Housing and Superannuation

Given the community concern about housing affordability, and the vested interests at play, the reaction to the latest rumours that the government may allow Australians to use superannuation monies as a first home deposit should come as no surprise.

There have been numerous critics, including a handful of thoroughly researched and no doubt well-meaning economic commentators who have noted the risks in the Australian housing market, including our sky-high private debt levels.

Paul Keating stated that the idea was scandalous, and that only a reckless government would put the superannuation system at risk with such a policy.

Interestingly enough, this view is vastly at odds with the position of the Labor party under then Prime Minister Keating, when they noted that; “a debt free home is as important a part of retirement security as superannuation income” with a policy proposal from the party that would “permit part of the deposit on owner occupied dwellings to be funded from the home buyers superannuation account”.

Before delving into my thoughts on the subject, I want to make three quick points:

1. From the point of view of making housing more affordable, freeing up superannuation so first home buyers can use it for a deposit won’t work, as it will only add to demand, not supply.

2. Even if it were made possible, and I didn’t already have an SMSF, I wouldn’t dream of using my superannuation to buy property today, as I think the Australian residential property market as a whole is at best exceptionally expensive, at worst grossly overvalued, with a handful of downside risks ahead.

3. I think both superannuation and the Australian housing market are far too big for own good these days, and, as currently structured (note the emphasis) hold back productive enterprise, growth, and the economic well being of Australians as a whole.

Despite the above, on balance I support the idea, for a handful of reasons I will explain.

Housing is a Critical Component of Any Retirement Plan
One of the key arguments against allowing Australians to use superannuation for a home deposit is that it will reduce the value of their portfolio; leaving them with a smaller pool of capital they can draw down on in retirement.

This is of course true, but it also misses two key points.

The first of those is that by buying a home, the superannuant is not engaging in a form of conspicuous consumption that leaves them with nothing to show for it at the end of the day.

They are still investing in an asset, with many in reality trading share and fixed income exposure for direct property, with the money able to be returned to their fund in the event of a sale.

Just as importantly, one can simply not have a credible conversation about the retirement needs of Australians without focusing on the importance of owning the roof over their head.

This much was made clear in the latest ASFA retirement standard update that suggested a retired couple wanting to live comfortably and who rented in Sydney would need over $1.15 million in their superannuation fund. Couples that own their own home would need only $640,000, placing non-home owning retirees “at a distinct financial disadvantage” according to ASFA CEO Dr Martin Fahy.

That circa $500,000 difference is substantial at the best of times, and is all the evidence one needs to understand why we simply can’t ignore the importance of home ownership when discussing retirement outcomes.

Furthermore, by preventing people from buying houses at a younger age, which is an inevitable outcome from forcing 9.5% of their income into superannuation (see stats below on declining home ownership rates for 25-44 year olds between 2002 and 2014), you also make it far more likely that people will be approaching retirement, or indeed enter retirement with mortgage debt.

The logic of this is played out in the data, with a recent article in the ABC, which quoted economist Saul Eslake, suggesting the proportion of people aged between 55 and 64 who still owe a mortgage on their home has tripled to 45%.

According to a 2016 ING report, the previous three years saw a 28% increase in the number of Australians aged 65 and above who retire with mortgage debt, three quarters of whom are owner-occupiers.

What’s more, given the sacrosanct tax status of the Australian family home, the logical decision for many Australians who enter retirement with mortgage debt is to use whatever superannuation to pay off their mortgage.

That decision will leave them with less in financial assets, but will mean they do own their asset-test exempt family home outright, and improves their pension eligibility.

This entirely foreseeable outcome blows a major hole in the argument that many in the superannuation industry espouse, namely that by allowing superannuants access to their cash so they can buy a home, those people will have a lower super balance when they retire, which places more pressure on the aged pension.

That is “true”, but it totally ignores the counterfactual, which is that by buying homes later in life, Australians are more likely to retire in debt, which they are more likely to pay off with their superannuation balance.

Superannuation is Already Invested in Housing
The current superannuation system strongly encourages young Australians to invest in growth funds, with healthy allocations to shares. The shares owned by these funds include a large weighting to Australian bank stocks, whose business models are built around lending to fund our housing market, with a heavy focus on investor home loans at that (more on this below).

At the same time, the law also allows SMSF trustees to use their superannuation to invest in Australian residential housing directly, despite the fact that nearly 70% of trustees already own their own family home.

To put that 70% in context consider the chart below, which shows home ownership rates for 25-34 and 35-44 year olds, and what happened to them between 2002 and 2014. 

Source: ABC Bullion, HILDA Survey

If you really think superannuation monies shouldn’t be invested in housing, then you could make an argument that given their housing centric business models, retail and industry funds should reduce exposure to Australian banks, and SMSFs should be banned from investing in Australian residential property.

Note that I’m not advocating for that personally, but it should be obvious to anyone why the status quo is not fair in any way to young Australians, who today face record low levels of wage growth and much higher rates of unemployment and underemployment, relative to the population as a whole.

At present, they are in effect banned from using their primary and fastest growing financial asset as a deposit for a property, whilst being forced to fund the creation of home loans which help push housing prices even further beyond their reach.

Freedom, Competition, Innovation, Engagement
By forcing Australians to consume compulsory superannuation, we are already, to some degree, limiting their financial freedom. Perhaps I’m showing my own libertarian bias here, but given this, surely it’s only fair that we give them maximum choice and freedom as to where that money is invested.

There are benefits on the competition front too, as opening a new and popular asset class to superannuation monies will put welcome pressure on existing fund managers and superannuation funds to improve their product offerings. After all, nobody is advocating that Australian superannuants be forced to invest their monies in Australian property – it will just be added to the product/asset class mix as it were.

