Advisers who fail to acknowledge to SMSFs clients their fund is not properly diversified will continue to feel the ire of the complaints authority.
Capital Advisory director Michael Miller analyses AFCA determinations and found one of the most common complaints is lack of diversification with SMSFs, particularly those focused on buying direct property.
“Often what happens with those disputes is the advice to purchase the property might have been three, four or five years ago, but it takes that long for that dispute to come out,” Miller tells Professional Planner.
“The driver of those disputes is the property might have supported the loan payments through rental income, but the actual re-sale value of the property has stayed stagnant or fallen a little bit. They have a negative return but that’s from the capital aspect.”
SMSFs typically rely on limited recourse borrowing arrangements (LRBAs) which involves taking out a loan from a third-party lender to purchase an asset.
“Particularly the rates on the LRBAs [within] the SMSFs loans have always been a lot higher than people borrowing outside of the super fund,” Miller says. “All the big banks have exited the market so there’s very little opportunity to refinance.”
Bunker down
Professional Insurance Managers founder Farrel Datt has noticed a similar trend and says rising interest rates and falling property values will only exacerbate the issue.
“We’re heading into that perfect storm,” Datt says. “The tenants of these properties are probably going to start running into all sorts of trouble.”
The RBA raised the cash rate by 25 basis points to 2.85 per cent during the November board meeting afternoon. The central bank has increased the rate 25 or 50 bps each month since May after being reduced to near zero during the Covid-19 pandemic.
Datt says the issue is these SMSFs hold an investment that has no revenue, decreasing capital value and secured by debt.
“It’s a perfect storm – it’s these three factors all coming together at the same time,” Datt says.
Datt says even have multiple properties still don’t match the equivalent investing in a diversified property fund that would hold 50 or even 100 properties.
“The cost of jumping in and out of direct property is also very expensive,” Datt says.
“You can’t just sell properties. In a property managed fund it takes five minutes to get out, whereas direct property is a three-month campaign and paying real estate agents.”
Getting diversified
Miller says complaints often take time to work their way through the dispute resolution system into a determination.
“Typically, when they’re generating these disputes it’s not somebody who had an SMSF of $500,000 in a share portfolio and they added a property,” Miller says, noting that it is usually an SMSF making a single property purchase with few assets left once the purchase is completed.
“There’s very few of those disputes where there is anything substantially more than the one property in the fund. It was not good advice on diversification, not good advice in terms of the risks of gearing.”
Datt says the reason AFCA labels this as “poor advice” is the lack of discussion around diversification in the Statement of Advice.
“You can have an SMSFs that have one or two properties in it, but you need to get the trustees to acknowledge that they understand the risk of having investments that are not diversified,” Datt says.
“The minute you have that signature and there’s some sort of discussion in the SOA, then you’ve managed the risk. Unfortunately, we see so many cases where these super funds have this lack of diversification and the SOA lacks a single word about diversification in real estate.”
