90% of SMSFs over-leveraged into property

The Australian Taxation Office (ATO) has questioned the investment strategy of as many as 20,000 self-managed super funds (SMSFs). It states that they appear to have over 90% of their monies in one asset or one asset class, very often the property occupied by the beneficiaries of the SMSF, and that this could see them in breach of the diversification requirements of the Superannuation Industry (Supervision) Regulations 1994. From The Australian:

The tax office has written to between 15,000 and 20,000 self-managed superannuation funds saying: “Our records indicate that your self-managed super fund (SMSF) investment strategy may hold 90 per cent or more of its funds in one asset, or a single asset class.

“This means your fund may be at risk of not meeting the diversification requirement as outlined in the operating standard of the Superannuation Industry (Supervision) Regulations 1994.”

Later the ATO letter tells trustees: “You could also be liable for an administrative penalty of $4200 if your investment strategy fails to meet these requirements”…

The investment strategies usually fall into two baskets: First, those properties that are occupied by the beneficiaries’ business. They include warehouses, factories shops etc. Second, residential dwellings where there was often high borrowing.

The Howard Government’s decision to allow self-managed super funds (SMSFs) to leverage into property and other investments was a mistake.

Specifically, it allowed SMSFs to be turned into speculative vehicles rather than savings vehicles, in turn dramatically increasing the riskiness of Australia’s retirement savings and financial system, further inflating Australian house prices, and transferring some of the downside risk to taxpayers, who of course backstop the retirement system via the Aged Pension.

SMSF borrowing is known as “limited recourse” because if the borrower cannot pay back the loan, the bank can’t go after any other assets — only the property in question. This is precisely the type of lending that was at the heart of the sub-prime mortgage fiasco that morphed into the global financial crisis a decade ago.

Back in 2016, David Murray –  the chairman of the Financial System Inquiry (FSI) – reiterated his call for SMSFs to be banned from borrowing to invest because of its risk to the financial system:

“Superannuation funds should not be leveraged, including SMSFs, because leverage magnifies risk. If the system is unleveraged, then if asset prices rise, bubble and fall then all the loss is contained within the superannuation funds and does not have another contagion effect because there are no forced sellers of other assets”.

Saul Eslake has also described the Howard Government’s decision to allow super funds to borrow as “the dumbest tax policy of the last two decades”:

“The last thing Australians really needed in the last 20 years is yet another vehicle or incentive for Australians to borrow more money in order to speculate on property prices continuing to rise”…

“You might have thought that someone would have heard the term ‘limited-recourse borrowing’ and recognised that there were some significant risks associated with it that we could have done without in the Australian context.”

Certainly, having mums and dads rushing into property investment using the tax-subsidised position of superannuation, and feeding what was already a property bubble, was a recipe for disaster.

It’s a crying shame that the FSI’s recommendation to ban super fund borrowing was ignored by the Coalition Government. Now, it has added another layer of pro-cyclicality and risk to Australia’s housing market, with the potential to exacerbate any future bust.

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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