Safe as houses?
Despite the regulator’s warnings, concerns are growing that SMSFs are being exposed to risky property investment and poor investment advice
It’s no secret that Australians have a love affair with property. ‘You can’t go wrong with bricks and mortar’ is the underlying attitude when it comes to property investment, according to author and veteran financial planner Noel Whittaker.
“The average Aussie thinks there’s nothing but property – the only investment is property,” Mr Whittaker says.
And in recent years, Australians’ appetite for property investment has been amplified by SMSFs and growing interest in limited recourse borrowing arrangements (LRBAs). However, this has seen both unqualified and unlicensed advisers enter the advice arena.
In particular, there is “no doubt” that property spruikers have become more active in encouraging investors to set up an SMSF for the purpose of buying property, says Ben Kingsley, chair of Property Investment Professionals of Australia (PIPA).
Further, both the government and the advice industry continue to harbour concerns that the number of inappropriate candidates establishing SMSFs is increasing as a result of the property hype.
“The situation has become so bad that ASIC has issued warnings,” Mr Whittaker says. ”Far too many of them have fallen on deaf ears.”
First things first
One “real concern” is that both prospective and existing trustees do not have appropriate levels of knowledge regarding property investment within an SMSF, according to managing director of the SMSF Academy Aaron Dunn.
“People need to make sure they understand two things: that the property investment is right for them, and that the fund is right for them,” he says. “They might have an interest in property, but have they got the awareness themselves around the issues, or the potential opportunities, of holding property?”
In turn, there are fears this lack of knowledge could lead to problems with portfolio construction – in particular, with diversification. Self-managed funds have historically lacked diversification and a heavy bias towards property has the potential to increase risk.
While this may not be an issue if the trustees are younger and are factoring the property purchase into a broader investment and diversification strategy, it may pose a problem for those close to retirement age, says Mr Dunn.
“Someone that maybe is looking to retire or transition into retirement [has] got liquidity obligations to pay pensions or lump sums and so forth ... how do you practically do that? You can’t sell a brick at a time,” he says.
“The concern is that there are people looking to get into this with [really] insufficient assets and skills to do it, or at an age where really it’s not suited because they’re going to be needing to rely on that capital to pay them an income stream,” he added.
In addition, adequate knowledge of borrowing structures is particularly pertinent to practitioners because of the complexity of these arrangements, according to Peter Burgess, head of policy and technical at AMP SMSF.
“There are some unique features of these arrangements which you don’t encounter in other types of borrowing structures,” Mr Burgess says.
“For example: the rules around being a single acquirable asset and what that means, the rules around replacing assets, and the fact that you can’t replace the asset in these arrangements, and what constitutes when an asset has been replaced and when it hasn’t,” he adds.
Certain estate planning strategies are also often overlooked and need to be appropriately factored in to any LRBA commitments a trustee has made, according to Mr Burgess.
“Quite often there’s not enough attention paid to what [happens] if things don’t go to plan,” he says. “The fund has an obligation to make loan repayments, of course, which means they need cash flow and they need liquidity.
“If the major contributor of the fund dies and then the fund’s cash flow dries up, they’ve still got to service that borrowing somehow. It becomes increasingly important in those situations that the trustees and practitioners think about the use of insurance when setting those arrangements up.”
There are also several disadvantages that trustees – and their advisers – should be aware of when considering property investment. Mr Whittaker, as an example, notes the level of administrative work involved for the related parties.
To gear through a self-managed fund you first have to set up a bare trust, and that trust can only be involved in a single property, he says.
“So, if you were considering eventually borrowing for, say, three properties, you would need to establish three separate bare trusts with all the administration and fees that would entail,” he explains.
While there are tax benefits when the property is positively geared, it works the other way when the property is negatively geared.
“A rental shortfall of $10,000 within a super fund would save just $1,500 tax; in the name of a high income taxpayer the tax saving would be $4,650,” he says.
“A fundamental rule of tax planning is that you take your tax breaks sooner rather than later. I would rather have a tax deduction today at 46.5 per cent than accept just 15 per cent in the hope I can get a tax break in 20 years.”
PROPERTY INVESTMENT ADVICE:
A two-part problem
In early 2013, the Australian Securities and Investments Commission (ASIC) said it was concerned about unlicensed SMSF advice and misleading marketing coming from property spruikers.
“We do not want to see SMSFs become the vehicle of choice for property spruikers,” said ASIC commissioner Peter Kell.
The regulator has warned it will take action against any unlicensed or misleading behaviour. However, according to Mr Kingsley, this message does not appear to be getting through.
Since SMSFs have been able to borrow money, spruikers – including mortgage brokers, real estate agents and property marketeers – have been offering SMSF advice which they are not licensed or qualified to offer, he says.
“So the scenario might go something like this: a property marketeer is selling something off the plan and has a mum and dad couple come into the office to look at potentially investing in this property,” he says.
