Industry expert breaks down what brokers need to know
Attendees of last week’s SMSF Deep Dive Webinar, which featured commentary from Aquamore head of distribution Matthew Porch and Aquilar Super SMSF specialist Chris Levy (pictured), were privy to a comprehensive exploration of the themes, misconceptions and nuances of this increasingly popular investment vehicle.
Over the course of an hour, Porch and Levy explored why SMSF property acquisitions are on the rise, common misconceptions about SMSF property purchases, the stark differences between commercial and residential SMSF property purchases, and much more.
MPA caught up with Levy after the webinar to discuss SMSF investing, and what brokers need to know about it, in even greater detail. Here’s what he had to say.
MPA: What are some common misconceptions about SMSF investing?
Levy: The biggest misconception I see with new clients is that they perceive superannuation and SMSFs as an investment in their own right, like an index fund or the share market. This is simply not correct. Instead, an SMSF and superannuation generally are simply a tax vehicle or structure like a company or a family trust. It offers fantastic tax benefits, albeit with some strict restrictions.
MPA: Why do SMSFs lend themselves so well to property investments?
Levy: Property as an asset class is typically considered a long-term investment, which mirrors perfectly the long-term focus of superannuation. In addition, property investments tend to receive associated rental income as cash and on a regular basis. This regular and consistent cash flow lends itself well to pension withdrawals once a person commences a pension from their fund.
MPA: There are stark differences between investing in business property and residential property through an SMSF. What are they?
Levy: Apart from their differing investment characteristics, the superannuation laws treat business property and non-business property (i.e. residential) very differently. Residential property cannot be acquired from the members, and more importantly, can never be used by the members or their relatives, even for a day or for repairs and maintenance. This also applies to holiday homes, and paying market rent does not overcome this restriction. These rules do not apply to business property, which allows a member’s business to rent the property on commercial terms.
MPA: Why are the super rules considerably more relaxed for business properties?
Levy: The origin and rationale for the differing approaches toward residential versus business property are unfortunately lost to the sands of time. What we do know is that the more flexible rules for business properties have been in place ever since Australians have been able to have their own super funds, which probably goes back to the 1960s or even earlier.
The prevailing view is that the government and regulators consider residential properties to be more open to misuse. There might also be a perception that people running their own businesses are somehow more sophisticated and therefore competent enough to manage the special rules and restrictions of leasing a property from their SMSFs.
MPA: What is the rationale behind the related-parties rules in residential?
Levy: Whilst the government and the regulator have, to my knowledge, never provided an explicit answer, the main concern would be misuse by the members. This could involve an underpayment or late payment of rent or overuse of the property (e.g. using a holiday home at peak times without actually paying for it).
Apart from this, the superannuation laws have a very strong aversion to any super member obtaining some sort of personal benefit from the investments held in their SMSF. Apart from residential property, this has impacted the treatment of other asset classes that could technically be owned by an SMSF, such as artwork, vintage cars, and exotic wines.
MPA: Is there adequate knowledge of the differences in these rules among brokers?
Levy: I suspect that most brokers have some idea that there are strict rules associated with SMSFs, borrowing in super, and purchasing and holding property in SMSFs; however, few would have a really solid knowledge. I suspect this is because unless the broker had extensive dealings with such scenarios, it simply doesn’t fit into their day-to-day dealings.
MPA: How do you recommend brokers increase their knowledge of the rules?
Levy: Apart from viewing webinars and attending relevant professional training/CPE sessions, the best and easiest path involves online research. There are some excellent resources online that explain the rules without being too technical, and one of the best sources for this is the ATO (Australian Taxation Office) itself.
MPA: What is the current iteration of the super fund borrowing rules?
Levy: Borrowing in SMSFs came about when Telstra was first floated by the Australian Government back in 1997 and involved the use of instalment warrants. Although these were an extremely crude version of borrowing, it opened the door to SMSFs borrowing when previously they were prohibited.
After several iterations, the current version involves what’s referred to as a limited recourse borrowing arrangement (LRBA), which requires the property to be held by a separate custodian entity in a bare trust arrangement. That is, the SMSF still owns the property, but somewhat indirectly until such time as the loan is repaid.
Furthermore, any loan must be limited recourse, meaning the financing business cannot touch the other assets of the fund in the event of default. Typically, this is overcome through the use of personal guarantees by the members of the fund (although not the fund itself).
MPA: You said in the webinar that there have been issues of brokers “spruiking” SMSFs. What’s the deal with this?
Levy: The typical SMSF property scheme involves a property business (typically a developer) encouraging people to establish SMSFs and assisting them with the establishment in order to purchase the properties that the property business is developing. This may involve borrowing. ASIC has demonstrated a high degree of ferocity in attacking such arrangements for a number of reasons.
Apart from the obvious conflict of interest involved, SMSFs are a financial product, like an insurance policy or a listed security, and can only be recommended by a suitably licensed professional after preparing a detailed Statement of Advice.
