A beginner overview to borrowing for SMSF propertyDecember 13 2022
Self-Managed Super Funds (SMSF), have gained popularity in recent years as they give people more control over how their retirement funds are invested.
Instead of being managed by a superannuation provider, that money can instead be invested by the individual in shares, term deposits, cash, or even an investment property.
SMSFs are generally prohibited from borrowing money, but one exception is for limited recourse borrowing arrangements (LRBA). These allow the SMSF trustee to borrow funds from a third-party lender to invest in commercial or residential assets. Over the June quarter, the value of LBRAs in Australia has reached $60.6 billion according to the ATO.
Borrowing to purchase residential or commercial property specifically using your SMSF is an option considered by more and more Australians. Though it comes with a couple of caveats.
Importantly, all funds needed to finance the property and its associated costs must come from the super fund or the rental income it generates, and cannot come from personal equity. Furthermore, the property purchased must comply with the following rules.
The property must:
- meet the ‘sole purpose test’ of solely providing retirement benefits to fund members
- not be acquired from a related party of a member
- not be lived in by a fund member or any fund members’ related parties
- not be rented by a fund member or any fund members’ related parties
Reasons to invest in property using your SMSF
Invest in a tangible asset
For some Australians, superannuation becomes an afterthought until the last few years of their career. The set and forget mentality is an advantage to some, but detrimental to others. Some people may put greater importance to owning a tangible asset that they can live in or rent out for stable cash flow once they retire.
Historically less volatile than the stock market
Majority of traditional superannuation providers invest your superannuation in the stock market. While it all depends on an individual’s risk tolerance and strategy, generally speaking, property has historically been less volatile with less dips in value compared to share equity.
Avoid the percentage-based fees
Industry or retail super funds normally charge weekly and/or yearly fees as a percentage of your total account balance. With an SMSF, costs are usually upfront and fixed, with larger funds benefiting from scale.
Due to the LBRA, should the fund trustees default on the mortgage, the lender is limited to the property the fund owns while any other SMSF assets are protected. Nevertheless, some lenders can get around this by requiring trustees to give personal guarantees.
Factors to consider
SMSF property has many benefits, but it is not all rainbows and sunshine. It is obviously a monumental responsibility, as it is an investment meant for your retirement. You and a maximum of three other trustees will be responsible for decisions regarding the fund, and its compliance with relevant laws. There are many factors to consider before you make that decision including:
High cost of entry and associated costs
Lenders generally have a relatively high minimum superannuation balance before they consider applicants. It is also important to take note that interest rates are higher when borrowing for SMSF properties compared to owner-occupier or investor loans. Additionally, there are added costs to setting up and running your SMSF, and they can be substantial for smaller funds. Some of the essential and common costs include the following:
- Establishment of trust deed
- LBRA documentation
- Corporate trustee
- Financial advice
- Stamp duty
- Property management fees
- Bank fees
Timely process to establish
Depending on the lender you choose and the administrator that assists you, setting up an SMSF can be an easy and streamlined process. However, it could still take a few months to establish so it is best to research thoroughly before going through the process.
Equity in investment not accessible
For the most part, an attractive perk of investing in property is your ability to access its equity to make renovations or other investments. However, when it comes to property acquired through your SMSF, any built up equity cannot be used until you’re of appropriate retirement age.
In the unfortunate event you are unable to work due to illness or injury, Australians are normally able to make a claim to access money from their superannuation fund. But since property is not a liquid asset, it could take some time for you to receive cash for the sale, or the property may need to be sold under market value.
Depending on your risk tolerance and investment strategy, purchasing property through your SMSF can be a viable option for many Australians. Importantly, it is always recommended to seek professional advice from industry experts. Definitely don’t go through it alone!
Any advice provided is general in nature and should be considered in line with your financial situation, needs and objectives.
WLTH. (2022, November 9). A beginner overview to borrowing for SMSF property. The natural evolution of money | WLTH. https://wlth.com/blog/a-beginner-overview-to-borrowing-for-smsf-property