The sustained cutting of interest rates over almost five years is not having a significant impact on the asset allocation of the SMSF sector to direct property.
Over the past five years, the exposure of SMSFs to direct property has risen only slightly despite the Reserve Bank's cutting of the official cash rate 12 times from 4.75 per cent in early November 2011 to 1.5 per cent by this month.
The SMSF exposure to limited recourse borrowing arrangements – the majority financing direct property – has risen over the past five years. However, it remains a small percentage against total SMSF assets.
Tax office statistics show that as at June 2011 – on the eve of the Reserve Bank's current bout of rate cutting – SMSFs held an estimated 15.48 per cent of their total assets in direct property. And limited recourse loans accounted for 0.35 per cent of SMSF assets.
Fast forward to 2016. By the end of March, the latest-available tax office statistics estimate that SMSFs held 16.9 per cent of their total assets in direct property. Limited recourse loans, again the majority for direct property, had risen to 3.2 per cent of SMSF assets – up from 0.35 per cent in June 2011.
It should be emphasised that in dollar terms, not percentage or asset allocation terms, the SMSF sector's holdings in direct property have, of course, risen significantly over the past five years – along with total SMSF assets.
The SMSF Investment Patterns Survey June 2016, published by SMSF administration firm SuperConcepts, provides more information about the relationship between self-managed funds, their direct property and their gearing through limited recourse loans.
A survey of 3300 SuperConcepts client funds found that 15.7 per cent held direct property at the end of June – a percentage similar to the tax office's figure. The average property loan was $278,000 compared to $100,000 for financial asset loans such as shares.
Many SMSFs with direct property would choose to keep holding the asset long after any loan had been repaid, often choosing to sell in the tax-exempt pension phase. Obviously, many investors would choose to gear direct property outside super with an intention of maximising negative-gearing deductions. Much would depend on personal circumstances including any professional advice received.
Informed SMSF trustees would remember that in October last year, the federal Government announced that it had rejected a recommendation by the Murray Financial System Inquiry to prohibit limited recourse borrowing by super funds. While the Government noted there are “anecdotal concerns” about SMSF borrowing, it didn't consider there was enough information at this time to intervene.
Nevertheless, the Government said the Council of Financial Regulators and the tax office, as regulator of self-managed super, would monitor the risk of SMSF borrowing and report back in three years.
The inquiry's recommendation and the Government's response would no doubt encouraged more SMSF trustees to even more carefully consider the consequences of gearing to buy direct property before making a decision.
Critical points for SMSF trustees to consider when thinking about investing in direct property and perhaps borrowing to make that investment include:
- The fact that the law permits an SMSF to directly borrow to invest using a limited recourse borrowing arrangement does not mean, of course, that it is an appropriate strategy given the particular circumstances of an SMSF and its members.
- It is crucial to understand an investment and its risks – whether or not the asset is geared.
- Investors should only accept investment advice about direct property from a holder of an Australian financial services licence – not from unlicensed property spruikers who have been the subject of numerous warnings in this market.
- SMSF trustees should not overlook their compulsory investment strategy when deciding whether to invest in a direct property and whether to gear the property.
Trustees are required to prepare, implement and regularly review an investment strategy that has regard to the whole circumstances of their fund. These circumstances include: investment risks, likely returns, liquidity, investment diversity, risks of inadequate diversity and ability to pay member benefits.
All materials have been reprinted with the permission of Vanguard Investments Australia Ltd.
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