Are SMSFs contributing to a property bubble and gaining an unfair advantage in the process? Peter Kelly begs to differ.
Over recent weeks there has been considerable media coverage regarding self-managed superannuation funds (SMSF) investing in direct property, the emergence of a residential property bubble and the absence of a level playing field existing between SMSFs and the larger superannuation funds regulated by the Australian Prudential Regulation Authority (APRA). Much of the commentary has been driven by emotion and, in some cases without full consideration of the facts.
In the interest of a balanced discussion, let’s look at the issues that have been topical:
SMSFs and the housing price bubble
SMSFs, along with APRA-regulated funds, invest in a range of property assets including direct property holdings and investments in listed and unlisted property related investments.
The residential property market in Australia is estimated to be worth $4.89 trillion according to RPData’s Capital Market Report - Spring 2013. SMSF total investments in direct residential property stood at an estimated $17.509 billion in June 2013 (ATO’s SMSF Statistical Report – June 2013).
Based on this data, the total SMSF investment in residential real estate accounts for approximately 0.3 per cent of the total residential housing market in Australia.
Most would agree, the current level of SMSF investment in direct residential property is hardly sufficient to fuel a “housing price bubble”.
Do borrowings give SMSFs an unfair advantage?
In September 2007, superannuation legislation was amended to allow superannuation funds to invest in “instalment warrants”.
During the previous half a dozen or so years, superannuation funds of all persuasions had been investing in instalment warrants, generally issued over listed shares.
The two superannuation regulators, APRA and the ATO came to the decision that a superannuation fund investing in instalment warrants was, in essence, breaching the borrowing prohibition contained in Section 67 of the Superannuation Industry (Supervision) Act 1993.
Rather than undermining the instalment warrant market, legislation was amended to exempt instalment warrants, subject to certain conditions being met, from the borrowing restrictions.
However, the wording of the legislation, whether intended or not, now allowed superannuation funds to invest in any type of asset using borrowed funds.
The arrangement simply had to be structured as an instalment warrant. Some clever design work saw SMSFs now being able to borrow to purchase a range of assets including real property, both commercial and residential, using borrowings.
Even though the relaxation of the borrowing restriction applies to all superannuation funds, SMSFs took the lead and we saw both mainstream and boutique lenders develop loan products for this market. Most importantly, the amendments to s.67 apply equally to the APRA regulated funds, as they do to SMSFs.
Statistics released by the ATO suggest that, as at June 2013, limited recourse borrowing arrangements entered into by SMSFs amount to $2.4 billion. However, more recent press coverage suggests this figure may be somewhat understated.
At a SMSF Professionals’ Association of Australia technical conference held in August 2013, a presenter suggested a figure of $6 – $7 billion was probably representative of the extent of SMSF borrowings.
As time passes, more statistical information is bound to surface that paints a truer picture of the actual extent of borrowings.
It is important to recognise that while SMSFs have been investing in geared residential property, gearing has also been used extensively by SMSFs for the purchase of non-residential property.
With a flurry of interest in the early days of borrowings, the 2010 Cooper Review into the Australian superannuation system considered the issue of superannuation funds and borrowings, making a recommendation that the relaxation of the borrowing restrictions should “be reviewed by government in two years’ time to ensure that borrowing has not become, and doesn’t look like becoming, a significant focus of superannuation funds”.
The Government agreed with the Cooper Review recommendation, stating it was “proposing that a broader review of leverage should be undertaken that includes all superannuation funds across the industry”.
Whether a superannuation fund chooses to borrow for investment purposes is a matter for trustees to determine in line with their funds’ own investment strategy and reflecting on the prudential management of their members’ interests.
The large APRA regulated funds may choose not to undertake direct borrowings in order to balance the needs of a large membership base.
SMSFs, on the other hand, tend to be more nimble and have a more intimate knowledge of their members’ needs, objectives, fears and prejudices. It is in this context that borrowings have tended to play a more dominant role.
The suggestion that SMSFs have an advantage over APRA-regulated fund, simply because they have access to borrowings, is therefore unfounded.
For some funds, borrowing is a perfectly appropriate strategy, yet for others and perhaps the majority of small funds, it is a strategy best avoided.
Whether changes need to be made to the superannuation borrowing landscape is a question for the legislators and regulators, based on a rational assessment of the current and projected future usage.
Borrowing for investment purposes has the potential to compound investments returns, both positive and negative. I am sure this topic will continue to be discussed for some time to come.
Taxation of superannuation funds
Another topic that has emerged in the SMSF debate revolves around SMSFs having an advantage over APRA-regulated funds to the extent that SMSFs don’t pay tax on unrealised capital gains, particularly when a member moves from the accumulation to pension phase.
While I do not profess to be an expert on superannuation fund taxation, I understand that APRA-regulated funds may choose to manage their fund’s tax liabilities at the fund level, or at the individual member level.
Whilst managing tax at the fund level might deliver an administratively simpler outcome for the fund, individual members may be advantaged or disadvantaged depending on their own particular situation and the investment options they have selected.
Unfortunately the way in which superannuation funds manage their taxation liabilities is not often discussed but may be a relevant point of consideration for financial planners, particularly when providing “super switching” advice to their clients.
SMSFs and ARPA-regulated funds are governed by the same tax laws. How an individual superannuation fund chooses to manage its taxation liabilities is a matter for the fund trustees and their members. Perhaps more transparency in this area would be a good starting point.
SMSFs have been the focus of attention in the media in recent months. Whether this attention is warranted or not, only time will tell.
Perhaps the drift of superannuation savings from APRA-regulated funds to the SMSF sector is more of a concern for the trustees and managers of the APRA-regulated funds who have used the media to bring into question the governance and integrity of the small superannuation sector.
Clearly, SMSFs are not for everyone. Just because a person has a few dollars in super, and a heart-beat, doesn’t mean they should be deserting their large superannuation fund in favour of an SMSF. Running an SMSF takes time and costs money. But, for some, an SMSF will be the most appropriate option.
In the meantime, let’s encourage rational debate based on facts, and not distorted by the emotions or prejudices of one camp or the other.
Peter Kelly is manager for technical advice at Centrepoint Alliance.
Originally published by SMSF Essentials.