SMSFs set to fuel surge in residential property prices

I often get asked can the property market continue to grow from its current levels and reach new heights.

While I do not believe every property in the market will show the same level of growth, there is a tidal wave of money on the horizon that will have an enormous impact on property value in years to come.

For many years the primary reason to buy property was to provide a roof over your head. As time went by, however, another driver entered the market. Investors started to look at the property as a money-making venture to help fund their retirement.

This really gathered momentum in the 1980s to the point now where over a million Australians own investment property.

We are now at the very early stages of a new and very powerful player entering the property market – superannuation investors.

Compulsory superannuation has only been around for 20 years and is in its infancy. Today there is over $1.4 trillion sloshing around in superannuation locked up until retirement and this is growing.

In the early years of superannuation all funds were managed by professional fund managers to maximize returns and the vast majority was tied up in the sharemarket.

Unfortunately sharemarket performance has not lived up to investor expectations in recent years. This year the share market has taken two steps forward and two steps back. On December 31 last year the All Ordinaries was at 4664 and peaked at 5200.

However, it has now lost all its gains and yesterday closed at yesterday it closed at 4748.

The sharemarket has been a great place for investors who trade regularly to make a lot of money. However for the investor that just wants a ‘set and forget’ strategy it has proved disappointing.

While I do not think that investors will turn their back on the sharemarket completely they will certainly look around for other options to diversify their investments. It is cycles like this that will make more people look towards the property market.

The desire for people to take control over their superannuation has seen an explosion in self-managed superannuation funds (SMSF’s). According to the Australian Prudential Regulation Authority, which oversees our superannuation system, thousands of self-managed super funds are set up each year. Traditionally, SMSFs have been the province of the self-employed an increasing number of salaried employees are now setting them up too. There is now $439 billion held in SMSFs and that figure is growing.

However, to date only a small fraction of people have elected to add direct property to their super fund. This is mainly due to a lack of funds in their super and uncertainty and complexity around the structure.

These investors have the opportunity to include residential property as part of the asset mix in their self-managed funds, thanks to regulatory changes in 2010 that enable gearing into super funds. Residential property is primarily a capital growth-based asset, and because of its stability relative to shares, it can provide a solid long-term way to boost the value of SMSFs.

Provided they choose high quality assets, investors with residential property in their SMSFs will be able to enjoy the best of both worlds when they retire. Residential property will give them geared growth assets, whilst shares will produce income in the form of dividends. They can draw down on the dividend income tax-free and use it for living expenses, whilst taking advantage of gearing to increase the capital value of their super fund.

This mix of residential property and shares is an ideal strategy for SMSF investors – it reduces the possibility of running out of retirement savings, by maximising capital growth as well as income.

Generally speaking, most people who borrow to purchase residential property for their super fund tend to adopt a conservative investment approach, and may gear at around 50% of the property’s value. This is a significant contrast from buying residential property outside super, where the gearing level is usually 80% or higher.

Even so, a 50% gearing level means the amount of money flowing into residential property from superannuation will explode in years to come.

Buying property needs to be viewed as a long-term play. The flow of superannuation money entering the market will be slow wheel to turn but it will gather momentum in coming years and push the property market to new highs.

Mark Armstrong is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers. This article first appeared on Property Observer.