DIY superannuation funds turbo-charged with borrowing to buy property are failing after two years because of high costs and low returns, sparking alarm within the billion-dollar retirement industry about the controversial investments.
Advisers recommending self-managed super funds claim they are being bombarded by property developers with offers of up to 20 per cent commissions, top-up bonuses and other special cash incentives to encourage the super investors to buy off-the-plan apartments.
“This is scary,” said Scott Hartley, a veteran banker and the chief executive of SunSuper, a $30 billion super scheme for major companies and individuals, about the pressures on investors to borrow against their retirement assets.
Investors are being offered "returns" on apartments equivalent to more than 20 times the Reserve Bank of Australia’s cash rate, which is the overnight money market rate, with free furniture and guaranteed tenancies.
Members of defined benefit pension schemes, which are considered the Rolls Royce of superannuation plans because they provide a guaranteed return for life, are also being advised to quit their plans for leveraged DIY plans, triggering more alarm amongst industry professionals, warns Andrew Peters, managing director of financial adviser group Semaphore Private, and a certified financial adviser.
“You could drive a coach and horses through the loopholes,” warned Andrew Baker, managing partner of Tria Investment Partners, a leading international financial services consultancy, about regulation of leveraged self-managed super funds, one of the nation’s fastest growing investment products.
Finance and property practitioners are demanding regulators get a grip on the scale of the emerging problem in the SMSF sector, which has more than $6 billion under management in nearly 40,000 schemes and which is growing at more than 11 per cent a year.
Industry super chiefs are expected to launch an affirmative campaign to The Financial System Inquiry's question on whether there should be “limitations” on setting up self-managed super funds.
“The industry has no control,” says Ben Kingsley, chief executive of the Property Investment Professionals of Australia, a new body attempting to monitor and control excessive borrowing, commissions and unethical practices.
“It’s imperative for the prospective buyer to work out whose best interests are being served by them buying a property for their superannuation,” he says.
Self-managed super funds (SMSFs), whose borrowings and derivative concessions were created to allow instalment warrants, account for about one-third of the nation’s $1.8 trillion of super savings.
During the past 20 years they have evolved from sophisticated investment structures for the rich into mainstream vehicles advertised on railway and bus stop hoardings.
Best-guess estimates are that the use of leverage in superannuation funds is “embryonic but growing”, according to the Financial System Inquiry, which last week published an interim review of issues facing the nation’s financial system.
During the four years to 2012 the proportion of SMSFs with borrowings tripled to about 4 per cent, according to the Australian Taxation Office.
The average amount of borrowings during this period also tripled from about $120,000 to more than $350,000. Total borrowings were more than $6 billion.
Additional research, by Investment Trends, found that in the 12 months to April 2014, the number of funds using gearing, or borrowing, increased by about 11 per cent to 38,000, making it one of the nation’s fastest growing financial products.
Most of the research is based on annual tax returns, which means it is about 18 months out of date, a big gap during a strong property market when sales in the nation’s capitals have been strong.
Some groups, such as the SMSF Professionals’ Association, an industry group promoting best practice, say that the $18.6 billion invested in residential property is less than 1 per cent of the $4.7 trillion Australian residential housing market and poses no systemic, or inflationary, dangers.
Others claim that while the numbers are small they are rapidly growing and the risk is increasing.
The Financial System Inquiry warned gearing could “create vulnerabilities” for the financial system “if allowed to grow”, adding it should not be a core focus of “any superannuation fund” and is “inconsistent with Australia’s retirement income policy”.
Relaxation of gearing rules for super about three years ago, allowing property investment through the funds, has been a windfall for many financial advisers who have been able to offset the loss of commissions on investment products with generous five-figure commissions from real estate agents for recommending clients use limited-recourse borrowing to buy property – typically off-the-plan apartments.
Advisers are also being offered “no course, no examination, 100 per cent success rate” real estate qualifications that enable them to tap into the big commissions from investors wanting to plunge into property markets.
Under the new regime, the financial adviser can take a fee as an adviser and a commission as a real estate agent.
Non-bank lenders, including low-documentation providers, are also cashing in as investors maximise negative gearing tax breaks with high-loan-to-value, interest-only loans.
Loan-to-value ratios are falling and there has been claims that some buyers may soon be using credit cards to help pay house deposits as credit and borrowing requirements ease, according to experts.
A mish-mash of prudential, securities, real estate and taxation regulators have created a confusing and confused set of rules for investors and those attempting to enforce them.
For example, a real estate agent is qualified to sell an apartment to the point where it touches on the issues of whether it might be a good investment for a retirement fund. At that point the agent must decline to offer an opinion, refer the client to a financial adviser, or become a financial adviser.
In addition, there has been an explosion in the number of self-designated "advisers" and "property experts" – the descriptions can be used by anyone – attracted by the lure of big commissions and cash incentives.
Often they are closely aligned to property developers, who see SMSFs as a tool for selling off-the-plan apartments, rather than providing retirement income.
Dante De Gori, general manger of policy and conduct for the Financial Planning Association, the peak body for certified financial planners, says many developers only care about the sale.
“People attempting to promote mass market products is a concern,” he says. “Any recommendation or advice needs to be appropriate, relevant and in the clients’ best interest.”
“It’s a grab for cash,” says Semaphore's Peters about the surge in off-the-plan sales.
“The lines between property advisers, mortgage brokers and financial planners have become hopelessly blurred to the huge detriment and confusion of consumers,” Peters says.
The boom in property sales for DIY super is also spawning intermediaries offering one-stop, legal, insurance and referral services that can pay more than $12,000 in commissions and fees to financial planners.
“Many of these professionals are qualified in their related disciplines, but often lack a sound and fundamental understanding of the type of area and property research required to identify investment grade property,” says Kingsley from PIPA, which is urging minimum qualifications for practitioners.
There are also fears that "bad apples" from one profession can form alliances that enable them to hide behind the experience and reputation of their better-regarded peers.
Greg Tanzer, a deputy commissioner of Australian Securities and Investments Commission, who along with deputy chairman, Peter Kell, head a task force looking into SMSF geared strategies, says: “A feature of these businesses is a ‘one size fits all’ approach where all investors who use their multiple services receive the same suite of products and services – they end up with an SMSF, a property investment and a limited-recourse borrowing arrangement.”
These types of structures also tended to inhibit competition, particularly on costs, according to the Financial System Inquiry. Kingsley says in other cases they can provide lower costs and more convenience.
ASIC reviews have also found that borrowing in superannuation is often associated with poor financial advice.
