Can super save the housing market?

This blog has talked a lot about government policies that have contributed to Australia’s sky high cost of housing – from supply constraints to the first home buyers grant, negative gearing and implicit and explicit support provided to Australia’s mortgage lenders.

One topic that has yet to be discussed is the Government’s recent changes to superannuation laws enabling leveraged investment (speculation?) in direct residential property by self-managed superannuation funds (SMSFs).

Below are a collection of articles explaining the super changes and highlighting some of the anticipated market impacts.

From the outset I will admit that my knowledge of super law is scant, so I am hoping that readers with a better understanding of the new rules can elaborate further.

I first became aware of the super rule changes back in January when Fairfax ran an article entitled Property’s a super option. Apart from a good dose of spruiking about how you ‘can’t go wrong with property’, the article contained the following tid-bits explaining the changes.

Over the past three years, the regulations governing self-managed super funds have changed significantly, making them cheaper to set up while at the same time relaxing the rules on how they can be used to invest in residential property and even borrow to buy.

As a result, many real estate agents have, over the past six months, noticed a sharp surge in the number of buyers in the market looking for investment properties – usually apartments – to purchase through their super funds…

Before the rules changed, it could cost up to $12,000 to set up the complex financial structure of a self-managed super fund but now it can cost as little as $4000, says Chris Duffield, the head of Dixon Advisory Property, which sets up funds for customers and then either advises them on property to buy, or buys for them.

In addition, it’s now possible for super funds to borrow a large part of the property price, usually up to 70 per cent.

“As a result, particularly over the last six months, we’ve been inundated with inquiries from people looking to use residential property to secure their future in super,” he says…

Benefits of buying property with super include capital gains on assets held for 12 months or more being taxed at just 10 per cent and, during the pension phase, being totally exempt from tax – as is income earned.

Then an article published in the Australian Financial Review (AFR) on 19 May entitled Real estate agents target DIY super, added further insight into the new super rules and their potential impacts on the housing market.

Real estate businesses are partnering with financial planners to target property investors in the $420 billion self-managed superannuation sector to take advantage of new rules that allow schemes to borrow to invest.

Details of the tie-ups have emerged as Tax Office figures show that residential property investments by self-managed schemes surged 32.5% between June 2008 and March 2008…

Property experts say the growing interest among do-it-yourself super funds in residential homes and apartments valued at less than $1 million is helping to stem the fall in house prices.

Real estate agents, who are looking to expand their databases of potential buyers, are recognising that financial planners and tax agents represent a gateway to the largest sector of Australia’s $1.3 trillion super industry.

Partnership deals give advisers access to a new pool of clients who are likely to need help with tax and gearing strategies.

Among the first to announce a partnership is property agency Ray White. Its Sufers Paradise office has teamed up with planning network SMSF Strategies and is conducting information sessions for DIY funds which want to invest in property…

SMSFs have become more active investors in direct property over the past year, attracted by softening house prices, strong rental income and changes in legislation allowing them to borrow to invest in property and shares…

Changes in 2007 to the Superannuation Industry Supervision Act in effect opened the door for super funds to invest in property by allowing them to borrow to invest in direct property or shares, subject to certain strict conditions.

Estate agents argue that one of the main benefits of buying property in a DIY fund is that capital gains tax is much lower and can fall to zero once the owner is in retirement.

“Rental income received by the SMSF is also non-taxable and can go straight off the loan and will not count as a trustee contribution”, said Mr Lee…

Asked whether DIY super funds were having an impact on the stability of the weakening property market, Mr Lee said that “it was certainly a mitigating factor in keeping current property prices stable in the under $1 million segment of the market”.

Certainly property industry representatives are happy with the super changes.

Founder of McGrath Real Estate, John McGrath, labelled the DIY super as the “next big thing” for the property market in a recent AFR article (Sharemarket holds back Sydney prices: McGrath, 2 June 2011).

New laws allowing SMSFs to borrow to invest in property would “put an enormous amount of pressure” on properties priced less than $1 million, in the price range of those that appeal to first home buyers, making them more expensive.

“I think this DIY super phenomenon is the next big thing… The problem of people trying to get their foot in is getting worse, not better – they may as well take the plunge”.

