The trouble with SMSF property

The problem with self-managed super funds is not that they’re buying residential property, it’s that they’re surrounded by sharks as they do it.

Tax breaks tend reduce one’s critical faculties. We saw that with agricultural investment schemes, which paid commissions of 10 per cent to financial planners and mostly collapsed, and now property developers are paying similar commissions to get SMSF cash.

Noel Whittaker, the author and financial adviser, has been campaigning against property spruikers for a while and in a recent newsletter related a story of a Rockhampton couple who were cold-called by an investment “consultant” who offered to fly them to the Gold Coast for a consultation.

“When we entered their offices in the Gold Coast, it was immediately evident that their only approach was property, that they purchase the land (where they felt was a “growth area”), they build the house, they find the tenants, they look after all the maintenance. They (if I remember correctly) promised that we would own the house outright within 5-7 years with minimal outlay as we use the equity in our own house; and the depreciation on the new house, rental income and minimal outlay from our current income would cover the cost of repayments for the house and land. There were no other options for ‘financial advice’ - this was their only push.”

They didn’t sign despite heavy pressure, but their driver back to the airport said they were one of the few who didn’t. There was another couple from Rockhampton: their proposed investment was a mining town in WA.

The Reserve Bank revealed last week that about $18 billion of the $500 billion in SMSFs is invested in residential property, or about 3.6 per cent.

Some surveys suggest the allocation to residential property could increase to 30 per cent, but this seems far-fetched.

However even it increases to 10 per cent, that’s another $32 billion to be used as deposits for buying properties. Gearing can be 70:30, so a 10 per cent average asset allocation would release $90 billion.

That is a juicy meal for the sharks. Google SMSF property and the paid results provide a long list of “consultants” looking to help investors find a property, in return for big sales commissions from developers.

People start an SMSF either because they own a business and want to put their shop or factory into a super fund structure for tax reasons, or because they just want more control over their investments.

And they usually want more control because they are either more conservative or less conservative than the balanced approach of big super funds – that is, they want more or less cash than them. During the sharemarket boom they wanted less cash and more equities; after the GFC it was the other way around. In the past 12 months they have wanted more high-yielding equities.

The trouble is that the sharemarket is often rigged against them and they know it. Insider trading, selective briefings of institutions by companies, high-frequency trading, expensive managed funds, CEOs who have their eye on short term gains and excessive salaries all tend to make SMSF investors want to invest in property – where, in theory at least, you can own the asset directly, go and look at it and know who’s paying the rent.

The reality is different, of course, with a lot of investors buying new properties that have very large marketing expenses built into them, including sales commissions, that virtually guarantee the investment will produce a poor return.

And the thing is nobody wants SMSF investors crowding into existing property and simply driving prices up; the best result would be if investors used their low-tax, mandated super fund money to expand the stock of housing in Australia.

That’s where regulators and the new Minister for Superannuation, Arthur Sinodinos, have a role: to ensure that SMSF investors don’t get ripped off when investing in new residential property.

A good start would be to limit the amount of marketing expenses that can be loaded onto the cost of a property.

In general, perhaps real estate developments aimed at investors should be treated like all investment products, with product disclosure statements or prospectuses and heavy liabilities on the promoters.

There’s no reason why the burgeoning SMSF sector can’t be used to solve both of Australia’s pressing shortfalls: retirement savings and housing.

But if it’s mishandled it could just as easily exacerbate both, by producing big investment losses and driving up real estate prices.