SMSF Property Investment Risks
Why banks are avoiding the risks of property investment through SMSFs
Self-Managed Superannuation Funds have become popular in Australia. Over 600,000 funds manage assets worth $700 billion. Many Australians have turned to SMSFs for wealth accumulation because they are attracted by the idea of being able to control their retirement savings and invest in real estate. While the idea of purchasing property with superannuation may seem appealing, it is not without risk. This is a fact that financial institutions are beginning to acknowledge.
Recent actions by major Australian banks such as Westpac, which has ceased to offer loans for SMSFs in order to purchase property, indicate a growing concern about the financial stability and viability of this strategy. Doron Peleg is the CEO of RiskWise Property Research and he points out that borrowing against super to invest in real estate is a risky financial strategy. It could have devastating consequences on a person’s retirement savings.
RiskWise Property Research has investigated the factors that influence the risk associated with SMSF investment. Our research shows property investment can be a good way to earn a high return, but there are also significant risks, especially for those who do not understand the inherent dangers of purchasing property via their superannuation fund. We provide information and insight to help investors protect their financial futures by making informed decisions.
SMSFs are a growing investment option for property and SMSFs
SMSFs are becoming a popular choice for people who want to have more control over their retirement fund. According to the Australian Prudential Regulation Authority and the Australian Taxation Office, SMSFs manage over $700 billion of assets with an average balance exceeding $1.1 million. SMSFs are attractive because they offer flexibility, allowing trustees the freedom to manage their portfolios and choose their investments.
SMSFs have the advantage of being able to invest in property. Real estate is traditionally viewed as an investment that can provide long-term stability, strong capital gains, and rental income. SMSF trustees are able to borrow money through a structure known as Limited Recourse Borrowing Arrangements. This arrangement allows SMSFs to purchase property with little or no out-of pocket contribution.
This borrowing structure may seem attractive to SMSF investors. However, it’s important to realize that using superannuation to invest in real estate is not without risk. Doron Peleg is the CEO of RiskWise Property Research. He has warned for years that investing in property through SMSFs could be dangerous, particularly if investors do not fully understand all risks.
Westpac’s decision to cease SMSF property loans
Westpac announced recently that it will no longer provide loans to purchase property through SMSFs. Westpac’s subsidiaries, such as Bank of Melbourne and St. George Bank will no longer offer SMSF loans. The banks claim that they are streamlining the lending process, but Doron Peleg thinks that this is really because SMSF property loan are too risky.
Peleg claims that banks cannot ignore the risks associated with SMSF property investments. SMSF investors may suffer substantial losses if property values fall or rental earnings do not meet expectations. This could result in a reduction of their super balances, and a significant decrease of their retirement funds. Peleg says that, given the growing number of retirees relying on superannuation for their retirement funds, banks are doing what is right by avoiding this high-risk industry to protect themselves and their clients.
The risks of SMSF Property Investment
Despite the fact that some investors have seen significant returns from SMSFs, especially when purchasing residential property, there are also substantial risks. RiskWise Property Research has identified several risks that investors need to be aware of when investing in real estate through their superannuation fund.
1. Equity risk:
Equity risk is the possibility that property values will decline and investors may have less equity than they owe in their loan. Investors may be in negative equity if property values fall dramatically. This means that the value of the property is less than the outstanding loan. This can be especially problematic for SMSF investors who may not be able to sell their property at a price that will cover the debt. This can lead to forced sale at a loss in some cases.
Negative equity is more likely to occur in areas with volatile property values or where they have been artificially inflate. In oversupplied markets or in areas with a slowdown of demand, for example, property values can drop unexpectedly. This puts investors at risk of losing significant amounts of their superannuation.
2. Cash Flow risk:
Cash flow risk is when an investor’s rental income does not cover mortgage payments. SMSF investors are particularly concerned about this, since the superfund may heavily depend on rental income in order to service its loan. SMSFs may have difficulty meeting their obligations if the property does not attract tenants, or if the rental income is below expectations. The trustee may be forced to borrow from other assets in the fund to make up the difference.
