Speaking to SMSF Adviser, Mr Frydenberg said he is taking a serious look at the Financial System Inquiry’s (FSI’s) recommendation to ban borrowing in SMSFs.
“This is one of the recommendations out of FSI that I am interested in looking at because superannuation is principally a retirement income stream and if people can leverage up, they run the risk that if there is a major external economic shock, they could be left high and dry,” he said.
“That’s neither in the interests of the superannuant or the government,” he added.
Mr Frydenberg announced late last month that the government intends to openly consult on this recommendation, and will explore options such as banning personal guarantees by SMSFs and improving the standard of advice given to trustees on leveraged investments.
The comments also follow the recent proposal by Treasurer Joe Hockey to open superannuation to first home buyers in light of housing affordability concerns for young investors.
“I get a lot of people approaching me saying that young people should be able to use their superannuation to fund a deposit on a home – on their first home,” Mr Hockey said.
“I am concerned about rising house prices and the accessibility to homes and homeownership for younger Australians. But we’ve got a limited pool of savings – we need to have these conversations.”
Lots of valid considerations have been mentioned. It would be nice if we had some sort of way to save for retirement that wasn’t at market risk, that provided a basic cover for us all in retirement. Taxing super on the way in also hurts us when trying to build savings for retirement. Get rid of that and the burden on Centrelink might lessen in future. Gearing needs to be assessed individually and can be ok for people who can afford to do this. I only sometimes think it slants people to one asset class – property. I don’t think this is a good idea especially if the trustees get caught up in property after property via spruikers.
I think the debate is not about to allow or not to allow LRBA. In my opinion it is a fantastic tool for some trustees to acquire some special properties. But in some other cases, all they have done is purchased a house in Blacktown NSW.
Blacktown has had approximately 15% cumulative growth since the madness started sometime in October 2012.
This cumulative growth translates to 52% over this three year period or in dollar terms a house sold for $450,000 has grown by $235,000 and now selling for $685,000.
There are about 300 properties for lease in Blacktown, rents have stayed stagnant. In real terms the yield has dropped 52% + due to CPI reasons etc. Vacancy periods are now reaching about 20% – which means that it takes about 10 weeks to find a tenant – and that too at reduced rent.
When and If interest rates rise, there will be a bloodbath and that is when vultures (those who sold and now waiting) will come in.
Leo, you seem to forget the basic behavioural factor at play with property. People in the large part don’t sell when the property is under water. They hang on because they KNOW it is worth at least what they paid for it. Maybe not right now but at some point in the future.
This is different to people who invest in shares and managed funds who would dump their investments to fly to cash. The ‘safe haven’. They crystallise their loses and lock them in permanently.
In contrast, if people will hold the house until it recovers.
Would any person be better off if they had sold their geared investment property in any of the ‘economic shocks’ over the past 25 years?
Leo what percentage of LRBAs would that be? Would it even be a fraction of 1% and even then of that tiny fraction quite possible they can still service the loan and property Market recovers. I’ve seen people put all or most of their super in SMSF into spec mining stocks and essentially lose it, do we ban ALLSMSFs from investing in shares because a tiny minority were silly?
You have also again ignored the positives effects of the person who greatly grew their super due to sensible gearing and went from needing to receive a pension to not.
The intelligent response to borrowing is to determine the level of borrowing where the positive effects vastly outweigh the negatives. Not a tiny minority might still suffer a wipe out so ban it, condemning thousands of others to inadequate super balances when they did not need to suffer that.
The property ‘market’ may or may not fall be 50%, but an individual property certainly can. Case in point- properties in some mining towns where the mine has shut down and there is a exodus from the town. The Investor is left with a large lumpy undiversified illiquid asset that isn’t providing any income. Some locations in the USA had similar experiences through the GFC.
Damian- if the share market falls 20% an ungeared share investor loses approximately 20%. If the property market falls 20% a geared property investor through a LRBA loses a far higher percentage of their net assets- possibly all the equity in their super fund.
If you ban personal guarantees and restrict LVRS to 50% ( which banning personal guarantees will probably force banks to do anyway) then the chances of an economic shock wreaking havoc on people’s SMSFs system wide will be almost so small it can’t be measured.
Indeed if there has been some sort of economic shock so severe it has reduced property values by more than 50% around the country then SMSF borrowing will be the least of our worries. We’d be talking about a war with China or something.
Banks suffer mortgage distress rates of LESS THAN A FRACTION OF 1% and that includes first home buyers on mortgage insurance etc. So if SMSFS are operating on 50% LVRs claims of LRBAS somehow putting the super system at risk would be preposterous.
Secondly let us not forget the far, far larger number of people who will have far more in super for having done some sensible gearing. People who might have had to go onto the pension who now won’t.
Personally I think that there are acceptable vehicles for investors looking for leveraged investments outside SMSFs, and that is where they should stay. The only reason why people want LRBAs is because they want to buy properties with super, which is not what super is for. I also think that people shouldn’t get an aged pension if they lose all their money because they leveraged super.
That said, LRBAs are a joke. Either the government should allow borrowing in super or they should ban it. Either way is better than the current work around.
Higher income in retirement means better living standard. SMSF trustees should be chasing higher yield on their investments and invest that income for a multiplier effect.
Lumpy growth asset like residential property have low returns and if you cocktail that with 50% – 60% borrowing you will end up nil or negative return. Without salary sacrifice and with only compulsory super many trustees will not be able to payoff the loan in their working life.
Lastly, residential property moves in cycles of demand and supply, so if at retirement, all you will ever get is CPI growth in the asset, you will have to depend on Govt. handouts for supplementing your retirement.
In my opinion those you cannot salary sacrifice (close to the cap amount), should not gear in super.
Because any major economic shock would have no effect on retail superfunds, isn’t that right?
What happens if the stock market has a correction and the value of the portfolio drops by 20%, is that an unacceptable risk?
Josh Frydenberg is correct in that the current LRBA may cause a high risk to retirement savings. I believe the concept of LRBA, stating that the lender only has recourse upon the actual secure asset, still places the member’s funds at risk. This is best explained by example. Many SMSFs with a LRBA only have a single asset, being the interest in the security asset, but they have also placed SMSF cash into acquiring the asset. The purchase of a $500K property may have a borrowing of $300K and cash input of $200K. A 20% fall in asset value would then value that asset at $400K. Upon sale, the members’ value in the SMSF would fall by 50% from $200K to 100K. The so-called limited recourse does not change the risk of increased loss alongside the hope of increased gain. If we are to continue with LRBAs, which is highly likely, then should the fund interest in the value of the acquired asset be limited to a percentage of the total members’ funds, thereby encouraging diversification.
Frydenberg has to be kidding himself, hasnt he? Most LRBA’s would be setup with an equity contribution of between 30%-50%. It would take a fairly dire “external economic shock” for that to have an impact on these arrangements. In addition, the effects of the “shock” is generally only evident for 18-36 months max after the event before things normalise. With good initial equity, tenants still paying (even if rents fall a little) then there should be little to no fallout. The only issue becomes when people panic. Any look in the rear view mirror would show that property doesn’t go down in value in the long term (which is different to fluctuating prices in the short term).