Last month, The AFR reported that Australian self-managed superannuation funds (SMSFs) are piling into Australian property, with investment up by 11% in the past year and by nearly 60% since 2011.
The Howard Government’s decision to allow super funds to leverage into property and other investments has been on the radar of policy experts for some time, who are concerned that by permitting leveraged investment, SMSFs have been turned into speculative vehicles, in turn dramatically increasing the riskiness of Australia’s retirement savings and financial system, and further inflating Australian house prices.
The final report of the Murray Inquiry into Australia’s financial system warned of the embryonic growth of SMSF property leverage, and explicitly recommended banning their ability to borrow:
Recommendation 8
Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds…Further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system… In addition, borrowing by superannuation funds implicitly transfers some of the downside risk to taxpayers, who underwrite adverse outcomes in the superannuation system through the provision of the Age Pension…
Borrowing by superannuation funds also allows members to circumvent contribution caps and accrue larger assets in the superannuation system in the long run…
It is also inconsistent with the objectives of superannuation to be a savings vehicle for retirement income. Restoring the original prohibition on direct borrowing by superannuation funds would preserve the strengths and benefits the superannuation system has delivered to individuals, the financial system and the economy, and limit the risks to taxpayers.
The RBA raised similar concerns in its recent submission to the House of Representative’s Inquiry into Home Ownership:
Another change in the landscape since 2003 is that superannuation funds are now able to borrow. Some self-‐managed superannuation funds have taken advantage of this by adding geared property into the fund portfolio, both residential and, in particular, commercial property. At the margin, this has increased the population of potential investors. Although the share of the housing stock owned by these funds is small, it has grown quickly (RBA 2013). The Bank has previously observed that leverage in superannuation funds may increase vulnerabilities in the financial system and therefore supports limiting the scope for leverage in these funds (RBA 2014c).
Finally, the architect of Australia’s superannuation system, former Treasurer and Prime Minister Paul Keating, has also called for curbs on SMSFs using leverage to invest in Australian residential property, arguing that it “is making it nearly impossible for younger people, owner-occupiers, to afford to house themselves” and arguing that “we can’t persist with the position where our children cannot afford to house themselves and that is where we are now”.
With these concerns in mind, it is disappointing to read today that Assistant Treasurer, Josh Frydenburg, appears to have backed down on previous indications and flagged that the Government will not ban SMSFs from borrowing to invest in property. From The Canberra Times:
Mr Frydenberg said he was troubled by stories of property spruikers pushing people to set up an SMSF so they could borrow against their retirement savings to make speculative property investments. However he said it was important to acknowledge that such events were the exception rather than the rule…
“To put it in context only 0.07 per cent, perhaps 6,500 properties, were held in an SMSF through a limited recourse borrowing arrangement in 2013,” he said.
“David Murray highlighted the risks associated with increased leverage in the financial system. Increased leverage always represents a risk and we recognise that. The government also recognises that most SMSFs do the right thing”…
However, Mr Frydenberg has at least left open the option of tightening rules around how SMSFs can borrow, saying that it remains “under consideration”. This could include restricting borrowing to commercial property, limiting personal guarantees, and/or capping debt levels.
SMSF leverage is yet another Costello superannuation wrong that must be righted. And while an outright ban on borrowing is preferred, I am at least hopeful that the Abbott Government will undertake reforms to limit risks in this area, thus helping to restore superannuation’s place as a savings vehicle rather than a speculative vehicle.
