and the fact that you get some other advantages like 15% tax break are just a bonus. Like others here I totally agree, one should focus clearly on the main problem here which to my mind is people paying inflated priced for property and not doing enough research to test the assertions of the sellers/developers.
Thoroughly agree with you Steve. Family Trusts are nothing like SMSF’s. There are no age restrictions with Family Trusts, neither are they submitted to annual audits for compliance.
It may well be that you use a Family Trust to house an investment which you ultimately use as a retirement fund.
The fact of the matter is that SMSF’s are like the magicians slight of hand. While the presenter is spruking about how much tax you will save the investor is not looking at the fuller picture.
The moral of the story – invest for gain and not for tax saving.
Hi Steve,
This week I was asked to look at a house and land package offered to a friend’s in-laws. Upon checking, it seemed they had already signed a contract to buy subject to finance. A quick analysis of their financial situation showed that they had no way of meeting repayments on a 105% loan plus their own mortgage and car loan. Today, they heard that finance was approved. The spruikers who put this deal together are deregistered and ASIC said they were not permitted to trade. The developer appears to be co-operative but hasn’t got back to us yet. And the poor people who are in this situation don’t even remember signing a contract for the purchase of the land. The contract has been forwarded to a mysterious solicitor not of the purchasers’ choice which I’ll address tomorrow. More work to do, so wish us luck.
BEWARE!
Ann
Great article Steve ,
i fully appreciate the argument that one should invest to make money and not to save tax per se .
However , I’ve got just one question :- Is it true that a property bought in a SMSF can be sold without paying capital gains tax ( after retirement age ) ; or is it only capital gains tax at 15% ?
Christopher
Super funds in accumulation phase pay 10% capital gains tax on assets held for over 12 months. In pension phase they pay no tax at all, so yes it’s true.
I note that Stephen Tolle is also advocating use of SMSF for borrowings toward new home purchases, I don;t think he is a scammer, what are your thoughts on this Steve??
No comment on Stephen as I have not examined his strategy.
But if he is advocating buying new property through your SMSF then use the principles in this article to be forewarned.
– Steve
I wouldn’t use his company as an example. In fact I would be highly weary of them.
1. Stephen is not and has never been a licensed real estate agent, yet will only let his members purchase in areas he says and properties he provides to be apart of the program.
2. His testimonial page uses his own staff to promote his business with alias names.
3. Half the staff listed on his page do not work for him and run their own companies, easily found doing a google search.
Shock horror! Someone who has come out against aggressive borrowing (or betting) against your retirement income.
I learnt many years ago that I needed to develop my exit strategy well before I decided what I was going to purchase. When I did purchase, look toward ensuring that it would make money, not eventually but from day one. Oh! that meant going down a low risk path ie higher deposit but it would not fall in a hole if the tenant far*ted.
The old listed property trusts which were required to have 40% minimum equity in the portfolio ensured that they weren’t overextended and that there would be sufficient income to weather a storm (or a 10% vacancy rate).
Do you have any comment on TIC The Investors Club whypaytax.com.au ? They seem to be all about negative gearing and claim to have over 200,000 members who swear by their system. I am about to have a meeting with their Queensland Manager tomorrow morning. I would really appreciate any feedback.
No, I don’t have a comment about this organisation specifically, but in general I would warn you to do careful due diligence on any property purchased where a third party is paid a commission for recommending it.
The usual speak about volume discounts, wholesale prices, special relationships with developers, surplus stock sales, etc. is usually pure marketing puffery with little or no substance.
My experience is that you are usually better off buying a secondhand property (say developed 3 to 5 years ago) at a much lower price rather than paying a premium for new.
– Steve
Great article, with one flaw. The pool of superannuation monies will not increase in perpetuity. At some stage, maybe in as little as ten years, the money being withdrawn from super by retired baby boomers will exceed the amount of contributions. This will create another problem for super funds invested in property: selling out of illiquid property investments in order to pay pensions.
I could speculate on the effect on property prices of retirees having to sell their investment properties in order to pay their living expenses. As the trustee of an SMSF for about 20 years, I have invested in both shares and property, while adhering to the sensible no-borrowing requirement that has now been removed. Property has tended to give me lower returns and over time as been almost as volatile as shares, while requiring more management effort.
All I can say is, if someone like me with long-term experience, who tends to know what they are doing as a self-directed investor and spends lots of time on education, wouldn’t go anywhere near these deals, then neither should anyone else.
Good point about the net withdrawal from superannuation as the number of BBs retiring increases .
I haven’t seen economic modelling, but I wonder whether increasing the compulsory contributions like the Labor government forecast would make a material difference.
– Steve
Hi Steve. Very good article. Firstly, I am a Financial Adviser with 20 years experience (I am a highly qualified CFP). Are the attacks on advisers necessary? Most of us are good people, doing the best for our clients in an uncertain world.