Not surprisingly, Meriton Apartments founder, Harry Triguboff, also supports the new super rules; only he would like them loosened even further. From Open the door to super: Meriton (AFR, 15 April 2011):

Australian’s should be able to use superannuation funds to buy their own homes, billionaire developer Harry Triguboff says. Such a change would give a big lift to property sales.

The founder of Australia’s largest apartment developer, Meriton, has called for the federal government to ease laws limiting the buying and use of residential property, particularly by SMSFs.

“We want to have SMSFs that can buy property, where a person can live in the property they bought with the super fund, or they can rent it out to family… This we cannot do today”…

“I spoke to a few financial planners in the industry and a lot of people are setting-up their SMSFs… From what they tell me, 99.9% do it because they want to invest in property”…

Meriton markets apartments in Sydney, Brisbane and the Gold Coast to SMSFs.

Call me cynical, but from where I am sitting, the super changes look like another government policy aimed at supporting the housing market. As with all demand-side policies, without a corresponding liberalisation of the supply-side of the housing market, this measure (other things equal) is likely to make housing even less affordable, as the extra demand would feed predominantly into higher prices rather than new construction.

Given that housing already comprises the lion’s share of household assets – 62% as at September 2010 (see below chart) – one also has to wonder about the efficacy of a policy that encourages households to concentrate even more of their assets in housing.

And then there is the broader issue of whether superannuation – a policy designed to ensure that households save for their own retirement – should be allowed to borrow to invest, whether in shares or property. Gearing both amplifies an asset’s returns and losses, making superannuation a far riskier proposition.

Finally, if real estate agents are going to jointly market property to SMSFs, isn’t it about time that they are required to be properly licensed by the Australian Securities and Investments Commission (ASIC), and be subject to the same rules and responsibilities as financial planners?

I am interested in reader’s views. Are the new super rules good policy or a retrograde step?

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Unconventional Economist
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  1. I disagree that allowing super to borrow to invest in property is generally a bad idea, although the timing of such at present would seem quite a risky option for retirement savings. But as a an accountant, I know that the ATO are taking a very strict technical approach to the rules and I would not encourage any of my clients to use the borrowing provisions, due to the lack of any flexibility. In essence the ATO say that the property can never be improved whilst it has a loan against it as that would constitute creating a “new asset” which is against the borrowing rules. The borrowing costs are also prohibitively expensive and there are other ways to access other equity to get the same outcome anyway.

  2. Thanks again for an interesting piece Leith. I’ve pondered the implications of this rising finance vehicle myself… a lot of people have huge amounts of super to splash around (not me though!) and are looking for somewhere relatively safe to put it. Seeing as the stockmarket is tracking sideways and offshore is still dodgey following the GFC, I’m sure rental housing looks like a great investment given the sky high asset growth since 2000 however I’m not sure about repeating that performance again over the next ten.

    Now I’m sure when people like Meriton promote apartments to locals and foreigners alike they are probably using (for example) capital growth in Melbourne 2000-09 to show people that ‘never mind the actual returns, see the appreciation!’ to get them buying without explaining the potential downsides. However until it all goes pear-shaped then I doubt that we will see tighter regulation of real estate’s defacto financial advice; the big lesson from the GFC in the USA and Europe was that regulators always look the other way provided things appear to be ‘normal’.

    The thing that really suprised me in your post was that rent is not taxable – given how much people just LOVE dodging tax in this country I’m sure a lot of people will be sinking their self-managed funds into that weatherboard dive in Coburg just for that reason alone.

    • Bubblelicious

      As with any investment, I think you need to take care with direct residential property as a superannuation asset. I’m no tax expert but;

      – 15% Tax in the accumulation phase would be less attractive from a negative gearing perspective for most people relative to holding the property outside of super.

      – 0% Tax in income phase applies to all asset classes in super, so you would need to consider the yield and any capital gain.

      Given current low rental yields on property and the outlook for capital gains, I suspect that many will opt for a term deposit as a safer option.

      The fly in the ointment is the conditioning of baby boomers in their faith in the property market, combined with the opportunity to leave the property to the estate (particularly if they feel the kids are locked out of ownership).

