The draft report of the Murray Inquiry into Australia’s financial system, released last week, took direct aim at self-managed super funds (SMSFs) and leverage, warning that they could pose risks to the financial system and retirement savings:
The use of leverage in superannuation funds to finance asset purchases is embryonic but growing. The proportion of SMSFs with borrowings increased from 1.1 per cent in 2008 to 3.7 per cent in 2012. The average amount borrowed increased over this period from $122,000 to $357,000. Total borrowings in 2012 were over $6.2 billion. More recently, Investment Trends research found that, over the year to April 2014, the number of SMSFs using geared products increased by more than 11 per cent to 38,000…
If allowed to continue, growth in direct leverage by superannuation funds, although embryonic, may create vulnerabilities for the superannuation and financial systems.
The Draft Report also recommended removing the ability of super funds to leverage into investments:
The general prohibition on borrowing in superannuation was introduced for sound reasons. Although levels of direct leverage in the superannuation sector are low, they are increasing. Removing direct leverage in superannuation is consistent with the concept that superannuation tax concessions should apply to funds that have been saved and not borrowed. There are ample opportunities — and tax benefits — for individuals to borrow outside superannuation.
Over the weekend, the Australian media built on these concerns and highlighted that many SMSF are now facing collapse due to leveraged property deals that have gone wrong.
According to Fairfax’s Duncan Hughs, some SMSF investors have lost up to three quarters of their investment in dodgy property deals:
Some self-managed superannuation fund investors who borrowed heavily to buy real estate have lost up to 75 per cent of their investments in two years…
These investors have typically bought their properties off-the-plan and have paid above-market prices thanks to incentives offered by the seller, such as guaranteeing rental income for the first 12 months…
The massive losses incurred by these investors are despite a buoyant property market posting double-digit increases and some of the lowest interest rates in history…
Each month more than 3000 property buyers are borrowing via their DIY super funds to purchase business or residential property…
From The AFR reported similar:
The collapse of over-leveraged self-managed super schemes invested in off-the-plan apartments strengthens a financial system inquiry call to ban direct leverage in the $1.8 trillion super sector.
Certified financial planners fear recent cases of do-it-yourself schemes collapsing under the pressure of servicing huge loans to buy apartments could be the “trickle that turns into the flood” as interest rates rise from record lows.
Commission-driven property advisers – a description anyone can use – are also being blamed for encouraging defined benefit scheme members, which offer guaranteed super payments, to switch into leveraged self-managed schemes.
The property buying spree is reportedly being fueled by generous incentives offered on apartment sales by developers to unauthorised and unqualified financial and property advisers that recommend their projects:
Cash payments of $40,000 are routinely made to advisers for recommending apartments, typically to self-managed super fund investors seeking to bolster their retirement income.
Investors are being offered astonishing double-digit returns, guaranteed tenancies, regular rental income and perks, such as “free” furniture, in a bid to invest in off-the-plan developments.
“Property experts” and “financial advisers”… are typically offered between 6 per cent and 10 per cent of the sales price as commission. There are additional perks and payments, such as extra bonus commissions, for additional sales.
Meanwhile, another article by Duncan Hughs notes that:
Advisers recommending self-managed super funds claim they are being bombarded by property developers with offers of up to 20 per cent commissions, top-up bonuses and other special cash incentives to encourage the super investors to buy off-the-plan apartments.
Allowing super funds to leverage into property and other investments was arguably one of the biggest blunders of the Howard Government. In permitting leveraged investment, the Coalition effectively turned super from being a retirement savings system into a speculative vehicle, in turn dramatically increasing the riskiness of Australia’s retirement savings and financial system.
Given many SMSFs have already lost large sums during a period of strong property price appreciation, one can only shudder to think what will happen once price appreciation slows or values fall.
It is a disaster waiting to happen and highlights the need for leveraged investment in superannuation to once again be banned.
