SMSFs are playing a ‘slow and steady’ race. Despite all the hype, they’re still relatively small players in residential property. But they have the potential to be huge, and totally reshape the market.
The two big stories in Aussie property right now are Chinese buyers and Self Managed Super Funds (SMSFs).
It’s headline news because both a relatively new phenomena. 10 years ago they were barely blips on the property radar.
But with all the hoo-ha in the papers it’s easy to overstate how important they are to the current cycle. The impression you get is that the only people buying houses in Sydney are the Chinese. The only investors making plays at the moment are SMSFs.
But the truth of it is, that right now, both players are still relatively small fish in the property pond.
And the stories about hordes of Chinese buyers cruising the streets of Sydney distract us from what’s actually going on – and that’s a broad-based cyclical recovery in property. You don’t get double digit growth in a market as big as Sydney just because one buyer segment goes on heat.
What we’re seeing in property right now is in a way, exactly what you’d expect. We had a number of soft years, while thanks to massive global money flows coming out of the US, Japan and Europe, interest rates fell to record lows.
It’s a perfect recipe for a bounce in prices.
And the cyclical recovery (predictable, bland and unnews-worthy as it is) is the real story here.
I think this is what Tony Cahill, general manager of wealth management at Bank of Queensland (BoQ), was getting at during the week. He was keen to make the point that SMSFs aren’t to blame for the surge in prices we’ve seen over the past year.
In fact, SMSFs have typically been more drawn to commercial rather than residential property.
He said:
Many DIY fund trustees are small business owners and current rules allow them to invest in a property where their businesses operate.
Yields – or investment income – from commercial properties are also usually higher than those netted from residential assets.
…residential property has [actually] declined as a proportion of SMSF assets in the three years to June…
SMSF borrowing to invest in property contributed to only a fractional 3 per cent of system growth in residential lending.
SMSFs are still small fish in the property pond.
And this is exactly the point I’d make.
The real impact of SMSFs (and Chinese buyers) isn’t going to show up in short-term cyclical dynamics. What we’re talking about are long-run game changers.
It’s not their current appetite, but the potential demand that they could end up bringing to the table over the next decade or so that’s the real story.
Because while SMSFs aren’t big property buyers now, they are sitting on a mountain of cash. At last count, they were worth $507 billion.
That’s bigger than Westpac.
And at the moment, residential property only accounts for around 3.5 percent of the total portfolio.
As I said, that’s not massive. That’s about $18 billion. Still a sizeable player, but nothing over the top.
… yet.
Because I’ve seen surveys that suggest that SMSFs would actually like to have much larger exposures to property – like something in the order of 30 percent.
Now we’re talking serious cheese. If SMSFs followed through on that promise, they’d be throwing another $160 billion towards property. Drop a rock in the pond that big and you’re going to have some serious waves.
But wait, there’s more! Under current rules, SMSFs could leverage that $160 billion towards something around $350 billion and some steak knives.
This is serious coin.
So it suggests that current SMSFs spending of $18 billion could well become $350 billion in a matter of years. How quickly? Well that’s anybody’s guess.
To get a sense of what kind of impact that could have, remember that average house in Australia are worth around half a mil.
So we’re potentially looking at demand for an extra 700,000 houses.
How big is that? Well, remember that we only build about 70,000 homes a year at the moment. So we’re potentially looking at a sudden surge in demand that’s equivalent to about 10 years worth of current supply!
Or imagine that SMSFs gradually roll out the desired increase in property exposure over a full decade. That will still see them potentially buying every new house on the market, every year, for the next ten years!
This is the potential SMSFs have to be a total game-changer.
They’re not there yet, and there’s no point blaming them for the rocket under prices in Sydney. It’s got almost nothing to do with them.
But what we’re looking at is a long run level-shift in Australian property prices. In economics they distinguish between cyclical ups and downs, and structural ‘level’ shifts.
And so in ten years, we’ll still have a property cycle. The property market will still be hotter some years than others. But the surge in SMSF demand will have created a level shift in prices. And in the process, they’ll prop up the cycle. Down years won’t be as down. Up years will be spectacular.
All we’ve got to do is get in on this side of the level shift. And as the data shows, that’s where we’re at. SMSFs don’t have the exposure they’re looking for yet. But they’re on the way.
And if the Chinese buyers reach their potential too… well, we’re looking at a very crowded pond indeed.
Jon Appleyard says
good morning interesting note that i have purchased 2 properties in the last 12 months under my smsf and nearly purchased the third this week
Bruce says
yes more rubbish from ignorant reporters
and the average Australian house is not worth but cost half a mil.
Rudolf Ruyter says
Hi Jon
I run our own SMSF, and would not invest in residential property as the returns are small, the risks are great (collecting rent and potential damage & repair costs), with continuous unrecoverable out of pocket expenses (rates, land tax, insurance etc), and if leveraged, it will probably be negatively geared, resulting in a cash drain out of the SMSF.
