Regulators are struggling to keep up as the nexus between real estate operators and financial advisers gets stronger, writes John Collett.
Property investment seminars being held around the country are striking a chord with those seeking a comfortable retirement.
Usually, the main speaker will be from a real estate company, though the exact nature of the business is not always clear.
But the pitch is clear enough: how real estate, particularly apartments, can be mortgaged inside a self-managed super fund (SMSF) where existing super is used for a deposit on the property. Some even advise that if you do not have enough super for the deposit, you can borrow against the equity in the family home.
Each week, about 700 self-managed super funds are established. No one is saying holding mortgaged property inside an SMSF cannot be a good investment. But it is the hard sell from unlicensed property spruikers that has the Australian Securities and Investments Commission, and others, worried.
"In the right hands, SMSFs can be very effective retirement savings vehicles," ASIC Commissioner Peter Kell said in a speech in April. "In the wrong hands, however, SMSFs can be high-risk."
Andrew Hewison, a financial planner with Hewison Private Wealth, which has many SMSF clients, says borrowing to buy a property inside super is not a strategy the "average person should be playing".
The risks of the strategy are probably not being discussed at the seminars, Hewison says. They are probably not discussing what happens if the property is vacant and no rent is coming in or if the people making the investment lose their jobs.
Also, with interest rates at historic lows, the strategy needs a buffer for when the cash rate and mortgage interest rates return to normal levels.
Once the preserve of small business owners and well-off professionals, SMSFs are being mass marketed. However, the rules and regulations designed to help protect people from unscrupulous operators are far from clear cut.
The superannuation rules were changed in 2007 to allow SMSFs to borrow to purchase real estate. Before then, only property that was owned outright could be held in an SMSF. The change put the strategy within the reach of most people.
Real estate operators are paying incentives to financial planners and accountants to recommend property to their clients. SMSF administrators, who set up and take care of the accounting and legal aspects, are advertising heavily on prime-time television, radio and the internet.
They are appealing to those who want to take control of their super. This mass marketing is increasing the awareness of SMSFs among ordinary wage and salary earners, most of whom are members of low-cost, well-managed super funds. It is also making the ground more fertile for the sales pitches of property spruikers.
The head of advice, wealth and super at researcher CoreData, Salvador Saiz, says its surveys of members of large super funds show up to 10 per cent say they intend to set up or join an SMSF over the next one year. A little less than a quarter say they are likely to establish or join an SMSF in the next five years.
"What is interesting, is that it is the 40-50 age bracket that is fastest growing within the SMSF sector, followed by those in their 30s," Saiz says.
Graham Hand, editor of non-profit financial education website cuffelinks.com.au, attended a "packed" seminar held in the offices of a real estate company. The main speaker gave an example where $140,000 of super could be used to buy a property worth $500,000. The speaker said that if the property was sold for $1 million in 10 years' time, and assuming the seller's age at 55, there would be no capital gains tax as the seller would be in the pension phase.
But the pitch neglected to mention some important details. The superannuation preservation age is between 55 and 60, depending on the birth date. The speaker did not explain, for example, that a 45-year-old would have to wait 15 years, not 10 years, to be in the pension phase.
Hand questions whether it is appropriate to borrow a large amount of money to invest in a single, illiquid asset worth more than the SMSF itself. In the pension phase, a certain minimum percentage has to be drawn each year. There could be a problem meeting the minimum draw-down if the property is without a tenant, he says.
Residential property in self-managed super is becoming part of "every real estate agents' kit bag", Hand says. "An industry that has never taken a backward step is seizing an opportunity."
The principal of Townsends Business and Corporate Lawyers, Peter Townsend, says real estate agents would probably be meeting the letter of the law if, at the seminars, they disclosed they were not licensed to give financial advice and that attendees should seek independent financial advice before proceeding. If these disclosures were made, the agents would be deemed to be providing only information and would be within the law, even though the sole purpose of the seminar was to encourage attendees to buy property through an SMSF, Townsend says.
The law says any advice on whether or not to start an SMSF would have to be provided by a licensed adviser or an accountant operating under the licensing exemption, but the regulatory environment is confusing.
Real estate agents are licensed under the states, while ASIC regulates financial products under the Corporations Act. The Tax Office is the prudential regulator of SMSFs. ASIC and the Tax Office have issued repeated warnings to the public about property spruikers targeting the SMSF market.
Kell has said that although ASIC does not regulate real estate, where the investment is made through an SMSF the person requires a licence because an SMSF is a financial product. ASIC has a taskforce looking into the risks of the SMSF sector.
But it appears the growth of SMSF administrators and real estate and property development operators targeting SMSFs has outpaced the ability of regulators to keep up. Financial advisers and accountants can generate large kickbacks from mortgage brokers and life insurers, and from real estate companies as well.
A financial adviser could refer the client to a mortgage broker and receive a "referral" fee, for example. Life insurers can pay commissions to a financial adviser that are worth more than the first year's premium. While the new Future of Financial Advice reforms will rid the financial planning industry of most commissions, they do not ban commissions or kickbacks on life insurance, mortgages or real estate, though these have to be disclosed.
Life insurance is likely to be taken out by anyone starting their own fund. The insurance commissions can be large, while mortgage commissions tend to be smaller, leading to concerns the advice could be biased towards setting up an SMSF.
Lenders have a role to play in ensuring they lend conservatively. Mainstream lenders to those who want to buy property inside an SMSF do have lower loan-to-valuation ratios, usually up to 65 per cent to 70 per cent of the purchase price, compared with ordinary mortgages where they can lend up to 90 per cent of the purchase price.
"In the regulated lender space, there is probably not too much of a problem," Vicki Grey, a partner at law firm Kemp Strang, says. "The biggest problem is those outside of the big lenders who are less scrupulous."
Big lenders usually make it a condition before the mortgage is approved that SMSF trustees first receive a "sign-off" from an adviser. It is not a legal requirement that trustees get advice, but usually a requirement of the lender, Grey says.
This strategy of borrowing to buy a property and putting it in an SMSF is a problem regulators are grappling with. There has been talk about bringing the whole buying arrangement into the financial licensing regime so that it comes under the Corporations Act and clearly within the reach of ASIC.
That is the solution the chief executive of the Association of Superannuation Funds of Australia, Pauline Vamos, favours. She says anybody giving advice - even if they say they are only providing "information" - about any investment into an SMSF should be licensed. That would start to "turn the tide" against property spruikers, she says. "It would help fill consumer protection gaps."
Total SMSFs 509,362
▲7% in the year to June
Assets $505.5 billion
▲ 15.3 % in the year to June
▲7.3% in the year to March
SOURCE: APRA, ATO.