      It’s also worth noting that the rule is really about gearing and so there are potentially other asset classes that can be geared into, such as shares.

  3. I would add that the fact so many boomers are about to rely on their Super to live off during retirementand and they already have too much of their wealth in property as shown in chart…this would suggest only younger people would be thnking odf this. BUt most younger people dont even know where there Super is and how it is managed. It is usually in later years and with more time that the idea of Self-Managed Super is appealing to your average under 40 year old.

  4. Not sure what legislative changes have been put through that makes SMSFs cheaper (and I work in super) but property has always been a popular option for SMSFs.
    The ATO (and other regulators) are starting to express concern over the gearing that is being offered to SMSFs. SMSF debt has to be very carefully structured, and a lot of banks have taken advantage of loopholes and tricky structures to get around this. he ATO has stopped being forgiving and has started enforcing penalties on funds that breach the rules, and I am inclined to suspect that a lot of the property ones are.
    Interesting that a lot of boomers are going to rely on property to keep them going in retirement- will the potential rent really be enough to fund day to day living?

  5. Leith,

    Some interesting data at this link:

    Interesting to note that at June 08, total Residential Real Property holding was $10,869m in a total Fund asset value of $320,086m. This represents 3.4% of total assets held in residential property.

    The estimate for Mar 11 Residential Real Property holding is $16,341m in a total Fund asset value of $432,370m. This represents 3.7% of total asset value.

    Total Fund asset value has gone up by 35% between June 08 and March 11. At the same time, value of Residential Real property holdings has gone up by 50%.

    Whichever way you cut it, the trend looks fairly obvious.

    Given that the most recent data is extrapolated from the 08-09 returns, could be that the trend might slacken a bit, given what has happened since then??

  6. The real issue is gearing in super. If super is supposed to be a savings vehicle for retirement then there should be no gearing allowed in super. It is simply too risky an investment given the purpose of super funds.

    By all means, if an SMSF has the funds available to buy a property outright then go for it. It makes sense if a fund can acquire a property with good rental yield to increase the investment earnings of the fund. But allowing gearing to chase capital appreciation/speculation is a mistake.

    Softening prices might make it less attractive to hold property in SMSF’s, i’d presume that if you arent willing to invest in property outside of super you wont do it within your super fund. I guess we’ll see, thus far investment in property may have grown quickly but thats off a low base and it includes the capital appreciation over the last couple of years as well. So far its still pretty fringe despite the efforts of agents.

  7. Using Super could be a good thing if it was actually used to help an individual instead of just helping the government keep the house prices high, It would be good if low income earners could access their super to purchase a home or to help pay off a mortgage, but the government would not think this way its all about keeping that people buying houses to keep that market going higher and higher, Its a shame we live in a country where the Government is run like a business and not a team of people working together to make our country a better/easier place for people to live.

    • An important thing to remember here is that our government believes the Flog, much the same as pretty much every other country. If the Flog were right our government would in fact be doing a marvellous job as managing our economy and securing the countries future. Sadly, the Flog are very wrong, still.
      Mind you even with that in mind our Parliament is still focused more on politics than on good policy.

  8. As part of the “GFC rescue packages” which included the FHOG, increased foreign investment as well as buying RMBS from the AOFM, the government changed te super rules, encouring more residential property into SMSF. A local accountant that I know , has been busily gearing SMSF with properties from a low socio economic area, that still has reasonable yields, maybe 4% before expenses.
    The other interesting rule change was the reduction in deductible super contributons from 100k to 50k. I believe this was too fold, one it lessens the incentive to sell a property realise the CGT and offset the gain agaisnt super contributions, secondly it encourages negative gearing and the creation of more credit.
    Treasury and RBA know exactly what they are doing.

  9. The main caveat with buying property in super is the in-house asset rule (although there is an exception for business property) and sole-purpose test.

    Effectively, if your super fund buys property, you can never live in it (even in pension phase) or rent it out to yourself or any related members of the fund, unless the total market value represents less than 5% of your super fund.

