Regulators sound alarm over SMSF property speculation

A surge in property speculation by leveraged self-managed super funds amid sliding house prices has triggered alarms.

Opposition Treasury spokesman Chris Bowen said the government was “asleep at the wheel when it comes to listening to advice and managing risks in the economy”. Picture: Kym Smith

A surge in property speculation by leveraged self-managed super funds amid sliding house prices in the nation’s biggest cities has sparked concerns among the powerful Council of Financial Regulators that many may be in over their heads.

Confidential documents, obtained by The Australian under Freedom of Information rules, reveal a renewed rush by SMSFs to take out mortgages for property investment despite an increasing crackdown by the major banks to close off the problematic credit products.

Documents collated for the regulator show the total value of property investment loans held by SMSFs has raced to $39 billion — more than 5 per cent of all assets in the $700bn self-managed super sector by the end of the June quarter.

Loans for property investment through SMSFs are considered “limited recourse” because if the loan defaults, the bank can claw back only the specific asset bought with the loan, not the rest of the assets in a fund. However, as loans can account for a large share of a particular SMSF’s assets, this can leave the borrower vulnerable to changes in property prices, risking pushing a retiree on to the age pension.

The number of limited-­recourse borrowing arrangements has risen dramatically from just 0.1 per cent of SMSF assets a decade ago to more than 5 per cent, as more SMSF owners have been encouraged to pile into investment properties by financial advisers and “one-stop-shop” SMSF advisories, which collect lucrative fees for establishing the funds and tipping trustees into housing assets.

Sydney home values have fallen more than 11 per cent from their July 2017 peak, while Melbourne values have dropped more than 7 per cent since November 2017. Analysts are expecting further falls this year.

Ratings agency Moody’s last week tipped Sydney house prices to fall 3.3 per cent this year with prices in Melbourne off 6 per cent.

The documents reveal that the Australian Taxation Office, which regulates the SMSF sector, has raised concerns with Treasury about the accelerating house price falls in Sydney and Melbourne.

“Of interest is that NSW and Vic have the highest number of SMSFs and Sydney is ranked first and Melbourne ranked third for falling house prices,” the ATO’s director of superannuation told Treasury in September.

Since then, the fall in house prices in Sydney and Melbourne has accelerated.

The concern about the use of the borrowings in SMSFs follows revelations at the financial services royal commission of systemic problems across financial advice outfits that spruik SMSF property investment and stand to win lucrative fees whether or not it is in the best interests of clients.

Almost one in 10 SMSF owners have accessed limited-­recourse borrowing arrangements, which are mostly used to fund property investments.

The Productivity Commission last week also called for dramatic reforms of the super sector including cutting down the use of multiple funds, addressing under­performance and warning that people in SMSFs with balances of less than $500,000 could be better off in regular funds.

The PC said that “given recent growth, coupled with taxpayers ultimately underwriting (in large part) any gross underperformance of SMSFs through the age pension, ongoing monitoring (of limited-recourse borrowing arrange­ments) was clearly warranted to ensure that SMSF borrowing to fund investments does not have the potential to generate systemic risks in the future. Many of the concerns expressed about limited-recourse borrowing arrangements relate not to their potential impact on the superannuation or financial system, but on SMSF members for whom such arrangements might not be appropriate.”

The Australian Securities & Investments Commission has been targeting poor consumer outcomes in the sector — finding that 90 per cent of financial advice given to SMSF owners failed to be in their best interests — the figures show the pace of borrowing has reignited in the most recent quarter.

By the end of June, limited-­recourse borrowing arrangements had grown to $39bn, an increase from the $32bn figure recorded at the end of March. This compares with a figure of just $418 million in June 2008.

The Council of Financial Regulators, a collection of representatives from Treasury, ASIC, the Australian Prudential Regulation Authority and the Reserve Bank of Australia, was tasked with a review of limited-recourse borrowing arrangements following David Murray’s Financial System Inquiry.

The 2014 inquiry recommended the government ban limited-recourse borrowing arrangements, citing the need to “prevent the unnecessary build-up of risk” and ensure super remained a vehicle for retirement income “rather than a broader wealth management vehicle”.

It was the only recommendation the Turnbull government rejected, noting that it did “not consider the data sufficient to justify significant policy intervention” as it tasked the Council of Financial Regulators to “monitor leverage” and report back in three years.

Since that decision, limited-­recourse borrowing arrangements have grown by a further $17bn.

Opposition Treasury spokesman Chris Bowen said the government was “asleep at the wheel when it comes to listening to advice and managing risks in the economy”.

“The Liberal Party has continued to recklessly ignore the financial stability risks associated with Australia having the second-highest household debt in the OECD for years now,” Mr Bowen said.

Labor has proposed banning limited-recourse borrowing arrangements if it wins office.

Treasurer Josh Frydenberg declined to comment yesterday but said today the government is “monitoring” the situation.

“Non-recourse borrowing by SMSFs is 2.9 per cent of total SMSF assets which is a small proportion of their overall assets, less than 1 per cent of the overall lending by banks and a very small part of the housing market which is valued at $6.5 trillion,” he said.

“That being said, it is something that has to be monitored which is exactly what the government has done.”

Mr Frydenberg said the government asked the Council of Financial Regulators to review non-recourse lending to SMSFs and to use enhanced ATO data to “report back to government within

three years in order to inform consideration of whether changes to the borrowing regulations might be appropriate in the future.”

“The government is expecting this report by the end of next month,” he said.

In September, Commonwealth Bank became the last major lender to stop offering the products, following Westpac ending the sale of LRBAs in July.

APRA told the Murray inquiry it had “long had reservations about extending the ability of superannuation funds to borrow” as “additional direct leverage may amplify returns but exposes superannuation fund members to greater financial risks”.