By Mike Sullivan : Many Self Managed Super Funds (SMSFs) are borrowing money for property investments under banking deals that may be in breach of the Australian Taxation Office (ATO) rules and the Superannuation Industry (Supervision) Act 1993 (SIS).  Superannuation: Protect your money.
Many property loans written by the banks are in breach of the SIS Act, Mr Gunn warned, "and I'd hate to think what it might cost to reverse these loans - which is what will probably have to happen eventually." The ATO, which regulates SMSFs, is looking at these breaches very closely.
Mr Gunn's Brisbane-based company The Quantum Group were the original developers of Property Instalment Warrants.
He said many banks are attaching the mortgages to the financial circumstances of the individual trustees and members of the super fund - conducting income and asset checks - and in most cases they will require personal and or directors' guarantees and this is not acceptable under the current legislation.
All aspects of the loan are to relate purely with the fund. The individual's circumstances, Mr Gunn said, are irrelevant.
The second slip up by lenders is in the creation of the instrument used - instalment warrants - which can only be established by the holder of an Australian Financial Service Licence (AFSL) compliant with derivatives. Many bank officers who are not suitably qualified or licensed are issuing these loans.
A SMSF loan is a limited recourse loan, Mr Gunn said, and many bankers organising SMSF loans were not abreast of the regulations and had not heeded many of the ATO's notices on aspects of SMSF administration. The amendment to SIS on September 24, 2007 clearly states, "allow investment by superannuation funds in instalment warrants that are of a limited recourse nature, over any asset a fund would be permitted to invest in directly".
An instalment warrant is a financial instrument, Mr Gunn said, regarded as a 'derivative'.
"It must be treated as a financial product, it must have a PDS (product disclosure statement) and be issued by a Licensed AFSL - they must be authorised and provide the advice to the trustees and members of the respective superfund, meeting the conditions of that licence at all times, or face charges. The Act is very heavily regulated by ASIC."
Mr Gunn said in his experience, bank officers don't issue a PDS, were not holders of an AFSL, they also don't issue a Financial Services Guide (FSG) and a General Statement of Advice, and the loans being offered were nothing more than a debt facility which, in general terms, doesn't constitute an instalment warrant.
"So where is the protection to the trustees?" he asked. "It's a traditional debt facility (investment loan) being set up and you have to meet their general lending criteria." Mr Gunn said.
"If you have to reverse it, it could be very expensive for the trustees - to the point where they could have to sell the property."
In a SMSF, property cannot be bought from a related party (in certain circumstance it is allowed) and a property cannot be refinanced within a super fund. There were issues with related party transactions and even related party contributions and many lenders were not fully abreast of the precise nature of the ATO's rulings on SMSFs.
EXTREMELY EFFECTIVE INVESTMENTS
Done properly, SMSF property investments can be extremely effective in building retirement funds.
Mr Gunn's firm, The Quantum Group, was the original developer of the first property instalment warrant - Quantum Property Warrant - which hit the market in March 2005.
So proficient has Quantum become that it can now command loans that rival regular investment mortgages - he has been known to get loan-to-valuation rations (LVRs) of 80 percent and 6.9 percent interest compared with a major bank offering of 72 percent and 6.54 percent.
"It's the way you educate these people, really," he said of the lenders. "Super is a minefield."
Changes to self managed superannuation that clarified property borrowing came through in September 2007 through then-Treasurer Peter Costello and Assistant Treasurer Peter Dutton. This allowed SMSFs to borrow through a structure based on certain conditions that had been introduced on March 16, 2005.
"It should not affect other assets or be leveraged against them," Mr Gunn said. "The pool of funds is meant to grow, regardless of the individual's situation - even if they were to go bankrupt, for example. The SMSF is there to provide for retirement.
"It's the only way these people will get ahead," he said of those who had encountered bad financial times and even bankruptcy. "It's the last call for many people."
Setting up a property through a SMSF is very different to a normal mortgage in Mr Gunn's experience.
"We don't do credit checks. And we usually leave a buffer to account for adverse times," Mr Gunn said. "Often that means paying interest on the loans 12 months in advance."
Mr Gunn's company handles the whole reporting function for the SMSFs it manages, has approved properties ready and does the due diligence on them, finding the most comfortable fit for a particular SMSF "and we find now we generally get a better price for those properties".
Mr Gunn said his business preferred to deal with developers at a very early stage - and developers often wanted to see about 25 percent of their properties committed before construction - so the readiness of SMSF funds worked for both parties in settling on favourable early pricing.
Mr Gunn said typically he would build in a small cash reserve in case of changes during the life of the Warrant, added with trustee and member's contributions along with other income.
He said the major risk taker was the security trustee that is managing the loan. His method was to set the funds up properly, within the laws pertaining to SMSFs - and only deduct industry standard fees.
"We often rebate fees when we come in under budget," Mr Gunn said.
"Banks will lend if you meet their criteria. Equity is cash. The interest rates are a bit higher and it's a limited recourse loan."
SUPER CAN SAVE RENTAL MARKET
Mr Gunn's view is that proper investment of SMSFs in property could mitigate Australia's current rental housing shortage.
"There was approximately $52billion in cash in SMSFs on December 31, 2008, in about 400,000 SMSFs," he said. "That's a lot of potential accommodation."
He believed people needed to take control of their superannuation, amalgamate or consolidate all funds they have and take charge of their investment future.
"Use conservative well balanced gearing levels, in what is the most tax effective investment vehicle available to all working Australians.
"These are important long term investment decisions," Mr Gunn said. "The sooner you make them, the better it is likely to work out for you."
www.quantumwarrants.com.au
References:
ATO Tax Alert TA 2008/5.
Tax Legislation Update 24/9/2007.
ATO Product Ruling PR 2005 / 27.
Brad A. Gunn is a Licensed Advisor to Blackstone Securities (Aust) Pty Ltd AFSL 307396.
Blackstone Securities (Aust) Pty Ltd is a subsidiary of The Quantum Group.
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