    Business property can be leased to the trustee or a related member – the common scenario is the trustees own and run a business outside super (usually in a family trust), the super fund buys the business premises (e.g an office or shopfront) and then leases it to the family trust.

    The cashflow from the lease is used to pay down the loan inside super. Once the trustees decide to retire, they can sell the business premises in super (usually tax free capital gains if done right).

    The gearing is the issue, as Pete raises: the maximum LVR used by banks usually means no negative gearing (which is good), but its still pretty high at 70% – not exactly a positive cashflow asset.

    Other risks are obvious – unless you have a big super fund (the average SMSF is almost 1 million, the average non-SMSF is less than 100K), you will be highly concentrated in a single asset that may not provide any positive returns if you are leveraged.

    In essence, the current rules are set up to make property investment a cashflow positive type structure with low gearing, but loosening of these rules is something to watch……

    great article Leith!

    • There are a number of issues that most people do not address with property inside a SMSF. For example; you Cannot improve the property. If you decide to put on an extension, you can be penalized. There is discussion that if a house is damaged for example in the Queensland floods, the property cannot be rebuilt inside the SMSF as technically the property will be ‘improved’. As such technically the owner may need to sell the ruin. Retain these funds and the insurance funds and then purchase a new property.

      You also cannot do any work on it yourself as this is technically a contribution. For example if the lawns need moving, either the tenant or a paid professional need to do this (I’m not sure how the ATO can watch for these kinds of things, but these are risks that investors need to be aware of).

      I am sure most people who are already employing this strategy would unlikely be aware of these issues, as well as many of those recommending the strategy.

      • Ah, that is very interesting and would make the acquisition of property via SMSF quite unattractive if improving/renovating/value adding options are rule out. Anyone know what the penalties are for doing so?

        • and what about returning an asset to its original condition ??

          penalties could be has harsh as non compliance

          • The Queensland floods brought a few of these issues to the fore. The ATO who oversees SMSFs had to give special exemption to allow property owners to rebuild as simply taking the insurance money and selling the land (which technically is all you can do after total destruction) was going to cause havoc with too many properties caught.

            Non-compliance (which happens rarely but is on a massive upswing) is a flat 46.5% tax across all assets of the fund, regardless of underlying characteristics (ouch!).

    • I have seen something that indicates that the ATO/Government would like to phase out/eliminate the 5% rule for SMSFs- ie no matter what the value is within the total portfolio interaction between related parties becomes a no go area.
      I suspect new rules ensuring that accountants have to be qualified to give advice for SMSFs should hopefully reduce the nu,mber of people who are unaware of the sole purpose restrictions- a lot of accountants (not all, but the bad ones do a lot of damage) seem to give the advice on purely tax basis and forget to ensure that the client understands the other responsibilities that the fund has

  10. Sandgroper Sceptic

    A worrying development if people get sucked in by this trend. I personally thought the old rules were fine – SMSF could invest in property but was not allowed to borrow, that effectively excluded a lot of SMSFs from investing in property and also lowered the risk of things going sour. The business property exemption was commonly used and in a lot of cases provided the SMSF owner with its best performing asset. I really cannot recommend that SMSFs borrow to invest in residential property for four reasons:
    (1) The asset class itself is overvalued, term deposits provide a much higher yield with no risk.
    (2) Most baby boomers with large SMSF balances will already be full to the gills with property outside their SMSF.
    (3) Borrowing creates a lot more risk, especially in a vehicle which should be conservatively managed.
    (4) There are quite a few rules which could trip you up, ie the improvement rule..

    Geez I am trying to get my Baby Boomer relatives out of their property portfolios this will only encourage them to go the other way. This will only encourage the ticket clippers and property spruikers.

    +1 On property spruikers getting a license too!

    • +4 Sandgroper.

      I might lean on you, Adrian and other planners/advisors out there when I write my article about investing in property in super.

      There is a place for it – I intend to invest in agricultural land/property (not MIS) – particularly business property (either own or commercially leased warehouses/offices etc), but the major concern is the concentration of resi property in pretty much every wealth asset the average Australian owns (i.e outside super, inside super, shares (banks are effectively a long call option on resi property) etc.)

