The opportunity to invest in property via SMSFs is important for many Australians. Instead of banning limited recourse borrowing arrangements (LRBA), the government should be focusing on regulating who can recommend property to SMSF trustees, writes Ben Kingsley.
When the Financial System Inquiry (FSI) handed down its final report in December 2014, it recommended removing the borrowing exemption that permits direct borrowing in SMSFs. The Property Investment Professionals of Australia (PIPA) was not an industry lone voice in expressing its surprise and dismay at this recommendation.
The report proposed the elimination of LRBA use within SMSFs on the grounds it would prevent “the unnecessary build-up of risk in the superannuation system and the financial system more broadly”.
However, PIPA believes a blanket ban on LRBAs, which enable SMSF trustees to borrow to invest in direct property, based on the remote chance of potential losses or systemic disruption to the financial system is a misguided and premature reaction with very little substance.
Over the years, well-selected residential and commercial property has proven a very profitable asset class and there is no reason why it shouldn’t form part of the superannuation investment mix. In fact, it’s concerning to consider it may be excluded.
Property is an accessible, trusted source of wealth that can help just about anyone build a better financial future – the ultimate goal of superannuation. Moreover, it’s an asset class backed by a real asset everyday Australians can relate to and understand better than many other investments.
Rather than reconsidering the ability of SMSF trustees to leverage their investment in direct property, PIPA’s suggestion is to instead focus on regulation around who can recommend property to SMSF trustees for investment.
Unlike other asset classes, such as shares, property is not recognised as a financial product by the Australian Securities and Investments Commission (ASIC) and remains without any regulatory framework. This means anyone is free to provide property investment advice without any qualifications or genuine experience.
This is a policy concern PIPA has been working hard to communicate to government and various corners of the industry for some time and believes it is the more pressing issue to be addressed.
A solid investment class
Before discussing the concerning lack of regulation in property investment advice, let’s take a look at why well-selected property should remain an option for SMSFs.
Certainly it’s clear from the current state of the property markets, in Sydney and Melbourne in particular, real estate is a very popular investment class.
In January, the total value of financing arranged for property investment in Australia totalled $12.5 billion, according to the Australian Bureau of Statistics, not much less than the $17.7 billion in housing finance written for owner occupiers.
There are many factors behind property’s investment appeal, one being the fact that outside of an investment, it satisfies another essential need – shelter for ourselves and our families. We all need a roof over our heads and this primary need means property will, over the longer term, always be in demand. It certainly won’t go out of fashion or become redundant, unlike some more speculative investments.
Property has also proven itself a very stable investment, particularly when compared to many other popular assets, such as equities. While both have delivered relatively similar overall returns to Australian investors over the years, property has shown far fewer price fluctuations and lower volatility compared to the share market. It’s this low level of volatility we argue should see sensible levels of borrowings maintained for those who have chosen to manage their own financial destiny.
Research released by the Australian Securities Exchange and Russell Investments demonstrates residential property delivered more steady gross returns over the 20 years to December 2013 compared to equities, with property generating a 9.9 per cent return per year and shares an 8.7 per cent yearly return.
From a returns perspective, property offers both the potential for capital growth and passive income in the form of rent – a compelling combination for excellent long-term wealth-building prospects and a passive retirement income.
Finally, property tends to be simple to understand and it is this simplicity combined with property’s tangibility that makes it appealing to many investors. They can touch it, understand it and feel in control of it – if the share market suffers a decline, you can’t live inside an equity.
Property and SMSFs
Australians’ big appetite for property as an asset class has translated into strong interest in property investment via SMSFs and indications are this interest will continue to grow.
A survey conducted by PIPA at the end of 2014 suggests demand for property investment via SMSFs continues to rise. Of the 627 property-investing respondents surveyed by PIPA and Smart Property Investment, 14.3 per cent stated they had invested in property via an SMSF before. Furthermore, 21.4 per cent of those surveyed said they planned to purchase a property via an SMSF within the next 12 months.
But despite the strong interest, property investment still represents only a fraction of total SMSF investments. Figures from the ATO show the amount of SMSFs using LRBAs is smaller than 3 per cent, with only 1.7 per cent of SMSF assets held under an LRBA.
Spruikers, not LRBAs, the problem
The figures above demonstrate LRBAs really only represent a small fraction of SMSF investment. And for those who want to invest in property we adamantly believe they should remain an option.
