The Financial Systems Inquiry (under David Murray) has strongly urged the government to end the access of Self-Managed Superannuation Funds (SMSFs) to Limited Borrowing Recourse Arrangements (LBRAs).

According to the latest Australian Taxation Office statistics, more than a million Australian retirees belong to a self-managed super fund. Thousands of these, it has been found, use part of this fund to purchase property through LBRAs.

LBRAs allow SMSFs to take out loans from a third party creditor. The loan and the available retirement funds are then used to purchase a single asset, which is held in a trust.

Dwindling interest rates and surging house prices have made these investments a very attractive option for retirees.

But such investments are not without their risks:

The borrower: Should the property price drop subsequent changes in the loan-to-value ratio may force the creditor to foreclose on the loan, sell the property at a loss, and leave the borrower out of pocket.

The housing market: This further interest in property investment adds more fuel to an already overheated market. As prices rise beyond the actual value of the property the possibility of a market bubble becomes ever greater: First home buyers are priced out of the market, buyers purchase overvalued properties, and the eventual market correction will hit everyone hard.

The financial system: Parking such huge sums of money in one area acts as a bottleneck to the flow of wealth within the economy. Such bottlenecks dampen economic progress, which increases unemployment, and reduces the standard of living.

John Barton of Shadforth Financial put it thus for self-managed retirees considering an LBRA: “You will be relatively poorly diversified, most people will already have a fairly big exposure to property, it’s not like property can’t go down

“I know an adviser who had a client who bought a property in Geraldton who paid $1.3 million for it and now can’t sell it for $400,000.

“Property is not guaranteed to go up every year. You have a relatively low yield, you are lucky to get a yield much above the inflation rate.”

The big winner, for property investors, is through tax benefits. Property bought through a SMSF is taxed at 15 per cent. A lot less than the 20 to 49 per cent applied to income tax.

The director of technical and professional standards at the SMSF Professionals Association of Australia, Graeme Colley, hosed down some of David Murray’s concerns. He said the portion of SMSF trustees was a negligible 1.3 per cent of the whole. But he acknowledged there are risks associated with the practice.

“If there’s a failure in the real estate market,” he told, “then that creates an unwarranted risk with your super fund.

“”If there is a drop in the value of those properties then trying to sell that property and be able to pay off the mortgage just from the sale itself may not be possible.

“If you can’t rent the property out and you have multiple properties where are you going to get the money from?”

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