      • I think you may have misunderstood what I wrote.
        1. I am not an advisor, although I work in the industry. 2. I was talking about property in generals terms, the issue is that most invest in residential property. 3. I think as you have said, there is some room for property in a SMSF. I still do not believe now is necessarily the best time to be buying any property, but that is just a personal opinion. 4. I believe that gearing is an approprate strategy for Superannuation. Simply put Superannuation investment should have a much much longer investment timeframe than any personal investment and as gearing is supposed to be a very long term strategy, I think it is apropriate, as long as the person understands what they are doing and what they are getting themselves in for.

        • I have been dreaming about property spruikers and licencing for a decade. I cant understand why if I tell a client to put money in a term deposit I need a Financial Service Licence costing me tens of thousands a year, but these clowns can say things like “invest in property its better than shares or super” (super is not an investment!) no one cares about proper licencing, experience, education, indemnity insurance, due diligence, etc, etc, etc. Sigh.

  11. This is old news, to a large extent. Agents have been marketing to SMSFs for some months now, especially at the low end of the market. Serviced apartments and hotel rooms with “guaranteed” rental incomes feature prominently.

    I suspect that a lot of SMSF capital has gone into real estate because of poor stock market returns. My impression is that SMSFs tend to be run by people with short attention spans, chasing the asset class with the best returns over the previous year or two. Since the ASX hasn’t done that well, property is the alternative. (They probably anchor their expectations on the high ASX returns of 2003-2007, so 6% on a term deposit is unacceptable.)

    However, for the same reason, SMSFs are equally likely to dump real estate if it doesn’t deliver the high returns they expect. Consequently any price support they provide is likely to be short-lived.

      • innocent bystander

        that was for the quote between the which got lost:
        “My impression is that SMSFs tend to be run by people with short attention spans”

        • SMSFs are, by definition, mostly run by amateur investors. Amateur investors chase last year’s Big Thing, and pay the price. This behaviour is well documented.

          No doubt there are exceptions, but they’re a minority.

  12. This country will be a mess when all of our debt unwinds. $1.3 trillion household debt and now they are allowing more borrowing through super. When we go belly up, these people who have borrowed through their super will end up on some sort of government welfare and the taxpayers will be forced to fund their mistakes.

    “Gold is the money of kings; silver is the money of gentlemen; barter is the money of peasants; but debt is the money of slaves.”

    • +1.

      Enough people make bad enough investment decisions with their super without gearing.

      Some countries are increasing deposit requirements to control asset bubbles but we are being encouraged to take on more debt??

  13. I am a financial adviser and get to see alot of what goes on re SMSF’s.

    It is hard to generalise as there are different types of people who use them. I would classify the market broadly into middle Australia and people with money.
    Middle Australia is largely made up by people who use them to chase returns and mum’s and dad’s who haven’t had a good experience with their super. You will find them at seminars/information evenings lapping up the shortage/doubles every 7-10 years pitch. Once they have been pre-qualified they get in on the ground for ‘high quality’ property.

    Generally most of these people should be nowhere near a SMSF. It is like giving a kid a loaded gun it will eventually end badly.

    These people are firmly in the sights of RE agents, developers, accountants, mortgage brokers and financial planners. The RE party has slowed right down so SMSF’s are an irresistible honey pot for alot of people right now. As long as super returns remain in the doldrums, expect the rate of migration from traditional super funds to SMSF’s to speed up. My firm belief is middle Australia is not going to have a positive experience with their SMSF.

    People with money pay well (fees not commission) for advice and tend to get alot out of SMSF’s. They tend to avoid the residential space leaving that to the savvy mum and dad property investors. The guys with money mainly operate in the commercial property space.

    • Completely agree with the assessment of the middle Australia SMSF investors- these are the same group that piled into Westpoint, Timbercorp and Storm. Those that trust that their advisor will always do the right thing by them (despite having nothing more than a commission basis) and have not worked out that investments go both up and down.

