More warnings on SMSF property leverage

ScreenHunter_30 Oct. 10 06.15

By Leith van Onselen

Jeremy Cooper, chairman of Challenger’s retirement income area and former deputy chairman of the Australian Securities and Investments Commission, has warned that self-managed superannuation funds (SMSFs) are accumulating too much property debt, which poses a major risk to Australia’s financial system. From The AFR:

“There’s enough leverage in society anyway…We leverage up our homes, the minute you buy a share you’re building leverage, there’s a lot of personal debt around and we’re seeing people going into retirement with more debt.”

Mr Cooper… said he was against government policy allowing self-managed superannuation funds to highly gear into property investments, but it was hard to unwind.

Cooper’s warning echoes those of the draft report of the Murray Inquiry into Australia’s financial system, which last month took direct aim at SMSFs and leverage:

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 Murray 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.

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.

Already, cases have emerged whereby SMSFs are facing collapse due to leveraged property deals that have gone wrong. Last month, The AFR reported several cases of collapses of over-leveraged ­SMSF schemes that invested in off-the-plan apartments, fueled by generous incentives offered on apartment sales by developers to unauthorised and unqualified financial and property advisers that recommend their projects.

Fairfax’s Duncan Hughs, similarly reported that some SMSF investors had lost up to three quarters of their investment in dodgy property deals over the past two years, whilst also noting 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.

Given some 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.

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Unconventional Economist
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  1. reusachtigeMEMBER

    Major risk… oh bullsh! Property investment has proven to be a great wealth strategy in this nation and the smart people know this. The more people that invest all their money into housing the better our economy will be, eventually.

    • Better yet, they should leverage to the hilt and invest other people’s money – it’s a proven way to get rich quicker!

      All the smart people are doing it – at least that’s what my “in the know” mates at the BBQ said.

    • So for a few years we have urgued that the property market will crash, I am still a fan of it crashing but when will we start to see something taking effect. Will it be a combined case of the mining cliff which car factories closing in the next year or so or could it be darker, a growing civil unrest with mass immigration where we reach a tipping point and people start taking the law into their own hands ?

      • The RBA obviously wants as many people borrowing as much as they possibly can so that when they put interest rates up they’ll be slaves to the banks which may just stay solvent.
        People forget that the ‘B’ in RBA is Bank, so their No.1 priority is to look after the banks…. Not the people.

      • Yeah im still waiting for. Despite reports of a downturn in the Perth Property market im not seeing any signs of increased stock for sale for any sign people are not prepared to pay above the going rate for what is on the market.

      • I’m waiting too, but am not holding my breath. More concerned about protecting my savings that would be confiscated when the crash comes!

      • I think when it turns it is going to turn quickly and once it starts the herd mentality on the downside will have the correction happen quickly and brutally.

        Personally I think we are fast approaching a perfect storm built up by a slowdown in China (read today’s property reports) coupled with Australia’s fiscal imbalance and rising unemployment.

        Once reality sets in that Australia’s property market is not unlike all others then we will see a reversion to fair value. There is no greater leveller than FEAR.

        I’ve been telling everyone I know that this is coming. I’ve shared the macrobusiness link and even bought Lindsay David’s Australia Boom to Bust for family.

        My strategy at this time is to stay liquid – with some options plays to profit on the downside.

        With respect to timing I’m picking a correction within the next six months.

  2. I suspect anyone in this situation based on recent events will have the fallback of suing the banks for lending them the money in the first place.
    That seems to be the way its all going.
    No need to take any personal responsibility.
    Sue the banks for lending you the money at all.

    • Well if it goes south I would suggest drawing your money out and buying something of physical worth such as gold, silver, platinum because I think it will crash the banking system and government will only pay out so much for bailouts.

    • +1 so true

      Fraudulent loans aside, those who chose to over-leverage into property deserve everything they get. Hopefully pensions are disallowed/reduced to these people – the other side of the leverage coin needs a decade+ of examples in Australia.

  3. It’s certainly a classic evidence of a bubble when it seems to have already run about as far as it can, and THEN institutions that have stayed away start to pile in.

    But I have reluctantly been persuaded recently that the big crash may not come till 2024 – 2026.

    Big crashes seem to require that the bears have finally been so “discredited” in the eyes of everyone, that no-one listens to them anymore, not even FHB’s; who sadly mortgage themselves up to over the top of their heads just before the crash, to “get on the property ladder”, with some utter shite-box that is all they can afford – quite likely some 50 square meter dog-box that will be the political “solution to housing affordability” by that time.

    • Remember to add in the capital explosion coming out of China Phil.

