Cross-posted from DFABlog.
The DFA Household Survey included coverage of households who held, or were considering property within a SMSF. Overall our survey showed that around 3% of households were holding residential property in SMSF, and a further 3% were actively considering it. Of these, 29% were motivated by the tax efficient nature of the investment, others were attracted by the prospect of appreciating prices (28%), the attractive finance offers available (17%), the potential for leverage (12%) and the prospect of better returns than from bank deposits (5%).
We have done further work on those SMSF with property investments. We asked where the trustees had received advice on their property investment strategy. As expected, some used mortgage brokers or financial planners. Others relied on their own knowledge, information from developers, or from the internet. The scores are adjusted for multiple answers.
We also asked about the proportion of the SMSF is invested in residential property (this excludes any by an SME). We found quite a range, some trustees spreading their investment risk, others have higher property exposure.
According to APRA as reported in their Annual Superannuation Bulletin (issued Jan 2013), total superannuation assets increased by 3.7 per cent during the year to 30 June 2012 to $1.40 trillion. Of this total, $439.0 billion are held by SMSFs, which are regulated by the ATO. The number of SMSFs grew by 8.0 per cent to 478,263 funds during the 2012 financial year. The Reserve Bank revealed recently about $18 billion is invested in residential property.
There are significant tax incentives for SMSF property investment, including the potential to offset costs, gain tax free capital growth, and the potential to structure loans such as to obtain more than 100% of the potential purchase price (most banks will only lend to 70%, but SMSFs can get loans from the trustees to lift the balance higher).
To quote Australian Property Investor: ” A negatively geared property can have the following benefits:
- Wipe out income tax on investments.
- Wipe out contributions tax (and income tax).
- Get back all, not just part, of franking credits.
- Save up income losses for future years when concessional contributions might be higher.
In fact, your SMSF can get itself into the position where it pays no tax inside the fund now.” Thus, for many its a totally logical, and sensible investment strategy, given the current tax regime.
Granted there are some limitations imposed thanks to limited recourse borrowing arrangements . Geared SMSF property risks include:
- Higher costs – SMSF property loans tend to be more costly than other property loans which must be factored into your investment decision.
- Cash flow – Loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan repayments.
- Hard to cancel – If your SMSF property loan documentation and contract is not set up correctly, unwinding the arrangement may not be allowed and you may be required to sell the property, potentially causing substantial losses to the SMSF.
- Possible tax losses – Any tax losses from the property cannot be offset against your taxable income outside the fund.
- No alterations to the property – Until the SMSF property loan is paid off, alterations to the property cannot be made if they change the character of the property.
SMSF Trustees have a number of significant obligations. There have been warnings from the ATO. ASIC and others about the risks involved, including rolling up the costs and commissions into the transactions. Lenders and Brokers have obligations about ensuring any loans are “not unsuitable”. Nevertheless spruikers are on the march! Just execute a web search….
But of course the real risk is if property prices take a dive. Nevertheless, but there is significant momentum here, adding to the current investor hubris.
I believe the negative gearing rules are to blame for this phenomenon, and should be changed. I would redirect property investment tax breaks only towards the building of new property, with a view to significantly increasing the supply.
But the most worrying aspect for me from our survey is that some of the “Want To Buys“, those who were not able to enter the owner occupied market, are attracted by the SMSF property route, because of the higher tax concessions, and the potential to break into an otherwise locked up market.