In the worst case scenario, the SMSF could be unable meet its mortgage payments. This would lead to defaulting on the loan, and perhaps the forced sale of property. In the event that the sale price does not cover the remaining loan balance, retirement savings could be significantly affected. SMSF investors could also face extended periods of vacancy if the rental yields drop in an oversupplied marketplace. This would further affect cash flow.
3. Settlement risk:
Settlement risk is when an SMSF investor cannot settle the purchase of property because the value has dropped suddenly or due to other market conditions. Off-the-plan properties (OTPs) are a good example, as they are purchased before construction has begun. OTP properties are risky, as they’re often sold on the basis of projected returns and values that may not match actual market conditions.
The value of a property can fall if market conditions worsen, or if it becomes part of a market that is oversupplied. This leaves the SMSF with a gap between the agreed upon purchase price and its current value. If the market conditions worsen or if the property becomes part of an oversupplied market, the value of the property may fall, leaving the SMSF investor with a shortfall between the agreed-upon purchase price and the current value.
Peleg warns investors that they are at greater risk of a settlement failure if they purchase OTP properties in areas where there is a high level of new construction. He says that if market conditions change against SMSF investors, they may not be able to complete the purchase of their property, resulting in financial distress and a possible loss of superannuation fund.
SMSF risk: The role of off-the-plan properties
Off-the plan properties are a popular choice of investment for SMSF trustees. They offer potential capital growth as well as rental income. OTP properties are not without risk. Peleg explains that OTPs are sold in large quantities to investors. This results in an oversupply in one location. This oversupply may lead to lower property values, increased vacancy rates and decreased rental demand. All of these factors can increase the risk that SMSF investors will suffer financial losses.
In certain parts of Brisbane where off-the plan development is significant, there are growing concerns about the oversupply on the market. Peleg explains that this oversupply may result in a decrease in property values and make it difficult for investors to refinance or sell their properties. SMSF investors can suffer significant losses if they cannot generate enough rental income to pay their mortgages.
The dangers of investing your super in property
Many SMSF investors are concerned that their retirement savings could be drastically reduced in the event of an economic downturn. The stakes are high for many Australians who rely on their SMSFs to fund their retirement. The impact of a declining property market on a person’s superannuation can be devastating.
Peleg believes that SMSF investors gambling their future financial security by investing in property are gambling their retirement savings. He warns that SMSF investors who gamble with their future financial security by investing in property could end up with only a fraction of what they had started with.
SMSF trustees must fully understand all the risks associated with property investments. It is important to weigh the risks of financial ruin against the temptation to use superannuation funds for property investments. In unpredictable markets, the financial consequences of a bad property investment are devastating, especially for retirees with limited time to recover.
Why Banks are Refusing to Loan to SMSFs
Westpac’s decision to stop lending to SMSFs is a response to the increased risks of this investment strategy. The banks are worried about large-scale defaults by SMSF investors. This is especially true for retirees, who may find themselves with smaller super balances in the event of a property investment failure. Banks are protecting themselves against potential financial losses by ceasing to provide SMSF loans.
Peleg says that banks understand the risks associated with SMSF property investments, particularly when SMSF investors are unaware of the dangers. It’s evident that banks are moving away from SMSF loans.
They are more cautious in this sector because they recognize the increased risks.
The conclusion of the article is:
RiskWise Property Research is dedicated to giving our clients the information and insights they need to make an informed decision about their property investment. Our team of professionals monitors the market for trends, risks and opportunities in order to assist investors with the complexity of the housing and investing markets. We recognize the appeal of SMSF investment in property, but warn that there are significant risks.
The recent withdrawal by banks of SMSF property loans should be a warning for those who are looking to invest in real estate with their superannuation. Although property is a valuable investment, using your super to buy property comes with many risks. These include equity risk, settlement risk, and cash flow risk. Understanding these risks for SMSF trustees is crucial to protecting their retirement savings, and preventing financial hardship in future.
We will continue to monitor the changing financial landscape and provide the latest information and news to investors to help them make informed investment decisions. If you are considering investing in property through your SMSF, or another avenue, it is important to carefully assess the risks and seek professional guidance before making any significant financial decisions.