      It’s going to be a nasty little mixture this time.

    • “But I have reluctantly been persuaded recently that the big crash may not come till 2024 – 2026.”

      The US and Europe barely scraped through in 2008, and now they have all that sovereign debt to manage.

      Japan is again in deep recession and after 25 years of deficit spending and very low interest rates, have proved conclusively that Keynesian economics is a terrible joke.
      These measures will be proved wanting in the US by Taper’s end and increased interest rates.

      Let’s hope so anyway.

      Whatever happens, this 43-year period of experimenting with fiat currencies, zero interest rates and QE will be the laughing stock of History.

      • No it won’t, it will be a typical effort by the status quo to maintain power whatever it takes. And it is naive to think that power will be lightly handed away to conform with some mythical notion of markets.

      • Hi aj.

        There is nothing mythical about the abject failure of Keynesian policies after 80 years of practise, and the 43 years of all currencies being fiat out of 5,000 years is not mythical either.

        The only myth is that people might think this can continue.

      • 80 yrs is a long time in the lives of men. Markets and their ‘morality’ is myth, there are only winners and losers. I see no evidence that today’s winners will be tomorrow’s losers.

      • If you will not learn from History you will have to learn through Experience, and Experience runs an expensive school.

      • Ha. You wish, bet you missed the biggest asset boom eva! Don’t worry it will correct of course, of course….


    • 2024-26? Why is it going to take another 10 years for it to crash? We have to be close to maxed out now.

      My pick is unemployment at 7.5%, the dent to confidence combined with foreclosures is about the only thing that is going to stop this beast.

      • I would rather my recent change of opinion was wrong, than my earlier opinion that the crash is imminent.

        But I fear the worst – that the people who have persuaded me that it has at least till 2021 to go yet, with 2023-2024 being “most likely timing” and 2026 absolute latest – are correct.

        I am using this argument with politicians in an endeavour to get them to reform now, because there is potentially another 10 years of debt run-up before a horrendous mother-of-all crashes, otherwise. The problem is not that most of them believe in an early crash rather than a later one; they believe in “no crash at all” and “a new normal”. Fools. I wish the early crash was the likely event, to teach everyone a lesson that would be a little more possible to recover from. The late one could be the full and final collapse of the entire credit money system that Ludwig Von Mises warned of.

  4. Given the number of bankers and politicians taking this path, we can safely assume their will be a bailout of some kind if there is serious falter.

      • Exactly. A bail-in is just a clever word for bail-out, what matters is that power and wealth is maintained.

      • There are conditions that absolutely cannot be fixed with bail-outs or bail-ins or easing. That is why the big crash might not come till 2021-2026. The bail-outs etc will work – until then. When they no longer work – head for the hills, stock up on bottled water, tinned beans and ammo.

      • I’m actually just saying let’s not confuse what we expect to happen in a market, with what will probably happen in a highly controlled and manipulated environment.

        We didn’t see asset deflation this time and we won’t next time, we will see currency deflation. There are only assets now. Whether it’s gold, stocks or houses, people are buying for the same reason. But which asset class do you think the pollies and the rent seekers will move heaven and earth to save?

      • @pb. Do really think the financial aristocrats, the lords of usury, give a sh&t if there is a crash if they hold all the assets as security? Do really think the politicians won’t bail themselves out with the public as a pretext?

        You guys are market believers, that’s nice.

  5. mine-otour in a china shop

    Challenger and property debt? Does the Life company’s assets not include lots of property “assets” under the company structure trust?

    Do they not hold lots of tier 2 capital via subordinated debt – most of it negatively geared?

    Why should a life insurance company hold so much assets in property and be exposed to this risk?

    People in glass houses…….

    • I wonder if Mr Cooper would be against buying an Annuity product with leverage ?

      Great unbiased opinion … NOT

  6. Staying away from property naturally, but yes, where is the safest place for your hard-earned? Shares in my opinion are better than money in “high-interest” account because I too believe the bank bailouts will not cover enough – besides it’s only $200K per person (or is it per-person-per-bank? or simply per-account??). Shares may drop when the property crash comes but it should rebound in the decade or two before I retire and there will be buy-at-the-bargain-bottom options available like in 2008. I used to think gold was a good hedge but with so much central bank manipulation and gold-holders being the minority I think manipulation will favour shareholders as I can’t imagine 90% of the population with share-heavy super accounts losing all their super again so soon.

    But hey, I’m no expert. Happy to hear what others are doing and more importantly what (and why) they are NOT doing. Also context is important (how far off retirement, etc).

    • Hi DaveK.

