One of the hottest topics right now is whether self-managed superannuation funds should be allowed to borrow to buy a property.
However, it’s become somewhat an academic question — even though the authorities have not ruled it out, any mortgage broker will tell you that in the aftermath of the Hayne royal commission, it is almost impossible for a self-managed super fund (SMSF) to get a loan.
It begs two questions. Do you need an SMSF? And, if you do, is SMSF borrowing for residential real estate a good strategy?
I have long been an opponent of it. Usually, those who do it have been talked into it by property spruikers, or they want to buy an investment property, but the only capital available is through their super fund.
Contrary to media reports misrepresenting factual evidence, there are many locations across Australia still experiencing capital growth.
It is a fact that house prices continue to grow in major cities. The latest data (dated 31 March 2016) from CoreLogic suggests house prices generally have risen in the past 12 months in Melbourne (up 10.7%), Sydney (up 7.5%), Adelaide (up 3.3%), Hobart (up 4.0%), Brisbane (up 4.9%) and Canberra (up 1.7%).
The generalised average situation across the eight capital cities is an annual rise of 6.6%.
Media has seen the figures differently. One News Corp headline claims that “property price growth has ground to a halt”. The Australian says house price growth is “the slowest in three years”.
Journalists arrive at these conclusions by generalising about “Australian property prices” and by focusing on short time frames. Monthly changes in price indexes are always erratic and ultimately meaningless – but journalists place great emphasis on them because it makes it easy to create negatively sensational headlines.
But the CoreLogic data is still mostly positive, even when examined over shorter time frames.
In the March quarter, there were rises in the house price indexes for Sydney (up 2.3%), Melbourne (2.5%), Adelaide (up 2.2%), Darwin (up 3.6%), Canberra (1.7%) and, leading the nation, Hobart (up 6.5% in three months). Brisbane is unchanged, and Perth (down 1.0%) is the only city in the negative.
So what do the figures tell us, in terms of meaningful, realistic trends? Industry assessment includes the following:
- The rate price growth in Sydney continues to slow down, not surprisingly as it is abundantly clear that Sydney’s boom is well and truly past its peak.
- Melbourne leads capital city Australia on price growth, but its rate of price growth has probably peaked and will show lower rates of growth shortly.
- Moderate growth is happening in some of the smaller capital cities, notably Hobart, Brisbane, Adelaide and Hobart. The Tasmanian capital appears to be gathering speed, rising off a low base as its economy recovers.
- Perth and Darwin, no longer boosted by a resources boom, continue to have struggling markets, although the rate of price decline is relatively low.
If you tell a lie often enough it begins to sound like the truth … expertise advice “Ignore the press”. If you are serious instead look towards factual evidence, and you will soon work out that there are opportunities abound to continue to grow and secure some wealth through astute property investment!
Industry Reports continue to demonstrate continued capital growth, here is the latest headline from CommSec “Rumours of the death of the Australian housing market are widely exaggerated,” says Craig James, Chief Economist, CommSec. Capital city home prices soared by 10% with the latest rise of 1.6% in May 2016
Melbourne, Sydney, South East Queensland continue to demonstrate capital growth, low rental vacancies, strong rental yields with high demand.
The 2020 Vanguard/Investment Trends SMSF investor report found that 32% of Australia’s 600,000 SMSFs seek the assistance of a Financial Adviser. Yet, more than 50% of SMSF trustees report having unmet advice needs about their SMSF.
If you are a trustee contemplating seeking advice, it’s worth considering the pros and cons of engaging an adviser.
Benefits Of Seeking Financial Advice
Investment Strategy Development and Implementation
More than 75,000 of the SMSF trustees interviewed by Investment Trends in its 2020 survey said they needed their SMSF investment strategy reviewed.
ATO data supports this. The average SMSF has more than 25% of its capital in cash and is overweight Australian shares while lacking exposure to the key asset classes of bonds, international equities and global REITs. The result is an inefficient portfolio that lacks diversification.
An adviser can lend some of their formal training and education to assist with building and investment strategy that:
- Takes into account your preferences and then helps you to build a robust, rules-based investment strategy to help you prudently manage your portfolio.
