Property takes one in four SMSF dollars

SMSF investors have higher allocations to property than a first glance might suggest.

ATO data may not tell the full story on where SMSF investors are directing their funds.

Self-managed super funds have made some very interesting — and revealing — changes to their asset allocation as reported by the ATO in the five years to June 2016.

The falling allocation to cash is of close to 3 per cent and an increase in geared investments classified as “limited recourse borrowings” of over 3 per cent are the most significant moves. Investment in property has remained reasonable static.

But, the data categories of the ATO may not tell the full story regarding where SMSF investors are directing their funds.

The ATO does make the assumption that “assets in trusts are treated as though half is invested in equities and half in property”. If this is the case then of the unlisted and listed trusts, which make up nearly 14 per cent of the asset allocation, half may be invested in property trusts including unlisted property trusts, which have the allure of high returns.

At the same time, the increase in geared investments or “limited recourse borrowings” is likely due to buying of investment properties. So both these weightings with another 15 per cent in real non-residential and residential property mean that SMSF members are quite exposed to the property market, with a weighting of around 25 per cent.

With major banks tightening lending standards, especially in the property development area, investors such as SMSFs are likely providing another source of funding for cash-strapped property developers.

But, if the developers cannot get bank loans, then the red flag should go up as they are most likely to be at the riskier end of the spectrum, which in turns exposes SMSFs to a higher chance of loss.

But don’t forget the failures.

There have been some spectacular falls from grace of some of the major property players over time. In the 1980s and 1990s Estate Mortgage and Australia-Wide failed, leaving investors in the precarious position of not being able to redeem their money.

The global financial crisis caused some problems again, particularly for unlisted property companies, with many unable to pay redemptions either because legally they could refuse to pay redemptions and distributions or their liquidity levels were below mandated requirements.

In the aftermath of the GFC unlisted funds including unlisted property trusts to the value of around $37 billion (according to data from Australian Securities & Investments Commission) were frozen.

Listed Australian Real Estate Investment Trusts or AREITs managed the more notable unlisted property trusts frozen.

Some of the managers of frozen funds included Centro Property Group, responsible for Centro Direct Property Fund valued at $1.3bn, Becton Investment Management managing Becton Diversified Property Fund valued at $61 million and APN Property Group managing APN Property for Income and APN Property for Income No 2 valued at over $800m.

The end result was frozen property trusts were either wound up, investors could apply for “rolling” distributions or the trusts were rebranded or renamed.

Four traps lie for investors:

Liquidity

Redemption can be a problem when there is sharemarket volatility and economic uncertainty, as investors are more likely to want their money back. There may also be a minimum investment period of between five and seven years during which investors cannot exit.

Gearing

Unlisted property trusts have in the past got into trouble because of high gearing levels, as did listed property trusts. Highly geared trusts should be avoided as they may also be supporting unsustainable yield from borrowings rather than cash flow.

NTA calculation

The method of calculating NTA can affect the value of the unlisted property fund down the track. Acquisitions costs can be capitalised upfront rather then written off, but then there is the risk that if the value of the asset has not risen by at least the amount of the capitalised costs at the next revaluation, then they will have to be written off at that time, negatively affecting the NTA.

Unsustainably high yields

A major attraction is often the high yield paid by unlisted property trusts. But, a huge level of risk may be the only justification for extraordinary returns. If the underlying asset is of high quality and there is a long-term lease in place to provide a sustainable income stream, the investment is likely to be more successful. As with any investment the more you move up the risk curve, the lower the quality of the investment and the increased chance of loss.

Britain’s decision to leave the European Union triggered a rush of redemptions on property trusts leading to many becoming frozen. The situation is different in Australia with no signs of funds being frozen, but investors should remain cautious about being over-exposed to unlisted trusts. Liquidity issues will arise if managers are in the position that they cannot meet redemptions and freeze their funds, which can remain in that state for many years.

The increased numbers of DIY operators satisfying the criteria for the “sophisticated” investor tag also has increased the risk to SMSFs investing in unlisted property trusts.

The increasing numbers of those likely to meet the guidelines to be classified as “sophisticated” (ie assets in excess of $2.5m), may increase their vulnerability to higher risk unlisted property trusts, which may be involved in development.

Rosemary Steinfort is research manager at marketplace lender www.directmoney.com.au