Direct property as part of a well-diversified portfolio can help advance your retirement goals. In addition to buying property, borrowing to purchase property is also an option currently available. As there can be serious consequences for getting it wrong, the strategies around borrowing to purchase property will be discussed with you by your financial advisor.
SMSF Residential Property Rules
You can only buy property through your SMSF if you comply with the rules.
The property purchased by the SMSF;
- Must meet the ‘sole purpose test’ of solely providing retirement benefits to fund members
- Must not be acquired from a related party of a member
- Must not be lived in by a fund member or any fund members’ related parties
- Must not be rented by a fund member or any fund members’ related parties.
SMSF Borrowing
Borrowing or gearing your super into property must be done under very strict borrowing conditions called a ‘limited recourse borrowing arrangement’.
A limited recourse borrowing arrangement can only be used to purchase a single asset, for example, a residential or commercial property. Before committing to a geared property investment you should assess whether the investment is consistent with the investment strategy and risk profile of the fund.
Geared SMSF property risks
- Higher costs – SMSF property loans tend to be more costly than other property loans which must be factored into your investment decision.
- Cash flow – Loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan repayments.
- Hard to cancel – If your SMSF property loan documentation and contract is not set up correctly unwinding the arrangement may not be allowed and you may be required to sell the property, potentially causing substantial losses to the SMSF.
- Possible tax losses – Any tax losses from the property cannot be offset against your taxable income outside the fund.
- No alterations to the property – Until the SMSF property loan is paid off alterations to a property cannot be made if they change the character of the property.
Additional Costs
You should find out all the costs before signing up. Some of these include:
- Upfront fees
- Legal fees
- Advice fees
- Stamp duty
- Ongoing property management fees
- Bank fees
Loan to value ratio
Ascendancy Planning have a company policy to not recommend a SMSF borrow to the extent that it causes a negative cash flow in the SMSF. The main reason for this is if the SMSF is relying on employer contributions to assist with the loan repayments and the members lose their jobs, then this puts the SMSF in a compromising position with the following options available;
- The members put more money into the SMSF (hard as they have just lost their jobs)
- Use the cash reserves of the SMSF (this will only last so long)
- Sell the property (this may not be ideal due to market conditions)
As you can see none of the above options are attractive.
As an example if your investment property has forcast rent (net of rental expenses) of $350 per week, or $18,200 pa less SMSF running costs of $3,500, would leave you a loan service amount of $14,700pa.
So if the interest rate was 6% on a principle & interest 30 year loan, then we would only recommend a maximum loan amount of $200,000.
Conflicts of interest
You need to ensure that the financial planner you use to give your SMSF advice does not receive any payments or incentives from the property developer, this helps to ensure you get independent advice.
Ascendancy Planning do not receive payments or incentives from property developers or investment product advisors.