There are many reasons why people purchase property using a self managed super fund with the most common reason being building wealth for the future with minimal impact to their personal budget. They are also often able to purchase better quality assets by having greater access to cash deposits and by utilising employer super contributions and proposed rental income to boost borrowing capacity in the superfund.
You are able to buy residential and commercial property in a SMSF and can generally borrow up to 80% of the purchase price. It’s important to note that you cannot live in a property owned by your superfund or derive personal benefit such as staying in the property if it is an Airbnb. However, for business owners, you are able to purchase a commercial premises and your business can rent the property from your superfund. This is a fantastic opportunity to create tax deductions in your business and add to your superfund by way of rental payments that you were otherwise going to be paying to a third party. Your business will essentially be paying off the SMSF loan and building wealth for you for the future.
Whilst it all sounds very appealing, there are both pros and cons to buying property in a superfund. It will not suit everyone’s strategy and also comes with significant compliance obligations that you will be personally responsible for meeting. Additionally, there are two major differences between investing in a superfund vs your personal name, a company or a trust and that is the inability to leverage the equity for additional purchases and that the property must be a ‘single acquirable asset’ meaning you cannot take out a construction loan or borrow for renovations in a superfund. The reason for this is because SMSF lending is a limited recourse borrowing arrangement (LRBA).
In this guide, we will explain what a LRBA means for you, the multiple entities that entails, how loan serviceability is assessed, what types of properties you can buy and what finance options are available for commercial and residential SMSF investment.
Limited Recourse Borrowing Arrangements
Firstly, as we mentioned above, SMSF borrowing is a limited recourse borrowing arrangement which is designed to protect assets within the fund by isolating them from other assets. This is done through a combination of entities being your SMSF and a Bare Trust. Whilst you have a loan in place for the property, the Bare Trust will own/hold the property on behalf of the beneficiaries of the super fund. Once the SMSF loan is paid off, the Bare Trust is dissolved and the property is officially transferred into the super fund. Each property you buy must have its own Bare Trust, although it is generally ok to have a common trustee. The majority of lenders will now only allow a corporate trustee for SMSF lending (a few will still allow individual trustees although we find we can achieve better interest rates with those who only accept corporate trustees). This means that if you are establishing a new SMSF and purchasing a property, 4 new entities will likely be established – the SMSF itself, a company to be the trustee for the SMSF (known as a corporate trustee), the Bare Trust and a company to be the trustee for the Bare Trust. Commonly this will cost $2,000 - $6,000+ depending on who is setting it up for you plus you may also need personalised financial advice in regards to the set up which will be an additional cost. This, along with the ongoing tax returns and annual audit requirements, means that there is a reasonable amount of cost involved in establishing and maintaining these structures. You need to consider this and discuss with your financial advisor and accountant whether it is suitable for you.
The other thing to understand with LRBA’s is that when a property is owned by a SMSF, one of the major downsides, is that you cannot leverage the equity in the property to buy another like you can with personal or trust owned properties. This means you continually need to generate deposits for subsequent purchases either by accumulating more cash or selling the original property. For business owners buying their commercial properties in a SMSF, you also need to consider this important factor as if you needed to take out a business loan in the future and wanted to offer the commercial property as security instead of a personal property, you wouldn’t be able to.
SMSF Serviceability Assessment
When buying in a SMSF, serviceability is calculated differently than normal home/investment loans where your income, expenses and other liabilities are considered to determine capacity. We seek to isolate the fund as much as possible and the primary sources of income SMSF lenders are interested in is the SMSF rental income (proposed or existing) and your standard regular employer super contributions. If there is a shortfall in serviceability between rent and regular super contributions, the lenders can review your personal capacity and assess a reasonable additional contribution you can make on an ongoing basis to the fund to support loan repayments. This can sometimes be a burden on cash flow and as you start looking at specific properties, you should assess the potential rent vs loan repayments to ensure your ability to manage personal finances is not negatively impacted.
SMSF Finance Options & Deposit Requirements
Many people don’t realise that SMSF lending is now almost all done outside of traditional/major banks. It’s been around a decade since the major banks ceased SMSF lending due to the significant compliance requirements and complexity, although you can still open SMSF bank accounts for your transactional needs and rolling balances into from your industry funds.
There are a broad range of specialty funders that now dominate the SMSF market and have streamlined processes to make your life easier. There are occasions when major banks can support superfunds, however this is only when the super fund is a unit holder in a unit trust and dilution rules must be met to comply with the SIS act. Generally this will work for developments or where multiple parties are purchasing property together and it is not for standard property investment.
On all other occasions, the specialised SMSF funders are the lenders we need and you are able to borrow up to 80% of the properties value with loan terms up to 30 years. If you are buying a specialised or high risk property as determined by the lenders internal policy, you may only be able to borrow 60-70% of the properties value. It’s important you discuss with your broker prior to making an offer to understand your cash requirements, however more often than not, we find we can achieve an 80%LVR for both residential and commercial purchases.
Interest rates are on average 1-1.5%pa higher than what you would expect on a normal investment loan but many of the SMSF lenders have now expanded their loan features to allow offset accounts and unlimited extra repayments (where the loan is variable) to help you reduce interest and pay the loan off faster. It is also important to note that the best rates are on residential P&I loans. For interest only and commercial loans, there is generally a rate loading to consider.
If you are purchasing a commercial property, it is also important to note that some properties will be subject to GST. Most funds will generally be able to claim all or most of this back post purchase but you will need to have the additional funds available upfront if GST applies. For the commercial property to be exempt from GST, it must be classed as a ‘going concern’ in accordance with ATO policies. When it comes to property, this will generally apply when the property has an active lease agreement in place at settlement that is being transferred to the new owner. Where there is no lease, GST generally applies.
Types of Properties
Other than not being able to take out construction or renovation loans which do not meet the single acquirable asset test, you can generally invest in most types of properties from residential to commercial/industrial to farm land. Whilst you cannot take out a construction loan, you can buy properties off the plan as by the time you settle, they are a finished product. There are also some specialised funds that will source land and build on your behalf to sell you a finished product that meets the single asset test, although this is not particularly mainstream yet. Some people also decide not to directly buy properties themselves and instead opt to use the cash in their superfunds to invest in syndicates where their funds are pooled with other investors to buy into much larger projects.
The options are broad but the first step is deciding what your goals are, if you are targeting higher yield or higher capital growth and also how much you are willing to contribute each month if the rent is not going to fully cover repayments and costs. Working with a buyers agency and your financial planner, can also help you avoid costly investment mistakes.
Whilst there is complexity and much to consider, investing in property using a SMSF can be a great way to build wealth for the future. We are here to support you on your investment journey and can advise on your best lender options as well as introduce you to the professionals you need to help you achieve your goals.
Get in touch with Alana to find out if SMSF property investment is right for you.
finance@fortunaadvisors.com.au
(08) 9240 4211