- Finds the ‘Goldilocks’ asset allocation for your needs in terms of risk/return.
- Integrates your SMSF investments strategy into a broader, holistic plan that considers all of your wealth (not just the super).
Experienced, professional advisers will consider portfolio construction from both a ‘top-down’ as well as a ‘bottom-up’ perspective. They can use their deep understanding of Modern Portfolio Theory (MPT) to help you establish a robust investment strategy that can act as a ‘safe harbour’ and prevent you from falling into many common investment pitfalls.
Integrating your SMSF with your broader strategic plan
Suppose you are looking for assistance for more than your SMSF’s investment strategy. In that case, a financial adviser can help you work through your broader financial situation to ensure it is adequate to meet your future objectives. This may involve an exploration of the following:
- Where your SMSF fits in your more general financial situation
- How much will you need in retirement
- How much of this needs to be funded by your SMSF
- Whether you can move more of your wealth into the concessionally taxed environment within your SMSF
- How much investment risk you can afford to take, and how much do you need to take to meet your retirement objectives
- What your testamentary intentions are and how they fit with your SMSF
An ongoing relationship with a financial adviser who understands your needs and objectives can be beneficial on several levels. A financial adviser can hold you to account and act as a sounding board for big decisions.
Moreover, suppose they’ve worked with you to develop your SMSF investment strategy. In that case, they are well placed to ensure you stick to it through both the ups and the downs of the economic cycle when many of us fall victim to the typical behavioural pitfalls. For example, in times of market sell-offs and rebounds.
The use of a financial adviser is an investment in freeing up time for yourself and dedicating resources to ensuring your portfolio is regularly rebalanced, monitored, and its performance appropriately tracked.
Time is money as they say, and as you move through life and your priorities change, you might prefer to outsource the time-consuming task of managing your portfolio and dedicate your time to pursuits that are more important to you.
Peace of Mind
Last but not least, the right financial adviser should provide you with peace of mind. This does not mean abdicating responsibility for the management of your SMSF.
However, working with a financial advisor should ease some of the worry associated with managing what might be your most extensive pool of capital. Knowing your investments are being handled by someone with expertise and experience can provide a great source of comfort.
One of the significant new trends in our marketplace today is the increasing number of investors buying the property with their self managed super funds (SMSFs).
Back in 2007, the super rules changed to allow people to borrow through their super funds for investment. It’s taken a while for people to get used to the idea of running their own super fund, let alone borrowing through it to buy a property. However, with more and more people setting up their own super funds today, we see a significant flow-on effect in the property market.
Latest figures from the Australian Tax office show a 50 per cent increase in property investment via SMSFs since June 2008 and a 13 per cent jump in the past year alone.
Just like the First Home Owners’ Grant prompted more first home buyers to get into the property market, more people are taking advantage of the opportunity to borrow up to 70 percent of a property’s value through their SMSF to buy an investment.
Australia’s largest mortgage broker, AFG reports that for every first homebuyer that takes out a new mortgage in Australia, there are three property investors doing the same right now.
I think SMSF property investment is becoming more popular because there are stable rental returns available, the costs have dropped, and quite simply, more people realise the benefits. I think a lot of people ignored the opportunity before because running your super fund sounds pretty daunting and the structures used to buy a property through your super are pretty complicated.
On paper, buying a property with your super sounds like a great idea, and there are definitely many benefits. But there are also many rules and regulations so I wouldn’t recommend using this strategy without getting some independent advice. Here are the main advantages and disadvantages.
- If you buy a property with your super fund and hold the property until after you retire and your super goes into the pension phase, you pay no tax on either the capital gains if you sell or the rent if you continue to hold your investment.
- Before retirement, capital gains and rent earned by your SMSF are taxed at only 15 per cent (if you have the property for more than a year, this drops to 10 per cent on capital gains).
- Direct control of your super investments and a real understanding of where your money is invested.
- Diversification in your portfolio.
In any event, even though conservative borrowing is a great way to build wealth, if the property is negatively geared — as most are — the effectiveness of negative gearing is enhanced by a high marginal tax rate, which produces a large tax refund.
Even if your SMSF could borrow, I suggest it would be a low strategy to go into negative gearing using a vehicle that pays 15 per cent tax, at most. You would be negating the tax benefits.