LRBAs empower SMSF trustees to take control of their retirement and strive towards a self-funded retirement. As with all investments, return is linked to risk and there are, of course, some risks to property investment. Certainly not every property asset will be a sound investment decision. Additionally, direct property investment won’t necessarily be suitable for all SMSF trustees. However, that’s not to say it shouldn’t be an option.
Rather than a blanket ban on LRBAs based on the remote chance LRBAs could cause a problem, the government should be looking at the very real issue of who can recommend property to SMSF trustees.
With the median Australian house price at $530,000, according to CoreLogic RP Data, property is often the highest-value transaction investors enter into and yet no formal training or education is required in terms of the provision of advice regarding property selection and strategy. This stands in stark contrast to advice surrounding equities, taxation, financial planning and housing finance, all of which are highly regulated. This disconnect is hard to comprehend.
This lack of regulation has meant some questionable operators have crept into the market looking to capitalise on this regulatory loophole and prey on unsuspecting investors and SMSF trustees. The perfect combination of high-value goods and an unregulated market naturally attracts the fast-talking and unscrupulous operators who are tarnishing the entire asset class due to their desire to make a quick buck.
We’ve all seen ads pushing SMSF property investment opportunities and no doubt many advisers have been contacted by spruikers offering incentives to recommend their properties and developments.
Allowing SMSFs to take ownership and responsibility for their actions, including borrowing to invest in property, has opened up new avenues for professional practitioners, such as buyer’s agents, mortgage brokers, accountants and financial planners, to provide their advisory skills with good intentions. However, there are pockets of operators providing advice outside of their fields of expertise or qualifications.
A vision for the future
As the peak association for the property investment industry, PIPA is steadfast in its view that direct investment in any form of property should be classed as a financial product and should be regulated appropriately.
In simple terms, this means if a consumer were seeking to purchase a property primarily for investment purposes, and they wanted advice about their property selection decision, they would need to speak to a professionally qualified property investment adviser. And if a property investment adviser, mortgage broker, builder, developer, buyer’s agent or the like is approached about setting up an SMSF, they should then have to refer the request to a financial planner or accountant.
An unregulated property investment market attracts unethical operators in search of big commissions, without any concern for the client’s best interests. The purpose of an SMSF is to support trustees to build a nest egg for retirement and the purchase of the incorrect property can be a major impediment to achieving this goal.
Equally concerning for industry practitioners is the fact a lack of regulation puts the reputation of ethical operators at risk as unscrupulous operators cast a shadow of doubt across the credibility of all advisers.
We need to see national regulation of property investment and it needs to come under the ASIC umbrella to coexist with financial products and credit lending products, but as a separate act requiring formal qualification of practitioners working in this specific field.
Under this legislation, anyone charging fees for advice or receiving commissions for the purchase of real estate for investment purposes would need to be licensed and regulated. A purpose test would determine what constitutes investment purpose, such as whether the real estate is purchased for income and capital growth returns.
No matter how you look at it, it simply doesn’t make sense a popular, legitimate and high-value asset remains unregulated. Trustees need qualified advice to ensure they select an asset that is going to deliver the appropriate returns.
Regular and comprehensive revision of the financial system and all of its complexities is important, and we welcome the government’s consultation with the industry on borrowing within SMSFs. We hope the outcome will be not only greater protections for trustees where they are required, but also ongoing choice and flexibility for investors to make informed investment decisions with their SMSFs to gain the greatest retirement outcomes. Banning LRBAs is not the solution and doesn’t serve those who are very capable of managing their financial affairs.
Incorporating property investment advice inTO your service proposition
In the absence of regulation around property investment, advisers need to be diligent to ensure any clients investing in property are doing so with qualified professional advice.
Some, in fact many, operators within the property space might offer attractive monetary incentives for your referral, but these could be at the risk of your client committing a chunk of their nest egg to a poor-performing property.
So professional SMSF practitioners have several options to ensure their trustees make a smart SMSF property investment.
The first option is to upskill and gain a formal accreditation as a property investment adviser. This is a great way to boost an adviser’s individual service offering if the necessary desire, time and resources are present.
Secondly, the adviser can stick to their existing field of expertise. Certainly it can be difficult to keep up with market developments and compliance requirements within just one field. Moreover, advisers will need to be careful of stepping outside of their professional indemnity insurance space if they pursue other fields. Opting to provide a professional introduction to an independent property adviser or advisory firm might be the most suitable option in this case.
Thirdly, advisers can diversify their businesses to encompass property investment advice and hire a qualified property investment adviser and buyer’s agent to facilitate this expansion.
A final option would be to consider a referral partnership with a property investment company delivering an expanded service to clients without completely diversifying the advice offering.