Contemplating property as a financial product
Would the classification of property as a financial product resolve some of the current issues surrounding SMSF property investment or lead to further problems in the industry?
Property investment in super is under constant scrutiny and negative SMSF-related press is often the result of trustees making poor decisions based on advice from unlicensed property spruikers.
Investing in property is a major financial decision, yet there is no requirement for potential investors to seek advice when making a purchase. The reason? Real property is not considered a financial product.
Pointing the finger at ASIC to take action to better regulate the advice process and stop spruikers from damaging the industry’s reputation, one suggested solution to the problem is to carve real property into the Corporations Act so it is considered a financial product.
But unfortunately, it is not that simple.
What is a financial product?
The Corporations Act 2001 defines a financial product as a facility through which, or through the acquisition of which, a person does one or more of the following:
(a) Makes a financial investment
(b) Manages financial risk
(c) Makes non-cash payments
Making a financial investment involves giving money to another party for the purpose of generating a return. This is where real property slips through the gaps and is excluded from being classified as a financial product. There is no third party involved in purchasing an investment property; the investment is instead made directly by the investor to generate their own return. This can be compared to an investment in direct shares, where the company is considered to be the third party generating the returns which are then passed on to the investor.
Amending the Corporations Act to include property
To allow for the inclusion of property under the Corporations Act, the definition of a financial product needs to be changed, however. This move would create implications and would call for consideration of the following technicalities:
- Differentiating between a principal place of residence or an investment property at the time of purchase in order to determine that it is a financial product.
- The possibility that this could lead to all properties being sold under the premise that it is a principal place of residence in order to circumnavigate this technicality
AFSL licensing issues – how would this change be implemented? Would anyone selling property need to be licensed under an AFSL?
What impact would property as a financial product have on the industry?
1 It would provide much-needed regulation to the advice process
The major benefit of carving property into the Corporations Act as a financial product is it will provide better regulation of the advice process, putting an end to the promotion of property investment in super from unqualified vendors. It also means those who do give advice on investment property will fall under the scrutiny of ASIC.
2 Investment property purchases are brought into line with financial industry standards
Currently, property vendors are able to sell real estate with no consideration of the personal circumstances and objectives of the individual. By comparison, SMSF professionals are required by law to obtain a licence before giving advice on purchasing property inside super. ASIC highlights in the Report 337 SMSFs: Improving the quality of advice given to investors, that since the purchase is made through an SMSF as an investment vehicle, it is classified as a financial product each and every time a trustee makes a purchase.
3 Blanket requirements would be an overbearing burden on the real estate industry and consumers alike
Listing real property as a financial product under the Corporations Act means all potential investors will be required to seek advice on the decision to invest in property, whether inside or outside super.
4 Estate agents would then need financial planning education
The sale of a financial product is considered to be a financial service and providers need to hold or be an authorised representative of an Australian Financial Services Licence (AFSL) which is governed by the Australian Securities and Investment Commission (ASIC). Under certain circumstances a limited AFSL can be issued to limit the provider to certain products or services.
There is the potential for a solution
Technicalities aside, it appears the system for treatment of assets would have to change to allow property to become a product, ‘sold’ by advisers. We do, hands-down, believe there is a middle ground, where a trustee needs to understand the following before making a property decision.
Regardless of commercial or residential, the SMSF property product that could be sold would look like the following:
- A checklist of risks signed off by the trustee when moving from a diversified portfolio to a single asset portfolio
- A synopsis of the range of value of property the trustee can acquire (upper ceiling spend and number of)
- A synopsis of the loan term which should be sought, including buffer for no rent and no work periods
- A spreadsheet highlighting the above visually, with a range of outcomes including an outcome highlighting a worst-case scenario of the property not experiencing growth in the period
If the following were put in place, then surely as professionals we have done enough work to protect the trustee in the search for property as an asset – regardless of who they then meet to discuss their purchase requirements.
If this was truly a product and a requirement to have before seeking to purchase property, it would reduce the volume of property-related SMSF bad press. Bad press in our industry is not what we need; regulating the advice process a little more but still allowing trustees to make their own decisions is a clear, long-term, sustainable fix.
Drew Grosskreutz, chief executive, Otium Group