In September 2015, Managing Director, David Johnston wrote about how APRA tightened the screws on the lending capability for Australian borrowers in an attempt to slow down the property market in Melbourne and Sydney. Simultaneously he floated the idea that APRA could direct their attention towards restricting lending to foreign buyers and Self-Managed Super Funds (SMSF). In the ensuing half year we have seen this phenomenon begin to be implemented by lenders.
Lending policies within these two market segments are now more restricted than ever due to reduced loan to value ratios’ (LVR), increasing the documentation required and in some instances not lending at all to overseas investors. The Victorian Government is even looking to increase stamp duty costs on foreign investment – a sign of more things to come.
See below David’s thoughts from late last year on “What is needed to slow the property market”, which included his suggested focus on tightening lending criteria for overseas investors and SMSF lending.
What is needed to slow the property market
In August’s InFront we discussed APRA’s recent ‘bank-slapping’ measures aimed at slowing investor demand.
For some time I have contended that if the RBA and APRA genuinely want to maintain property prices at reasonable levels, two key areas require regulatory crackdowns:
- foreign investment
- SMSF borrowing to purchase investment property.
Government crackdown on illegal foreign investment
Thankfully – and at long last – the government seems to be devoting resources and taking legitimate steps to block illegal foreign investment in Australian residential real estate that has been fueling the property bubble in our two biggest cities.
During my discussions with various people about how to stop rogue overseas investors, a common argument is ‘even if loopholes are closed they’ll find another way through.’
I have a more optimistic outlook and believe if the qualification process is more stringent and penalties tougher, then fewer people will want to take the time or risk.
Under the new legislation, intermediaries and third parties – such as lawyers, accountants, mortgage brokers, real estate agents and buyer’s agents – who are found to be facilitating illegal investment will face severe criminal offences and fines. Placing increased accountability on such professions, as well as imposing greater deterrents for would-be illegal purchasers, is definitely a step in the right direction.
Rein in SMSF borrowing
Another area that I believe requires legislative and lending policy change is the SMSF space to:
- help curtail the likelihood of poor performing assets being added to unsuspecting customers’ superannuation investment portfolios
- protect consumers against risky property investment practices
- ensure most Australians – who tend to heavily invest in property via family home and investment properties – maintain some diversification and, therefore, risk management by having some exposure to shares through super.
The Australian Taxation Office says super fund borrowing has risen during the past five years from less than $500 million to more than $9 billion. Further, the Government’s own Financial System Inquiry Report (released in December 2014) has warned current growth rates could create a systemic risk in the future. It recommended a ban on borrowing within superannuation due to concern that leveraging of assets may destabilise the superannuation industry if property prices fall. The report was also worried about the sheer number of SMSF borrowers that could make the super industry property heavy.
By way of background, the Financial System Inquiry Report led by David Murray set out a ‘blueprint’ for the nation’s financial system for the next decade and carries significant clout. The previous Wallis report in 1997 led to the establishment of ASIC and APRA (amongst other things); and 16 years earlier (1981), the Campbell report led to the floating of the Australian Dollar and deregulation of the financial sector. In short, this recent report is an influential one that will be listened to and acted on.]
Back in 2012 when the property market was in flatter times and people had concerns about where values were heading, I penned an article about how SMSF money would underpin – if not drive forward – Australian property values.
I tried to ease people’s anxiety by stating values would hold ground (or better) over the longer term due to the amount of super funds and borrowings being poured into the market due to legislative changes allowing average mums and dads to borrow money within their SMSF to purchase residential real estate.
A simplistic idea that I floated at the time – and still support – was restricting SMSF borrowing to 50% of the property value.
The benefits for customers who borrow at a higher loan-to-value-ratio (LVR) are limited for various reasons – the most obvious being a lack of negative gearing benefits given the relative lower tax rates within superannuation and the higher risk attached with having less equity in the property from the start.
Lowering the maximum LVR could help unwitting investors from making investment mistakes and weed out the fly-by-night operators who are trying to take financial advantage. I have seen firsthand greedy spruikers trying to recruit property, tax and financials advisors (they approach us all the time) to help sell poor investments at top prices – activity that we vehemently oppose.
Unfortunately the property investment industry is unregulated and most financial advisors don’t fully understand the property market and, importantly, what drives individual property values. This is understandable as property isn’t their expertise. Cash flow and rent is easily quantifiable and measureable. Where property investment gets complicated is trying to ascertain the likely capital growth. This is the micro of property analysis.
Further, if qualified tax and financial experts can not only fall for great sales pitches, but also agree to take significant payments for referring clients, what hope does the average consumer have when it comes to differentiating a good investment property from one that is only attractive from a cash flow perspective but provides little, if any, growth prospects?
Limiting the LVR would also mean less super money would flow into the property market, therefore, helping to meet APRA and the RBA’s goals of taking the steam out of property values.
Perhaps my proposal is catching on: AFR recently reported Westpac has started cutting lending to SMSFs for residential investment properties – reducing its maximum LVR from 80 to 70 per cent – ‘amid concern many buyers have paid too much and might not be able to service the debt because of falling rents.’
Personally, I think the falling rental income is less of a worry than the value of the property dropping or providing very little growth in value between now and retirement.
Purchasing a property within your SMSF can be a great strategy. As with any investment, the quality of the asset that you purchase is paramount to ensuring your investment success.
Cash flow affordability through tax deductions and proposed rental returns are to a property spruiker what the diversionary tactic is to a magician: they perform the purpose of taking your eye away from what they don’t want you to see. Cash flow is easy to see, likely capital growth prospects is not, so don’t take your eye off the ball because it could cost you a lot in the long run!