Limited Recourse Borrowing Arrangements
LRBAs are helping many small business people marry their business goals with their long-term retirement income strategy.
When David Murray handed down the final report of the Financial Services Inquiry in December 2014, the Federal Government accepted every recommendation bar one – to ban limited recourse borrowing arrangements (LRBAs) for self-managed super funds (SMSFs). It was the Government’s belief that this was a legitimate investment strategy for SMSFs, and as such chose to reject this, subject to future review. It is our strong conviction, that the Government got it right, certainly when it comes to commercial property and that the years since the Murray Report was tabled support this.
Critics of LRBAs, and there’s no shortage of them, point to the robust growth in this debt instrument and argue it must be causing a systemic risk in the SMSF sector. They typically provide no evidence for this assertion, aside from the growth numbers from a low base and the fact it has attracted property strikers into this space for the prime purpose of securing a sale, and not as part of a considered retirement income strategy as required under the SIS Act.
So how fast are LRBAs growing? Based on ATO numbers, at 30 June 2016, LRBAs made up 4% of all SMSF assets ($634 billion) at $25.4 billion. And it’s been growing – smartly. Over the preceding two years to 30 June 2016, LRBA assets jumped 68% compared with 18% for all SMSF assets.
The focus of this debt has been to acquire residential and commercial property, with 93% of the $25.4 billion invested in residential or non-residential property at $12.2 billion and $11.5 billion, respectively. [Non-residential includes all other property such as industrial, retail and office space.] In this two-year period, the residential market, especially in Melbourne and Sydney, was experiencing sturdy growth and LRBAs were being promoted as a way to enter the market.
But what gets forgotten in this debate is the $11.5 billion in commercial property. Our experience is quite the opposite of how LRBA critics would have you believe it.
As to be expected, the three mainland eastern states have the bulk of the debt, with NSW 51%, Victoria 28% and Queensland 15%, while industrial represents 52% of the loan book, office 20%, retail 9% and other 19%. The average loan-to-value ratio (LVR) is 63.9%.
There are a few other interesting numbers. Self-employed borrowers represent nearly 90% of the loan book, while owner-occupiers make up nearly 60%. But most importantly, none of the current loans is in arrears, only one loan has ever defaulted (following a cyclone) and that loan did not incur a loss.
Still, there is criticism that having an LBRA-backed property asset inside an SMSF does not meet a typical diversification strategy, that being overweight in one asset is too risky. Trustees must ensure they obtain well-considered advice that is appropriate to their circumstances in this respect.
If the fund is in accumulation phase (and the vast majority of LRBAs are in accumulation funds), then it can make excellent sense for a small business owner to consider placing their business premises in a fund and lease the property back to business. Provided all the stringent rules governing this commercial relationship are meet, it’s a tax-effective solution that provides a business with greater certainty. It’s not how the APRA- regulated funds would (nor should) invest, but for many SMSFs it can be an advantageous solution, dovetailing with the philosophy of this superannuation sector – individual investment choice and flexibility within the goal of self-funded retirement.
Currently, the Council of Financial Regulators is reviewing LRBAs, and, hopefully, it will offer support for an investment option that is proving of real value to small business owners. If the review does this, it might just provide further reason for the Labor Party to rethink its commitment to abolish LRBAs.
We believe the negative media around LRBAs has been primarily generated by the increase in this debt to buy residential property. In particular, the criticism focused on two factors. First, property spruikers giving poor or conflicted advice, especially for an asset that should be part of long-term retirement savings. Second, at a time of high housing prices, LRBAs were being portrayed as another contributor to a “property bubble”.
The second argument has never stacked up. With a residential housing market worth about $6 trillion, and LRBAs sitting around $12.2 billion (2016 figures), that comprises 0.2% of the market – hardly a market-moving number. In addition, with housing prices now in retreat, especially in Sydney and Melbourne, it seems demand for LRBAs to enter the residential market will cool off.
But the possibility property spruikers may still be working this market (although, they, too, will find it harder to find “clients” as prices fall) is of concern. We certainly endorse any legislative or regulatory moves to expel them from the market where the actions of a few have unfairly muddied the waters for the genuine players.
The use of LRBAs to buy non-residential property is an important retirement savings strategy for small business owners who accumulate most of their retirement savings via their small business. To deny them access to LRBAs would significantly impact on their ability to save for retirement.
LRBAs have proved a boon for them – a prudent boon. It meets an immediate business need by providing security of tenure while dovetailing with an astute long-term retirement savings strategy; to use that old cliché, it’s a win-win. It’s to be hoped that in any review governments don’t throw the baby out with the bathwater. To do so will hurt the retirement efforts of many small business people and conceivably end up placing more pressure on the federal budget if fewer people are able to fully fund their own retirement.
One final point. As outlined in the preliminary report of Commissioner Kenneth Hayne about other forms of advice, concerns about the quality of advice provided by advisers are better addressed by enforcement of sound regulation than be either writing new legislation or banning products that may have been abused by some. It is generally held common ground that LRBAs involve levels of complexity that most SMSF trustees require expert advice to deal with.
A Statement of Advice from a licensed financial adviser is meant to provide this and the appropriate regulator should ensure this to ensure this is the case.
Lauren Ryan, Investor Relations Manager, Think-tank