Buying property with a self-managed super fund (SMSF) can be an “accident waiting to happen” for those who are not careful.
That's the view of Doron Peleg, the chief executive of residential property researcher RiskWise Property Research. He believes many are gambling with their retirement funds.
The amount borrowed to buy residential and commercial property inside DIY super funds is low in comparison to the total size of the retirement savings pool, but has grown rapidly since the Howard government lifted the ban on borrowing in 2007.
Peleg says many risk falling into debt they will not be able to climb out of if there is a property bust.
His concerns are mainly with residential property. While Sydney and Melbourne property prices have come off a bit, he points to huge falls in values in the mining towns and regions of Western Australian and Queensland.
Peleg says there are less likely to be problems with trustees with large account balances, who take good advice and are well diversified.
The potential problem is with those with smaller balances, particularly those buying an apartment off-the-plan.
There are more risks with buying off-the-plan and even more so when buying through a super fund, Peleg says.
Many off-the-plan apartments carry high levels of risk due to potential oversupply, leading to depressed property values and high vacancy rates, he says.
Property analysts have long warned of "developer premiums" of up to 20 per cent of the purchase price of off-the-plan apartments, compared with similar established apartments.
Hein Preller, the managing director of super fund administrator Superannuation Warehouse and a chartered accountant, agrees that the usual risks of buying off-the-plan are even greater when buying through a super fund.
Sometimes with an off-the-plan contract, it will be a long period of time after the deposit is paid until the property is complete.
Preller says one of the risks of purchasing with a mortgage is if the lender’s final valuation comes in lower than the contracted price.
In that case you may be forced to make up the shortfall in your DIY fund, which could be an issue if the fund does not have sufficient assets, Preller says.
Borrowing to make a property investment inside a super fund is governed by strict conditions known as "limited recourse borrowing arrangements", where the minimum deposit on the property usually required by lenders is 30 per cent.
If there were to be arrears on the loan, the lender only has recourse to the property and not the other assets in the fund.
The members of the fund usually have to sign a personal guarantee to the lender that they will make good any shortfall from their non-superannuation assets.
SMSF property loans tend to be more costly than other property loans, which must be factored into investment decisions.
The Australian Prudential Regulation Authority has been pulling levers since 2015 to force lenders to increase their interest rates on property investment loans, as it believes investors have been a factor in rising house prices.
The limited recourse loans used for borrowing inside a DIY super fund are up to one percentage point higher than the already elevated interest rates on standard property investment loans.
Also, interest rates are at historic lows but, eventually, they will return to normal levels.
Andew Yee, director of superannuation at HLB Mann Judd, Sydney, says a potential downside for those with a residential property in their fund, in which there is not much other money left in the fund, is a lack of liquidity.
In the pension phase, a certain minimum percentage of the fund has to be drawn down each year and meeting that requirement could be a problem if the main asset in the fund is the property, Yee says.
He is worried by the "one-stop shops"; those businesses where the exact nature of the business is not always clear but where there will be a relationship with property developers.
“A lot of these promoters are targeting people who have an affinity for property and also saying to them that if they don’t have a deposit, no problem, as the super fund may have enough money for the deposit,” he says.
They say it's a chance to secure your financial future using your super fund and to provide for your retirement – all in the low-tax environment of super, he says.
Support for Labor's pledge to ban DIY super fund borrowing
Labor says if it wins the next federal election, it will ban SMSFs from borrowing. The pledge is part of its housing affordability package, which includes other measures that would also be grandfathered, such as reining in property investor tax breaks.
The Association of Superannuation Funds of Australia (ASFA) has called on the government to ban borrowing in its submission to the government prior to the federal budget in May.
The association says borrowing magnifies the gains and losses from fluctuations in the prices of assets held in super funds and increases the probability of large losses within a fund.
"This puts individuals’ superannuation at risk," the ASFA submission says.
Saul Eslake, independent economist and vice-chancellor's fellow at the University of Tasmania, says the decision by the Howard government to lift the ban on borrowing by SMSFs in 2007 was one of the "dumbest tax policy decisions of the past 25 years".
Eslake says there definitely can be a place for owning residential property outright inside a fund.
"But I could not see why you would want to change the law to provide Australians with yet another vehicle to engage in leveraged property speculation," he says.