      That said, a lot of the funds on the industry side (don’t know about retail and they get a second bite at the money through funds management for SMSFs anyway) have started to put this point across to potential SMSF owners. They have recognised that there is no point running after the ones with real money (who know what they are doing), but that there are good possibilities in the mum and dad investment sector. I would expect to see more aggressive ads noting how much work really goes into SMSFs, and the returns against that work, in the next few years- much like the hated industry fund ads. Anecdotally (I don’t work that close to the coalface anymore) there are disillusioned SMSF investors returning to the fold of public offer funds

      • The big retail players (within conglomerates) are developing SMSF offerings to try and get into that market, as well as improving high net worth and affluent offerings. As with everything else, they wanna clip the ticket as many times as they can.

        The industry funds arent in a position to do this, and thats their vulnerability. They have advantages in fees and economies of scale, but are at a disadvantage in being able to develop full product offerings which have multiple fee-earning possibilities.

  14. Alex Heyworth

    Two points:

    1. you can gear your allocated pension fund by investing in geared share funds. Just as risky as gearing property, probably more so.

    2. 0% tax on capital gains means 0% of capital losses can be offset. Caveat emptor!

  15. renovate this

    “Real estate businesses are partnering with financial planners to target property investors” – is that ‘target property investors’ or deplete property investors of funds?
    You know it is going to end in tears for the hapless ‘investors’ from the Mum and Dad Ozzie Investors Club.

  16. SMSF Investment in property is certainly a worry. I have seen many a client engage in it and they simply don’t understand the costs and complications. Advisers AND ACCOUNTANTS take clients for a ride on these strategies.

    Thousands to set up the fund and administer it, advice on the property etc. All so someone with $100k in super can allocate it all to a geared 3 bedroom shoebox in the suburbs!

    To address the topic though.

    1. I don’t see this as an attempt to prop up the market. Why? Because borrowing within an SMSF was never intended for this purpose, clever legal minds exploited the small loop hole of instalment warrants and then ATO had to concede (to the legality) of their strategies. Now that so many of them are in place the Govt really had no choice but to sure up the legislation or risk a compliance nightmare.

    2. The ATO and the Govt have made it very clear they are not at all happy about this situation, the rules are strict and SMSF borrowing arrangements are set for review in 2 years time. It has also been made clear that should the govt see a large increase in SMSF borrowing as a result of the new legislation they will shut it down. The ATO does not want you engaging in this activity and any data that suggests these strategies are contrary to the stated national objectives for superannuation (being conservative retirement savings) will give them ample ammo to close the door.

    My 2c

    • I agree with most of what you say BB except that the ATO were the ones to come back and redefine a long established definition of what consititutes an Installment Warrant.

      This is where all this has come from.

      Previously these borrowing structures where only allowed against shares, but much to the surprise of the SMSF industry they delibritly broadened the definition to include all assets an SMSF was otherwise allowed to invest in. No one was asking for it or looking for it, the ATO came out on its own, and they have already stated that they have no intention to broadly peel back the new definition in the future review.

  17. An excellent piece and great amalgamation of desperate media releases. I fear this leveraging exercise will just prolong the inevitable housing de-leveraging, leading to declining values as in the UK and US. Why superfunds at this stage? Maybe it’s just the bank of last resort.

  18. It is easy to prudently invest in property in a SMSF – via listed entities that specialise in the class of property desired.

    For residential; well managed home builders are presently trading substantially below NTA and paying dividends comparable to direct residential investment. Why bother with direct property with high transaction costs (retail) when one can buy at 50-60% of wholesale and own a part of a professionally run business?

    3% on 50% > 3% on 105% QED


  19. Much of what has been said is true.

    What has not been raised is when a SMSF members wants to receive a pension income.

    In pension phase, the fund MUST pay a minimum 4% of the asset value as a pension income (if under 65 yo) and 5% if age 65-74.

    Now, with net yields on residential property at less than 4%, and insufficient cash reserves, eventually the SMSF will be forced to sell their property investments to finance their pension income.

    Whether you invest inside or outside of super, the yield on residential property is less than current term deposit rates.

    Residential property inside of SMSF now has an ‘end-date’….when members reach 55-65 and require a pension income.

    Expect greater selling pressure on residential property.

  20. Spot on DavidB which is why I like the low transaction costs of using listed vehicles. Even the most illiquid stock is more liquid than direct RE.