SMSFs leverage into property bonfire

Back in 2016, David Murray –  the chairman of the Financial System Inquiry (FSI) – recommended self-managed superannuation funds (SMSFs) be banned from borrowing to invest because of risks 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”.

In 2019, the Council of Financial Regulators (CoFR) backed David Murray’s call, recommending the federal government ban property investment via SMSFs after 18,000 of these Funds were found to have more than 90% of their savings in a single asset class, specifically investment properties. However, its recommendation was snubbed by Treasurer Josh Frydenberg.

According to new ATO data published in The AFR, SMSFs are now leveraging big time into the property market, adding fuel to the sychronised boom being experienced across Australia:

SMSFs held $59.4 billion worth of limited recourse borrowing arrangements at the end of March, up almost $4 billion from the $55.8 billion worth of LRBAs at the end of December, according to figures released by the Australian Taxation Office on Wednesday,

The 6.5 per cent jump in outstanding leveraged loans in the $750 billion SMSF system is a return to sharp growth in property investment for self-managed nest eggs…

Is this really the purpose of Australia’s superannuation system: to allow SMSFs to operate as speculative 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 backstop the retirement system through the Aged Pension?

SMSF borrowing is known as “limited recourse” because if the borrower cannot pay the loan back, the bank cannot go after any other assets — only the property in question. This is precisely the type of lending that was at the heart of the global financial crisis more than a decade ago.

It’s shame that the recommendations to ban SMSF borrowing was ignored by the Coalition Government. Because now we have another added layer of pro-cyclicality and risk to Australia’s property market.

Having households use the tax-subsidised position of super to buy property, and adding fuel to the bubble, is a recipe for disaster.

Unconventional Economist

Comments

  1. The Traveling Wilbur

    Besides, they wouldn’t want to miss out on all that government funded risk-free pork. It would be un-Australian.

  2. I think this risk is overstated. Much of the property in SMSFs tends to be the business premises of the SMSF beneficiary eg: doctor’s rooms or shop fronts. This is done for asset protection as much as tax (because the interest rates on LRBAs tends to be a lot higher than for assets held outside of the SMSF).

    Going forward, it will be harder and harder to do as the amount you can put into super is limited. Furthermore, the people doing this have a negligible risk of being on the pension as they will also have substantial assets outside of super.

    • We are planning to get a SMSF next year and will borrow a significant amount (maybe 50-60% if possible) to buy a business premises. I wouldn’t ever borrow for a ‘regular’ investment property in an SMSF, but for owning the business I think it makes more sense.

  3. LVO
    Its a bit more complex than you have set out. The bottom end of SMSFs should have never been allowed to “leverage” as there were way too many horror stories. But a blanket ban isnt right either. On a personal level, we had an industrial warehouse unit in the inner city (sydney) bought on an 8% net yield, geared to 60%, sold six years later on a sub 5% yield. Fund in pension phase no CGT. There are parts of the tax regime for SMSFs that should be fixed but we will never burden the tax system in retirement. I would go again but the cost of borrowing in a SMSF is too high now.

    • LabrynthMEMBER

      5%? are you talking 2012?, inner city stock is selling around 3%-4% gross yeild range now.