Engagement would almost certainly improve as well, with numerous surveys indicating that Australians (and in particular young Australians) are largely unengaged with their superannuation.

You only have to see how much mileage any debate about housing affordability gets in the media to realise that 99% plus of the population is highly engaged in how expensive the roof over their head is, and who owns it.

Outside of cancelling compulsory superannuation full stop, its hard to think of a single move the government could make which would increase the engagement of young Australians with their superannuation.

Finally, we see considerable scope for innovation here. After all, Australians are required to put 9.5% of their money into superannuation. Owning a family home is still the Australian dream for many, and as discussed earlier, a critical part of securing a comfortable retirement.

Given there are superannuation funds designed for specific and diverse target markets from tech focused millenials (Spaceship) to vegans (Cruelty Free Super), is it really such a stretch to think that our superannuation funds, our banks, and even our property developers might be able to come together to build innovative new products that target young Australians wanting to own their own family home?

I for one wouldn’t have thought so.

How Safe is Super Anyway?
Another key argument against allowing younger Australians to access their superannuation for a home deposit is the potential risk in the residential property market now.

This is a risk that I’m acutely aware of, having discussed it in a recent publication where we discussed the warning signs; “including the circa 10% price declines seen in the Perth residential market in the last few years, the record levels of supply coming to the market on the East Coast, and the uptick in vacancy rates we’re seeing in parts of the country.”

But it has to be noted that the average young Australian invested in growth superannuation funds already has their money at risk, and would likely see a serious fall in the value of their portfolio should our housing market decline meaningfully.

To give some context to this risk, consider the chart below, which shows returns for both Australian residential housing and growth superannuation funds going back to 2003, with both investments rebased to 100 for comparison promises. 

Source: ABC Bullion, Australian Bureau of Statistics, Super Ratings SR25 High Growth

As you can see, there was a precipitous fall in the value of growth superannuation funds during the GFC, with a peak to trough drawdown of some 38% between October 2007 and February 2009.

Young Australians investing in these funds did not recover their monies until July 2013, whilst property prices have continued on their primary uptrend for this entire period, despite the small decline suffered during the GFC.

That was then, this is now, one might argue, and whilst I would agree that Australian housing is on balance now a riskier investment proposition than it was 10 to 15 years ago, I’m not at all convinced the average growth fund is any safer today than it was back then.

After all, the vast majority of these portfolios are still invested in Australian and international equities, two asset classes that face no shortage of challenges in the years ahead.

If we look at international equities, using the S&P 500 as a proxy, the market is at best fully priced, if not outright expensive. This is based on a broad range of indicators, including cyclically adjusted price to earnings ratios, total market capitalization to GDP, and Tobin’s Q ratio. Analyst Doug Short publishes a regular average of four valuation indicators for the S&P 500, with his March 2017 update suggesting they are some 84% (no, that is not a misprint) above their long run averages.

The research team at 720 Global, who look at valuations and fundamentals (including GDP and productivity growth, government deficits, debt levels, earnings growth, etc.) are even more concerned, with their analysis suggesting the market has not been this expensive since the 1930s.

Whilst not all markets are expensive as the United States, it is still difficult to envisage investors achieving a positive overall return from international equities should the S&P 500 go through another major correction, given the weighting to US stocks in any global equity benchmark, and the correlation of developed market equity returns in this post GFC environment.

On the domestic front, there is cause for concern too, especially with a local bourse dominated by financial stocks, including our banks, whose primary business is funding Australian residential home loans, as we discussed before.

During Australia’s last recession, bank dividends were cut by close to 35%, with share prices falling across the board too. When the GFC hit, banks cut their dividends by over 20%, whilst the value of their shares fell by closer to 50% in some cases.

These brutal declines occurred despite the fact that the Australian residential housing market suffered a decline of less than 5% during the GFC, with the overall economy continuing to grow.

Now consider the table below, which plots the lending profiles for our banks at three points across the last quarter century. 

Source: ABC Bullion, Reserve Bank of Australia, Australian Bureau of Statistics

As you can see, home loans now comprise more than 60% of total loans, a number that is circa 10% higher than when the GFC hit, and nearly 40% higher than the situation back in the 1990s.

Loans to housing investors have tripled over the past 25 years.

It is painfully clear that Australian banks are far more exposed to Australian housing than they were both when the GFC hit, and especially relative to when our last recession struck. As such, one can’t help but worry about what might happen to these stocks were there to be a severe housing market downturn in the near future.

The bottom line here is simple. If you think our housing market is a high-risk investment today (an assertion I’d agree with fully), then so are our major banks, and therefore so too is the ASX and most growth superannuation funds younger Australians are steered toward with their compulsory 9.5% contributions.

Frying pan or fire – take your pick!

Summary
On affordability grounds alone, the idea of allowing Australians to use their superannuation for a house deposit would almost certainly be a failure. From a competition, engagement, innovation and freedom perspective, and from the point of view of social utility, it is definitely a win.

From a “risk” perspective, given the way superannuation money in growth funds is currently invested, I’d say it's a toss of the coin, with the risk in both strategies undoubtedly high in the coming years.

As such, whilst it would be no panacea for our housing affordability crisis, and whilst I think there are a number of other more important policy changes the government and superannuation industry should look at, allowing young Australians to use their compulsory superannuation contributions for a housing deposit is not as scandalous as it might first appear.

Until next time,
Jordan Eliseo

Please note an earlier version of this article appeared in NestEgg on the 24th of March 2017. This version of the article contains some amendments/additional comments.

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