Therefore, a sound principle is to refrain from buying a property in the name of your super fund. It is better to buy it in your own name, or that of a family trust, and gain the benefits of negative gearing in terms of the taxpayer with the highest marginal tax rate.
Next, let’s consider the question of whether you should be running an SMSF at all.
There is no easy answer. Running your own fund is not as simple as it sounds.
It involves three primary jobs: administration (doing the paperwork), investment (deciding where to place the money); and insurance (arranging appropriate cover).
If you can handle these tasks with ease, you are well on your way, but you also need to take into account the assets the fund will hold. If these are not at least $250,000, the setting up costs and annual expenses of an SMSF are probably not worth the exercise.
Unfortunately, judging by the massive amount of queries I receive from SMSF trustees, people are still woefully ignorant of the rules.
As related parties run an SMSF, most breaches relate to acquiring assets from members or relatives, buying the wrong investments, getting the fund’s money intermingled with personal funds, and providing financial assistance to members and relatives.
These are serious matters with heavy penalties.
One of the most significant areas of confusion is acquiring assets from a related party.
With some specific exceptions, a fund cannot acquire assets from a related party because it could be seen to be enabling members to obtain access to their super funds before they are entitled to do so.
The main exceptions are listed securities from members or their relatives, provided the securities are acquired at market value, and real business property from a related party, again, provided the property is acquired at market value.
Given that much of the work of running the fund will happen after retirement — and probably will be done by one family member — there are two other questions to consider.
First, is this really how you want to spend your retirement? And second, who will run the fund if the person currently doing so dies or becomes incapacitated?
In summary, an SMSF is excellent for high net-worth individuals who want to run their own race and have the skills to do it.
However, you should not start your own fund just because the share market is down generally and you believe, “I could do better myself”.
Taking control of the investment decisions for your life savings is a massive responsibility, and making mistakes while learning with your own money could cripple you financially.
If you are not happy with your super, you may be better off to seek another fund with better returns and lower fees, rather than taking over the management yourself.
Three things to consider
The Cost of Advice
When you seek unconflicted advice from a professional, you should expect to pay for their skills and experience. The majority of advisers will charge a fixed fee for the development and implementation of your advice strategy. They may also charge a fixed or percentage-based fee for the management of your SMSF portfolio.
The costs of delivering compliant financial advice are typically linked to the time it takes to develop, implement and manage the client’s financial affairs and will be influenced by the level of economic complexity and assets a financial adviser has responsibility for.
An adviser will provide you with a detailed summary of the fees associated with seeking advice as part of your initial engagement.
The Adviser’s Business Model
Commissions for the sale of financial products were endemic in financial advice in the past. Recent changes to the Corporations Law have almost wholly stamped out these practices. It is, however, always worth understanding whether an adviser’s business model involves you investing in managed funds owned by the advice practice or not. This will help you know the actual cost of advice and the potential business model of the advice practice.
One of the most significant benefits of establishing and maintaining an SMSF is that it allows you the ability to control when, how and who you invest with. If you appoint a financial adviser to manage your portfolio, you will likely relinquish some of this control. This may or may not be right for you and requires detailed consideration.
This list is by no means exhaustive. If you are thinking about reaching out for advice, it is best to think first about what services you want. This will help you ask the right questions of prospective advisers before you engage them and hopefully lead to a mutually beneficial relationship.
- If you borrow to buy a property through your super and you’re negatively geared, the tax offset only applies to other income earned within the fund – not your regular income.
- You can’t live in the property and neither can any friends or family members.
- You can’t renovate a property purchased through an SMSF while it is still under a loan.
- There are thousands of dollars in set-up costs, and there are sometimes higher fees involved in getting a loan through your SMSF.
- Running an SMSF is complicated, and penalties for getting things wrong are high. However, you can pay a professional to run it for you.
- Buying property through an SMSF is generally only suitable for funds with $200,000 in combined funds.
Buying property through super is a great way to invest for retirement, but it’s probably more relevant for people who are only 20 to 25 years away from it. Not only do they have more super money at their disposal, but they are also more likely to be able to hold the property until after retirement to realise those significant tax savings.