If I was to invest such funds, it would be in commercial, &/or industrial property where the tenant pays all out goings, the returns are better, and far less chance of vandalism by tenants or bad debts write offs.
For my SMSF I would not be borrowing to make such investments as the returns would be dismal, if any, after paying the interest.
I would only purchase outright or not at all.
Another consideration is such investments destroy any chance of quick liquidity.
These are just some of the thoughts and ideas I apply to my SMSF investment strategies.
Regards
Rudolf
Eileen says
Rudolf, when you sell a property through SMSF, don’t you have a problem with ‘lumpy assets’ (ie; the whole amount goes back to the fund)? I thought I heard that the ATO will allow 10 years for people to sell…… before it will apply. What happens after that?
Greg M. says
I agree with Rudolf. In a 15% tax bracket it just isn’t worth negative gearing. My SMSF bought 1 commercial property last year, but still has >50% in Ozzie shares. I like the franking credits.
Asian Investor says
Guys,
Just go buy in US then use the cashflow from US to finance/purchase your properties here in Australia.
Here are reasons why below:
1. You can control a lot more properties with the same amount of money that you have.
2. There is no such thing as negative gearing in US. They are always cashflow positive.
3. Returns of 8%+ are average.
4. You can buy properties for less than five figures. If you know where to go, you can even buy land for only a few hundred dollars.
5. You are also hedging your money by buying in US.
Hope that helps.
Cheers,
Asian Investor
Graeme says
Rudolf… tell me again how safe Commercial or Industrial property is again… with vacancy rates in the teens in most states and businesses going broke everyday I hope you are not relying on the income from your Super to live happily ever after. And how has the capital growth been on commercial property over the last 10 years. Sure there are some small downside to residential but when you add capital growth to rental income over a 10 year or more period there are not too many investments that can beat it. And it is one of the safest… try to get an 80% lend against commercial property… even the Banks think it is a low risk.
Rudolf Ruyter says
Hi Graeme & all.
The considerations I take, is that any commercial or industrial property I buy will be home for another business I build, that way we have the benefit of “earnings” instead of “Limited Contributions” to the superfund, I also control the rent payments and the tenant (me), and profit from the businesses.
And Yes we have substantial Commercial & Industrial holdings and a few businesses.
Unfortunately most of these assets were built up before they moved the super contribution goal posts and limited super contributions, so now I have to work out a way to move the properties into the SMSF so rents become earnings. (Any ideas anyone?)
Further more our SMSF is building up a separate “Alternative Income Stream” so we do not need to liquidate our assets for retirement, and our kids will inherit a wealth generating machine/system to springboard them into earlier prosperity.
And at 67yo I can safely say our assets far far outweigh the debts. So our near future retirement is rosy.
Regards
Rudolf
Rudolf Ruyter says
Hi again Graeme,
Just to prove the point, our commercial & industrial properties have doubled and tripled in value over the last 10 and 14 years, and our shares have increased by 35% over the last 3 years since buying most of them, and the shares are returning over 10% in dividends on buying price.
And I am just an amateur in the stock market.
…….And the businesses are profitable.
Why would I chance residential property investments.
I guess everyone lives to the beat of a different drum,
and if we all did the same there would be little profit for any of us.
Regards
Rudolf
Eileen says
Rudolf, as far as I know, once you buy a property outside a SMSF, you can’t transfer it into a SMSF. You’re also limited, (within the fund) not to have any family members living in residential property purchased through a SMSF. You’re exempt from Capital Gains Tax, (CGT) which is nice but need to have your accounts audited every year. You cannot deposit or withdraw within the super fund unless it’s directly connected to the SMSF. I believe penalties are harsh if you make an error.
Rudolf Ruyter says
Hi Eileen
Commercial & industrial properties within a SMSF are differently treated. These can be used by our businesses, where rents then become earnings, which, when in the pension phase, are tax exempt within the SMSF.
I believe that after owning such properties for over 15 years, there is a way to contribute (or sell??) them to the SMSF, CGT free, and not pay Vic state stamp duties on the transaction. I have yet to discover how.
I believe the theory is that small business owners can hardly afford the invest in their factories or shops and build up respectable super as well, so, to make up for that, there is a way to transfer such assets into the SMSF.
(Any advise anyone)
Regards
Rudolf
Dave says
Graeme is 100% right and at 37 with 127 residential properties in the capital cities around Australia, I would be far from suggesting that the returns are meagre!
Brendan says
Let’s hope that rock drops, I’m ready to ride some waves.
Great post Jon, keep em coming.
joe petranov says
“Holy crap Batman … with all these Asians and smsf buying new prop. and looking for tenants …. how will the rental returns fare ? This may mean yields will drop 🙁
…… quick to the batphone we need to call the Minister and increase immigration”
Diversify i say !!!