Exploiting low rates 2: Good numbers for gearing

So, the bookies were wrong. An interest rate cut was odds-on favourite last week. But nothing. Not until next month at least. Possibly longer.

Every interest rate cut – for years, actually – has only been icing on the cake for property investors. Rates have been so far below “average”, for so long, as to almost have been a non-issue in recent years.

From an investor's perspective, rate cuts should now be irrelevant. Pleasant, but irrelevant, to the main question of whether it is the right asset class/investment to be in.

The underlying investment of geared property necessarily involves a long-term time frame. Property has high entry and exit fees. Property's downswings can last for years. You really do need time to be able to ride out the bumps.

And, given the current rules of being able to sell capital gains tax free in pension mode in super, you would want to have a good excuse to sell before age (roughly) 60.

There is only one thing more beautiful in the investment world than being geared in a rising market. And that's when the gearing is at ultra-low interest rates.

Geared assets in super?

Techically, SMSF trustees can gear into any asset that an SMSF can legally purchase. But it has never made sense to gear into cash (for obvious reasons), and rarely makes sense to gear into bonds (thought it can in the right markets).

But particularly when you get slugged a higher rate for SMSF investing, which banks do.

Gearing is all about growth assets – shares and property.

So, does it make sense to gear into property and shares now?

That depends on whether you think there is further growth left in those asset classes. If you don't believe there is in the short to medium term, then don't invest. And wait until you believe that the next upswing is coming.

If you believe you can make the call to gear into an upward swinging market, then all power to you. If you get it right, you will be handsomely rewarded.

Property has been on a canter, broadly speaking, for about the last two years. Shares have been galloping for the last three (since May 2012).

Are we at the end of another bull run? For both asset classes?

Property gearing

I'd argue the answer is no. But that's not an across-the-board no. There are suburbs and cities that, to me, have pushed beyond what could potentially be considered current fair relative value. Compared to other assets, in similar markets, these assets would appear to be overpriced.

In every property market, there will always be underperforming suburbs, where relative bargains exist.

For mine, Sydney's property market has been strong for too long. For investors. (I'm less concerned for home buyers, who buy and sell in the same market and get a personal enjoyment out of the asset, which is not an investment.) Finding investment value in Sydney will be harder than in other cities, though not impossible. Melbourne will still have relative value in pockets. Brisbane, for mine, broadly, is underpriced, following a razor-gang government that has since been ousted and replaced with a government that is more likely to grow the public service.

Interestingly, it would appear that SMSFs are not so sure about this question themselves. The ATO's quarterly survey suggests that there has been only modest growth in lending for limited recourse borrowing arrangements (LRBAs) in the most recent year. In December 2013, outstanding LRBAs stood at $8.96 billion. In December 2014, it stood at $9.38bn. Over the 12 months, the growth was 4.7 per cent. Unspectacular.

So much for the hyperbole about SMSFs weighing in and elbowing first-home buyers out of the market.

Interest rates for investment properties in super are charged at a higher rate than non-SMSF properties. The standard variable rate for SMSF investment property loans are around 5.6 per cent to 5.7 per cent. (Non-SMSF loans are about one percentage point lower.)

I am seeing plenty of new interest in property investment in SMSFs. Of the ones that I am encountering, are they doing the right thing? Of the ones that I am speaking to, they are largely ticking the right boxes. Is property gearing, in super, right for them? Do they understand the risks? Do they understand that not all property markets are going to push upwards? Yes.

My biggest fear, always, has been those new SMSFs who know little about property investment, who attend property-spruiking seminars. Suckered in to buy cheap quality, low-potential, usually out-of-town property that will cause their retirements serious pain. But see my previously published opinions on that (Renewed threat to SMSF property gearing, 27 August, 2014).

As always, if you can avoid rubbish property, your chances of success are vastly improved. I don't believe it's that hard to avoid those properties. But you either need to do the research yourself, or find a reputable professional to guide you.

Gearing into shares

Even more so than in property, in every share market, there are companies who have been overlooked, to the detriment of others who have potentially been overbought.

Gearing into shares should, therefore, be easier to make money out of. If you know what you're doing.

But, the problem with shares and gearing in SMSFs is the need for diversification. And the current SMSF gearing rules, regarding LRBAs, don't make for easy investment into shares, as they do for property.

Individual investments into shares need to be made into individual “bare” trusts. If you want to build a portfolio of 10 shares, you will need to purchase 10 bare trusts.

If you believe the overall market has great room for improvement, then a single bare trust, with the likes of an index fund or exchange-traded fund (ETF), could be worthwhile.

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.

Bruce Brammall is managing director of Bruce Brammall Financial. E: bruce@brucebrammallfinancial.com.au. Bruce's new book, Mortgages Made Easy, is available now.

• Treasurer Joe Hockey says there is a “compelling” case to separate access to health concession cards from pensions, The Australian Financial Review reports. Hockey told the newspaper that many higher income earners structure their finances to access the age pension so they can obtain health concession cards.
• The Government should not ban the use of limited recourse borrowing arrangements by superannuation funds, according to the SMSF Association. The body does not support the Financial System Inquiry's recommendation to ban direct borrowing by super funds. The SMSF Association's alternative recommendations to avoid a build-up of unnecessary risk in the super system include bringing LRBA advice under the AFSL regime, increasing ASIC resources, limiting the use of guarantees and tightening related party borrowing rules.