Since 2007, when Self-Managed Super Fund (SMSF) trustees were allowed to borrow to buy assets, purchasing property through an SMSF has become a compelling investment option. Many Australians have embraced this strategy to diversify their retirement savings. Investing in residential property via an SMSF not only grants greater control over investment choices but also offers potential tax benefits and significant long-term growth. However, navigating SMSF regulations and the property investment landscape requires careful planning, expert guidance, and a thorough understanding of the rules.
Leverage: The Key Benefit of SMSF Property Investments
Leverage is a significant benefit of SMSF property investment, as it allows the fund to amplify its investment potential using borrowed funds. Here’s how leverage benefits SMSF property investments:
- Increased Investment Capacity: SMSFs can use borrowed funds to purchase property, meaning the fund doesn’t need the entire purchase price upfront. This allows SMSFs to acquire more valuable or multiple properties than they could afford with only their existing superannuation savings.
- Potential for Higher Returns: By using leverage, any appreciation in property value and rental income can generate higher returns relative to the initial equity investment.
- Diversification: Leverage enables an SMSF to diversify its investment portfolio by allocating funds to property while maintaining investments in shares, bonds, or other assets. This diversification can help mitigate risk and enhance overall portfolio performance.
- Tax Advantages: The interest on the property loan and other related expenses can be tax-deductible, reducing the fund’s taxable income and providing additional financial benefits.
- Capital Gains Tax (CGT): If the property is held until the members start a pension, any capital gains can potentially be tax-free. SMSF earnings are generally tax-free in the pension phase.
- Regular Income Stream: Leveraging a property investment can generate a steady stream of rental income, boosting the fund’s cash flow and providing regular income to support the SMSF’s ongoing expenses and obligations.
- Long-Term Growth: Over time, property values generally increase, providing long-term capital growth. Leveraged investments allow SMSFs to benefit from this appreciation on a larger scale than if they had invested without borrowing.
However, leveraging also introduces additional risks, such as:
- Interest Rate Risk: Fluctuations in interest rates can affect loan repayments and the fund’s cash flow.
- Market Risk: Property values can decrease, leading to losses greater than the initial investment if the market performs poorly. Professional property investment advisors can help identify investments in areas with strong capital growth and rental returns.
- Compliance Risk: SMSF trustees must comply with strict regulations regarding borrowing. Any breaches can result in significant penalties.
Careful planning, due diligence, and seeking professional advice are essential to effectively manage these risks and optimise the benefits of leveraging in SMSF property investments.
Purchasing Property Through an SMSF: Steps and Compliance
Purchasing residential property through an SMSF in Australia involves several steps and requires careful compliance with superannuation laws. Here is the process:
- Set Up an SMSF
- Seek Expert Help: Engage a licensed financial adviser with specialist SMSF knowledge.
- Create a Trust Deed: Outline the rules and structure of the fund.
- Register with the ATO: Obtain an ABN and TFN.
- Open a Bank Account: Open a separate account in the name of the SMSF for fund transactions.
- Develop an Investment Strategy: Align it with the sole purpose test, which is to provide retirement benefits to its members. Consider risk, return, diversification, liquidity, and the fund’s ability to meet liabilities.
- Ensure Compliance: The property must provide retirement benefits to fund members and cannot be lived in or rented by fund members or their relatives.
- Find and Purchase Property
- Engage a Buyers Agent: Find a suitable investment property that meets your SMSF’s investment strategy and legal requirements. SMSF property investments are limited to single contract properties. SMSFs cannot invest in properties requiring construction loans.
- Independent Valuation: Ensure the purchase price reflects market value and seek legal and financial advice.
- Limited Recourse Borrowing Arrangement (LRBA)
- Set Up an LRBA: If borrowing is needed, set up an LRBA. The lender’s rights are limited to the asset purchased.
- Bare Trust: Hold the property in a separate trust (bare trust) where the SMSF holds a beneficial interest. The trustee of the bare trust must be different from the SMSF trustee.
- Loan Agreement: Enter a loan agreement that meets LRBA rules.
- Purchase Process
- Contract of Sale: The contract should be in the name of the bare trust trustee, noting the SMSF as the beneficial owner.
- Settlement: Complete the settlement process, ensuring all documents are correctly executed and the property is transferred to the bare trust.
- Ongoing Management
- Property Management: Manage the property as an investment. Rental income must be paid into the SMSF bank account, and associated fees must also be paid from this account.
- Compliance: Ensure ongoing compliance with superannuation laws, including regular audits and financial reporting. An accountant can assist with compliance.
- Review: Regularly review the investment to ensure it meets the SMSF’s investment strategy.
Key Considerations
- Costs: Significant costs are involved in setting up and managing an SMSF and purchasing property, including setup fees, legal fees, stamp duty, ongoing administration, and compliance costs.
- Liquidity: Ensure the SMSF has sufficient liquidity to meet other obligations, as property is an illiquid asset.
- Risk: Property investment carries risks, which can be minimised with professional advice. Diversifying investments helps spread risk.
Given the complexity, it is highly recommended to seek advice from SMSF specialists, qualified property investment advisors, financial advisors, and legal professionals to ensure compliance and optimal structuring of the SMSF and investments.
Case Study: Exceptional returns in Adelaide
A first-time investor came to inSynergy looking to grow their wealth through property investment. They purchased a recently completed two-bedroom, one bathroom, one car apartment in a lifestyle location in Adelaide for $310,000 through their SMSF. This property has grown by an incredible 45% in the two and half years since it was purchased in December 2021.
This property is also achieving an exceptional long term rental yield of 7.5%. This immediate increase in cashflow into the SMSF has allowed the mortgage to be paid down and the cash buffer to increase. This client is now looking to grow their SMSF investment property portfolio with the acquisition of their next property.