      The Financial Claims Scheme “guarantee” is $20 billion per bank with the actual deposits of the Big Four as of 2012: ANZ, $397 billion; CBA, $428 billion; NAB, $420 billion; Westpac: $395 billion.

      We are a member of the G-20 and as an organisation it was decided in 2010 that after the bail out of 2008 whereby sovereign countries increased their debt beyond reason, in future there would be bail-ins …depositors being unsecured creditors.

      This means that after $20 billion per bank is dispersed in Australia… bail-ins will apply.

      • Jagster,
        Listen to flyingfox, he’s telling you something of significance.
        Your logic is warped. Good grief…

      • FF is delusional living in fantasy land..

        Im living in the real world talking about real world experience.. Take or leave it.

        The example I provided could be taken advantage of in this market if youre prepared to put in the leg work.


    • Not Shares -. Way too risky with PEs expanding
      Not Bonds or TDs – Negligible returns at about the inflation rate

      I still think residential property is the way to go over the next decade in Australia in a low interest rate environment with more money printing and inflation coming down the pipline.

      Also the tsunami of dodgy (and not-so dodgy) Chinese money about to flow onto our shores over the coming years should see +5% pa growth for the foreseeable future…

      I’ve used a similar IP example previously to explain the effect of Negative Gearing as many people still can’t seem to comprehend it.

      Use this as a general example only.

      Purchase price $350000
      Purchase costs @ 4% of price is $14000
      LVR @ 80% is $280000
      Loan interest rate is 4.99% fixed for 5 years
      Rental income $380 wk
      R&M expenses at 25% of Rental income
      Depreciation expenses (Non-cash costs) after year 1 is $5000
      Marginal Income Tax Rate + ML @ 34%

      Rental Income $380 x 52 = $19760 pa

      Loan expense $280000 x 4.99% = $13972 pa
      R&M expense $19760 x 25% = $4940 pa
      Depreciation expense after year 1 is $5000 pa

      Income less Expenses
      $19760 – $13972 – $4940 -$5000 = -$4152 Tax Outcome is Negatively Geared
      -$4152 x -34% = $1412 Tax Refunded

      Cash Outcome
      $19760 – $13972 – $4940 + $1412 = $2260 pa cash flow positive

      Include the possibility of a modest 5% pa capital growth for a total combined growth (before CGT) & return (after Income Tax) after year 1 of over 23% pa ($17500 + $2260 = $19760 pa) of the initial $84000 capital invested. Rental income should also increase at between 4 – 6% pa in well chosen areas as depreciation expenses decline in future years.

      With examples such as this it is difficult not to see property prices appreciate in the medium term (5 – 10 years) while interest rates are low and the unemployment rate stays below 6 – 7%.

      All investing involves RISK, but this really is a no-brainer…

      • Add the 4% on 70K that you would get in the bank = 2800 as an expense and you are cash flow negative.

        Rental income should also increase at between 4 – 6% pa in well chosen areas as depreciation expenses decline in future years.

        Should and would are too different things my friend…

        Edit: BTW your rental income seems very high …

      • Uranium GeoMEMBER

        It will be interesting to see if that unemployment rate remains below the 6 – 7 % more data on the UE trend may reveal otherwise.

        I guess that’s the risk you take…….

      • FF- Im not sure we’re on the same train of thought

        Capital invested by the investor is $84,000.
        In a 4%TD that is a return of $3360 before tax.
        At a Marginal tax rate + ML of 34%, that is an after tax return of $2217.60

        Comparison is $19760…. Almost 900% more than $2217.60.

        Like I said… Its a no-brainer

        Also the rental income is typical for inner city apartments.

      • @Jagster

        You need to account for the loss on income on your deposit. CG aside, (it goes both ways), you’re already cf negative.

        Also the rental income is typical for inner city apartments.

        not ones you pay 350k for!

      • Youre not investing in the TD if youre investing in the IP.

        Comparisions need to be made between the investment outcomes.

        The after tax difference on return between both investments is almost 900%…

      • Rental income of $380 per week on a $350,000 property is fantasy . As is the 4% rent appreciation – currently 2% and falling.

        Current gross returns are closer to 2.5% then there are rates , strata fees and agents costs. Also the cost of a vacant period – I always suggest you model at least 5% as a contingency.

        Also need to consider the income foregone on the 20% deposit.

        Redo your numbers and consider the risks of an illiquid asset and factor in a period of unemployment to get your heart rate pumping!

      • @jagster

        You must be one of the financial advisers with 20 hours of training I keep hearing about. Every heard of opportunity cost? LIBOR? risk free rate of return? Two scenarios.

