The SMSF lending slowdown

Summary: Are SMSFs being held back from entering the property market? Yes, absolutely. Is this a bad thing? That's less certain.

Key take-out: The growth in limited recourse borrowing arrangments by SMSFs has slowed down, a lot. Here are some reasons why, backed up by the numbers. 

You don't have to go back far to find screaming headlines that DIY funds were the devils responsible for pushing property prices ever higher.

And, as a result, making ‘the Australian dream' inaccessible to first home buyers.

A year ago, there were near-daily calls for the government to shut down, completely, the ability of self-managed super funds to access limited recourse borrowing arrangements (LRBAs).

Those demands have died down. As I argued at the time, SMSFs were neither the cause of the property price boom, despite the arguments of some critics, nor a major force in propping it up. Further, the relatively tiny market share of SMSFs in the residential property market was never going to have a major impact on demand (which ultimately leads to higher property prices).

The proof has been in the results. In the Australian Tax Office's most recent stats, it estimates the growth in SMSFs using LRBAs grew by just 12 per cent in the year to September 2017. Outstanding LRBA investments grew from $27.08 billion to $30.73 billion over that period.

In the final quarter, between June and September 2017, outstanding LRBAs grew just 0.85 per cent, according to the ATO's estimates.

SMSFs weren't really able to borrow commercially for investment properties until around 2010. Their total investment represents a tiny fraction of the total value of residential property holdings in Australia.

So, given the government didn't act to ban LRBAs, why has the previously strong growth in SMSFs taking out LRBAs slowed down so much?

SMSFs have been hit by the much broader attempts to slow down lending to all investors, part of a three-year battle by the Australian Prudential Regulation Authority (APRA) to get financial institutions to restrict borrowing to investors.

As a result, property buyers (both owners and investors) have seen the lending market split between home buyers and investors.

Home buyers now pay a lower interest rate than investors (by, in some cases, more than 1 per cent). And those who still want interest-only will pay a higher rate than those prepared to make principle and interest repayments.

Loan-to-valuation ratio (LVR) restrictions or reductions have been placed, increasingly, on all types of properties.

When it comes to SMSFs and LRBAs, the restrictions have been far-reaching.

Prior to APRA's war on investment lending starting in about April 2015, the previous standard LVR for SMSFs was 80 per cent. There are very few mainstream lenders now who will lend beyond 70 per cent, with some restricting borrowers to 60 per cent or less.

Interest rates for SMSF investors have soared. Interest rates that were averaging in the mid 5 per cent range at their lows are now in the mid-to-high 6 per cent range, with Bank of Melbourne/St George charging more than 7 per cent for its variable SMSF investment loan.

SMSFs have always paid a higher rate for loans than mum and dad investors. And as all SMSF borrowers are investors, they pay on average a much higher rate now and have not benefited from the reduction in home loan rates.

Several lenders have put minimum size restrictions on SMSFs – they must have a minimum of $200,000 or $250,000 to even begin qualifying for a loan.

Most lenders for LRBAs have placed restrictions on loans for ‘new' properties. Most notably, AMP will not lend at all for properties younger than six months. Many other lenders have restrictions on loans to purchase properties less than two years old.

The reason for this is simple. Too many new SMSFs were being set up for the express purpose of being able to purchase brand new, or off-the-plan, investment properties, direct from developers. These properties are most often purchased via developer-run seminars, where investors are encouraged with shiny baubles (tax deductions) to purchase properties that often fall in value over the first few years and can take a decade to recover their initial purchase price.

From this standing point, the restrictions make a lot of sense.

Yes, it has become considerably harder and more expensive for SMSFs to qualify for investment loans.

I largely applaud the restrictions on ‘new' housing, particularly where they stop new SMSFs being set up by parties tied to developers to flog their inferior product. It has probably saved hundreds of SMSFs being set up and fleeced.

The subdued LRBA growth coming through in the ATO's statistics somewhat parallels the remainder of the investment market.

The $30.73 billion of LRBAs in SMSFs includes both residential and commercial properties. Directly held commercial properties held by SMSFs for the same quarter was $79.1 billion, and residential was $33.8 billion.

Since mid-2015, when the ATO made some changes to the way it measured LRBAs, the growth of LRBAs hasn't been outrageous, when compared with the value of non-LRBA properties over the same period, as estimated by the ATO.

(However, the ATO warns about the currently available SMSF statistics. The ATO says the FY17 and beyond figures are extrapolated from FY16 figures and will be revised when FY17 data is complete in June 2018. It expects the drop in concessional and non-concessional contribution rates that kicked in on July 1, 2017 to impact final figures.)

But the tougher lending restrictions have now been met with a slowdown in lending to SMSFs, which both coincide with the cooling of some parts of the national residential property market.