Anyway, you raise some very valid points in the article and I agree with you that negative gearing is hoping for a gain to offset a certain loss. Sadly, most clients eyes light up when the topic turns to negative gearing as they think it is the road to riches.
I have advise several clients about property investment via their SMSF and I always encourage them to get an independent valuation. I also make sure that after the loan is established (if a loan is required) there is sufficient ‘cash buffer’ to ensure they can meet all the expenses of the fund and the loan, without relying on contributions. By the way, I charge clients a fee and do not receive any kickbacks from developers.
I have had many instances where a client has already decided to buy an property (funded by a loan) with an SMSF and they need a financial adviser to ‘rubber stamp’ the bank’s paperwork. The client’s often only have a scant understanding of what they are getting in to and they often are pushing the envelope where they have to borrow a large portion of the purchase price and have little wiggle room left.
I personally would like to see the legislation changed so that all advice relating to property purchases (especially where a loan is involved) should be provided by an independent adviser, who is not connected in any way to the developer or any way along the sales chain. I also think mandatory independent valuations should be compulsory (and the valuers should be held liable for valuation errors) and lastly, I don’t have a problem with sales commissions per se, but they should be fully disclosed and a declaration should be signed by the buyer, ahead of the offer and acceptance.
By the way, 0 to 130 properties was a great read, I need to pull it out and have another read of it.
No, attacks on all advisers are not warranted or necessary.
Yet informing the public is, and to the extent that it sheds light on the questionable activities of some advisers, then that is a good thing.
Capital appreciation via real estate will be the topic of my next blog, and if you thought this one was controversial, wait until you read the next one.
Thanks for your contribution.
– Steve
Seems you’ve opened an interesting can of worms here Steve! I personally would not want to invest any of my SMSF money in something that wouldn’t give me tangible returns regularly over an annual period. The growth prospective of an investment is appealing and a purchase would be considered with the end profit in mind but over a length of time capital growth is subject to change with ambient economic conditions and possibly in a negative manner – regardless of experienced investment savvy. To rely on growth alone isn’t enough, I think a SMSF investment should bring in annual returns and as an added bonus, capital growth just tops it all off.
Tamara
I think we would all be well advised to draw a distinction between general wealth creation and retirement savings.
I for one would normally advocate investments in a SMSF to be lower risk, especially as a member ages and the opportunity to recapture losses via time based growth becomes more problematic.
The purpose of the article was simply to note that aggressive investing strategies are being used by developers, many of whomare more interested in selling for profit than advising for long term wealth.
– Steve
Cogent discussion Steve!
Great article Steve, I think its important to remember that SMSFs are regulated, so if you are recommending property in a SMSF, its a financial product – this is financial advice.
That means that the person/ organisation recommending the property, must be licensed (i.e Australian Financial Services License), if they are not licensed they are breaking the law and will face a significant fine OR jail.
We are seeing the ‘same’ spruikers who have been targeting property investors for years (google smsf property scam) are now placing their marketing focus on SMSF investors “use your super to purchase property” and these messages are coming across in ‘property’ seminars on a weekly basis across Australis, where these unlicensed spruikers are recommending property to mum and dad investors who are fooled into using their hard earned super on a overpriced apartment. Unfortunately, we are seeing these horror stories – where the ‘one stop shop’ model is being used by the SMSF property promoted to sell to the investor. Allot of these properties are off the plan and given volume and the horror stories many lenders are excluding off the plan from the lending criteria, making it harder to finance off the plan. Not only that, if your valuation does not come in at ‘contract price’ you will need to cover the shortfall from your super balance.
At the same time, with a one stop shop model – the spruiker has earned a 6% commission on the sale of the property, commission on finance also…..have they disclosed this? and have they issues a Statement of Advice around the recommendation of the property? most of the time the answer is NO.
Respectfully I will disagree on one point – its not a ‘new con’, its been there for a while, so more suckers now, with more education lets hope that we can stop the spruikers.
Cheers, Ivan
Good old Mortgage choice tried to sell me of to Bluewealth property and make themselves a hefty commission. Certainly didn’t have my best interest at hart.
Cheers
Stefan
Great article and comments. I thought we moved on from negative gearing.. #my2cents
How do we know if a developer is ethical and it’s safe for us to buy properties from them if we are overseas residents. Is there any way to find out? Because my wife and I attended this real estate seminar in Jakarta, Indonesia. The seminar was actually to market their new project, an apartment in Melbourne. How do we check that the developer has a great record? Thanks
Reply for; Learning Real Estate
Its more complex than just the Record of the developer, but any good developer would have a solid track record that is obtainable via themselves, their company and outsourced searches online.
I personal would look into the market area, population, prices of the existing properties that are similar to what you are looking at.
Kind regards
Jaxon Avery