        1) I by the IP you outlined.
        2) I leave the deposit in the bank.

        My cash flow is always computed compared to 2.

        The decade prior to the last 18 months, Sydney prices were growing at 2% in nominal terms. Other cities were averaging much less than your 5%.

        Rental yields have not been growing at 4-6% either, not on average over a decade.

        Go away now….come back when you have something better to say except 900%….leverage cuts both ways my friend. Just as the SMSF investors …

      • Unbelievable..

        Are you so blind you cant see your hand in front of your face??

        The returns Ive outline are around if you are prepared to look for them.

        In well chosen areas rents are increasing at 4 – 6% if you are prepared to look for them.

        Also you don’t account for opportunity cost when calculating a rate of return. You compare the calculated rate to the alternative opportunities… This is Finance 101.

        Perhaps you shouldnt give lectures on topics you have no idea about and get educated first 😉

      • @jagster

        You know what, you’re right. everyone should go and buy an inner city apartment. They can all enjoy their 900% return since there is such a dearth of them.

        Also you don’t account for opportunity cost when calculating a rate of return. You compare the calculated rate to the alternative opportunities…

        Sure. Thats what your financial advisors certificate says you should do. Whats your cash flow position if you are 100% geared? What is your return less CG if you are 100% money down?

        Perhaps you shouldnt give lectures on topics you have no idea about and get educated first 😉

        Since I have no idea what I’m talking about, I will just shutup and look after my CIP portfolio, returning >9% net including opportunity cost and no CG.

      • Wow!!

        I obviously didnt realise whoe I was talking too.. An Investment Guru earning a return of >9% after tax on their CIP Portfolio, or a delusional insane twit that cant see the forest for the trees. Im sure its the latter..

        Anyway you continue to earn your imaginary returns while I live in the real world and continue to smoke your ass with my handfull of IPs earning the real world returns Ive identified above..

        Goodluck buddy, cause youre gonna need it 🙂

      • @jagster

        So now you have are proven wrong, you resort to name calling … more than one person has identified several serious flaws with your arguments yet they are the insane ones…

        Anyway you continue to earn your imaginary returns while I live in the real world and continue to smoke your ass with my handfull of IPs earning the real world returns Ive identified above..

        Don’t care what you do, your ass is going to get smoked soon enough…no doubt about that…but I do care that you are out preaching nonsense.

        As for returns, all I can see is that you are losing money, day in, day out until you sell. You might make some CG, you might not. On average anyone buying and selling in Sydney between 2002-2011 lost money in nominal terms.

        In the meantime, I am 100% leveraged (with lots of cash in hand mind you) and even at 100% leverage I earning > 2% in cash returns. Don’t care about the CG …

        Should add, by your math, that makes it Inf % return…right?

      • @jagster

        You haven’t actually answered anyone’s criticisms of your so called magical business plan but are happy to slap yourself in the back. How do you expect to be taken seriously?

        Glad you’re having fun. Hope you’re reading the other articles on Mb as well. Might save you some grief later on.

  7. “Locavesting” is really what investors SHOULD do with a LOT MORE of their money instead of putting it into paper instruments on which Wall St clips the ticket:

    But why should they, when every bureaucrat in town will be out to “get” the enterprises they have invested in, over their “environmental impact”, their “health and safety”, their “workplace practices”, their “carbon footprint” etc etc etc.

    • Phil, check out 4 Corners tonight and grow up on the environment issue.

      To iterate, it’s not so much that the boomers raped and pillaged the country, f..d the environment, rooted up all the democratic institutions, and oversaw the most stupendous destruction of the greatest gift to humanity ever, antibiotics. It’s more that they still hold themselves out as some kind of hardworking, super ethical survivors.

      Most never saw a war, never saw a hard time other than what their parents told them about. There was nothing built, only destroyed in their time at the helm, the institutions they inherited from others are diseased and degraded. Listen to them tell you they didn’t have much when they were young, but oh we still used to go sailing and collect lobsters in the underfished, unpolluted oceans … And we’d play in our streets without some tattood meth freaks trying ruin our lives.

      Yeah – thanks for all your work boomers.

      • I regard the position of Matt Ridley, “The Rational Optimist”, as the “grown-up” position on the environment.

        Every enviro indicator has improved as economies have developed thanks to trade and specialisation and private property. Except for CO2, which is the anti-capitalist watermelons last stand. And even that is improving; as Jesse Ausubel (one of the brightest minds on the planet) has said, “on current trend, all the carbon will be out of the global economy anyway in a century or 2”.