“They do some quick analysis [and conclude] they can’t afford it in their personal names. So [the marketeer’s] next strategy is to ask them, ‘Maybe you should buy it in an SMSF?’ They talk about an SMSF as a possible option for them to invest through and they are simply not licensed to do so.
“Under the current legislation, these professionals have no role to play in assessing or making any recommendations as to the suitability of an SMSF for anyone,” Mr Kingsley adds.
He acknowledges, however, that while spruikers remain a widespread concern, there are many property businesses that establish appropriate introductory relationships and are conducting themselves in a professional manner.
The concern of the regulators and the industry is that product is coming before structure – that is, investors are attracted to the prospect of an SMSF for the purpose of a property purchase.
“So there are pockets of promoters really saying, ‘Well, we want the sale, the sale fits into the self-managed fund environment, therefore that’s the way it’s done’,” says Mr Dunn.
“We need to make sure that, as an industry, people [are] making informed decisions rather than getting into [SMSFs] to suit an investment but then … getting locked into something that is illiquid,” he adds.
Unlicensed operators are not the only concern in the advice arena. Earlier this year, ASIC’s SMSF Task Force found “pockets of poor advice” involving property and SMSFs issued by “gatekeepers”, such as financial advisers and accountants.
The current “enthusiasm” for property, which has arisen since LRBAs were opened up, is attracting practitioners to the marketplace who are unqualified, inexperienced and potentially product-driven, according to the chair of SPAA’s NSW chapter, Adam Goldstien.
“One of the issues I see facing the industry [is that] everybody is a ‘specialist’ today because that’s where the money is, obviously,” Mr Goldstien says.
Mr Kingsley, similarly, flagged the issues associated with licensed practitioners, particularly financial planners, not having the adequate knowledge and education to provide sound property advice to their clients.
“[PIPA] remains troubled by the knowledge that financial planners and accountants with no formal qualification or education around property investment are potentially providing advice on property selection to SMSF trustees,” he says.
“We have concerns on both sides,”
Mr Kingsley continues. “We have concerns [about] unqualified people giving [advice], but on the other hand we also have concerns that those who are regulated to give advice have a lack of education and knowledge to provide sound [property] advice for their clients.”
THE PUSH FOR ACTION
Services related to property investment need to be “far better informed” – from an advice perspective – compared to other forms of investment, given that property is such a significant financial decision, according to Graeme Colley, SPAA’s director for technical and professional standards.
“Anyone providing advice should be competent to provide that advice, because it is a complex area and it is an area where people are making long-term decisions and are long-term genuine investors,” adds SPAA’s chief executive officer, Andrea Slattery.
“They need to understand the risks and responsibilities that they take on with these strategies.”
This perspective reflects SPAA’s broader push to address the education and the adequacy of knowledge within the SMSF advice sector, with Ms Slattery claiming that lack of knowledge is a “pervasive” problem.
Ms Slattery believes practitioners offering SMSF advice should possess an undergraduate level of competence. Those who only meet current RG146 requirements “haven’t actually extended their knowledge enough”, she says.
More specifically, PIPA has long argued that the government should legislate for property to be classed as a financial product when the purpose of sale is for investment. Mr Kingsley says this would be a positive move, providing “better protection for trustees of SMSFs”.
Increased regulation has been put in the government’s “too hard basket” because the property purchasing area includes other parties, such as owner occupiers, creating a grey area when trying to define ‘investment’.
However, according to Mr Kingsley, there is a simple purpose test that clearly categorises the nature of a property purchase.
“If you’re buying it for a capital gain or you’re buying it for a rental return, the purpose of your buying is investment,” he says. “So it’s nice and clean, it’s very easy to define [and] it can separate people who are buying for owner-occupied purposes,” he says.
“We don’t think the government has an argument to say it’s a difficult thing to regulate.”
Mr Kingsley adds that SMSF practitioners should be encouraged to undertake further education and further training in relation to property investment, given the significance of the purchase.
“It’s such a high-value transaction – it’s not like buying $10,000 worth of shares,” he says. “Households are in some cases taking big gambles as opposed to really understanding the consequences of a poor investment.”
Despite criticism, Mr Burgess believes there has been a “vast improvement” in recent years regarding the competencies and knowledge of practitioners who offer SMSF advice.
However, advisers who cover property investment need to have specific skills and knowledge to produce an effective outcome for their client, he adds.
“It’s important for practitioners to have that knowledge so they can give balanced advice to clients about these arrangements,” he says.
The regulators’ concern is to ensure existing and prospective trustees are making appropriate decisions regarding their SMSF and property investment, and are not getting “sucked into the all the stars and lights and all this sort of fanfare that sits around it”, says Mr Dunn.
“Whilst there’s a growing number of people moving into SMSFs, it’s quite clear they’re not for everyone,” he says.
“There’s a real need from the industry to ensure that the right people are identified as candidates for SMSFs. I think as a sector if we don’t stay conscious of that … there’ll be those few that ruin it for everyone else.”