DIY funds have thrived in recent years as the range of potential investments widened: Perhaps the most important of these new opportunities has been the ability to use an SMSF to borrow for property.
But as the new year opens, a crackdown on lending to DIY funds for property investment is well underway and AMP Bank has now stepped ahead of the regulators by banning off-the-plan properties completely.
The system-wide reaction from banks is probably summed up best by the announcement from AMP Bank, upon re-entering the market for geared property to DIY funds in December. (The vast majority of lending to DIY funds for property is through Limited Recourse Arrangements, known as LRBAs).
AMP “re-entered” the market at Christmas because late last year its lending to property investors had reached such strong levels the only way it could satisfy new criteria from APRA was to effectively close its books to new deals for several months.
Prior to July 2015, AMP was one of the leaders in the LRBA space. When it returned to investor lending late last year, it announced severe restrictions for investors.
AMP Bank said it would no longer lend for new properties (including off-the-plan developments), it would drop the maximum loan-to-valuation (LVR) ratio from 80 per cent to 70 per cent and it would introduce a “minimum fund size of $200,000”.
Many other banks had already reduced LVRs for LRBAs. And while not necessarily stating a “minimum fund size”, they had introduced changes that had similar impacts.
In my opinion, the most important change AMP has introduced is this: “Properties less than six months old (including off the plan) are now classified as unacceptable securities (for SMSF loans only)”.
As I’ve written recently, the single biggest threat to SMSFs (see Property in DIY can be a monstrous investment, February 11 2015) is that posed by property developers. The Australian Investments Securities Commission (ASIC) is making some inroads in dealing with the issue, but it really needs actions of banks to make policy changes like that which AMP has made.
So the crackdown has its benefits: It will cool off some of the more speculative property developers, it will slow the amount of debt building up in SMSFs (see today's feature by Emma Koehn: DIY investors load up on mortgage debt) and perhaps protect some of the more naive DIY investors who have been preyed upon.
What should SMSFs interested in purchasing property do?
But what can serious investors do now? It’s important to note SMSF trustees can still get a loan to purchase a property via an LRBA.
A survey report by Canstar into SMSF lending in October last year (unfortunately rendered out of date almost by time of publication due to the volume of changes last year) surveyed 17 of the top lenders in the space.
Canstar found that maximum LVRs had only fallen, on average, by 1 per cent, from 79 per cent to 78 per cent over the previous year. However, the report was published in October, prior to further changes being made by the banks.
Looking to the year ahead, it seems that the bigger banks are the lenders, which will make the most severe changes, while smaller banks and regional lenders may be slower to crackdown on lending terms.
If as an SMSF trustee you are in the market for an investment property, you’ll need to shop a little harder. Here’s some suggestions:
• If you’re intending to put up a significant deposit (such as 30-40 per cent, plus costs including stamp duty) to buy an existing property, then you’ll find that most lenders in the space will accommodate you.
But if you’re looking to borrow 80 per cent - the maximum LVR that I’ve come across as a mortgage broker – then your options will be somewhat more limited.
Needless to say, even if a bank makes it possible, be wary of buying off-the-plan property from developers. I’m hoping more lenders in the space follow AMP’s lead.
• Look out for those loan products that have offset accounts attached to them. Not many products in SMSF loans have this feature. SMSFs are, usually, significant holders of cash. So if you’re going to both own a geared property in your SMSF and continue to hold ample cash, then an offset account will generally be far more valuable than earning taxable income in a high-interest savings account (see ‘Cash is king’ is dead, June 3 2015).
• Be aware of legislative risk – the rules could change at any time.
We know the Government gave every indication that LRBAs would continue to be allowable last year, but it is important to remember that David Murray’s Financial Systems Inquiry had recommended such loans should be banned.
The government approved 43 of Murray’s 44 recommendations, with the only one rejected being a proposed ban on LRBAs. In other words, just because this political regime is happy to keep DIY funds borrowing for property, another political regime may not be as comfortable with the idea.
• And for those who have used related party loans – loans from yourself or your business to your SMSF – to purchase investment properties, remember you only have until 30 June this year to make sure those loans are on commercial terms. See here for more information: Does your SMSF loan pass the ‘smell test’?, November 4, 2015.
On related party loans, the ATO plans to get tough immediately following the 30 June, 2016, deadline.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.