Why Are More Australians Considering SMSF Property Investment?

With house and land prices skyrocketing due to concerns about securing their financial future, many Australians are considering creating a self-managed super fund. One method people keep hearing or reading about is creating a self-managed super fund to purchase some property. This sounds sensible-at least on the surface; how can a thing like real estate not increase long-term value? Is this a viable option, though?

SMSF property investment also has its specific rules, risks, and rewards. Whether you are considering this approach to retirement or just want to know how it all works, this guide will break it down in a clear, friendly way with no financial jargon, just the essentials you need to know.

Key Benefits of Investing in Property through SMSF

• More control over your super investments: Unlike the traditional super funds, an SMSF allows you to decide where your money goes. This way, you are free to invest in property instead of waiting for fund managers to make that happen. For the individual investor, property affords a level of stability, in addition to ownership of retirement funds.
• Potential for rental income: The SMSF can earn regular rental income by owning a rental property. You can use this income to service loans and pay for maintenance, which will gradually increase the fund's balance. A good location with strong demand guarantees steady returns.
• Tax advantages: The tax benefits of SMSF property attract investors. The tax rate on income from rentals in an SMSF is a mere 15%, significantly lower than personal tax rates. Selling the property after retirement may result in entirely tax-free capital gains, thereby making it a tax-efficient investment strategy.
• Long-term wealth accumulation: Property tends to appreciate over time and has long-term value. Thus, keeping the property in an SMSF will therefore generate capital growth as well as rent income, making for a better retirement. This requires careful choice of a good-growth property with sound market fundamentals.
• Super portfolio diversification: Adding property to an SMSF takes the reliance off stocks and managed funds and hence seems to be a way of diversifying with lower risk, thus taking into account a balanced investment approach. Furthermore, research has demonstrated that the value of property remains significantly more stable compared to the stock market.

Issues with SMSF Property Investment

• Deposit requirements are significant: Most SMSF loans require a 20% to 30% deposit, meaning the balance in an investor's superannuation fund needs to be considerable before they can even think of buying a property. If the SMSF account is low on balance, the costs associated with investing in property may be prohibitive.
• Limited lending options: Not every bank offers SMSF loans. Those that offer them usually place stricter conditions regarding approval. Generally, lenders judge the rental income, SMSF cash flow, and member contribution. This loan is rather strict in comparison to a simple property investment; securing funding proves to be even more challenging in this case.
• Higher interest rates: SMSF property loans generally come with higher interest rates than traditional home loans. This means higher repayment costs, which can affect the overall profitability of the investment. It’s essential to compare different lenders and loan terms before committing to an SMSF loan to avoid excessive costs.
• Ongoing fees and compliance costs: Running an SMSF involves annual audits, accounting fees, legal costs, and administrative expenses. These can add up to thousands of dollars per year, reducing the fund’s overall returns. Investors must ensure that rental income and super contributions are enough to cover these expenses.
• Strict usage rules: The ATO clearly states the regulations that an SMSF must use the property strictly for retirement benefits. In this regard, the fund members cannot live on the property; they cannot occupy it as a holiday home; they cannot rent it to their family members. Any breach of this rule can result in severe penalties.

Understanding SMSF Borrowing Rules 

• Limited Recourse Borrowing Arrangements (LRBAs): The only way an SMSF can borrow money to invest in property is by using an LRBA. Essentially, this limits the claim of any lender to the actual property purchased, preserving the other assets of the fund; however, SMSF loans are riskier and more costly than any normal property loan.
• Separate Trust Needed: The property must be held in a bare trust. This is a legal structure used for setting up SMSF property acquisitions. It is then held in a way that the property isn't owned by the SMSF, but at the same time, the fund controls it. Setting up a bare trust involves legal and administrative costs.
• No major renovations using borrowed funds: SMSF loans can only be used to purchase or maintain a property, not for improvements or renovations. Any major upgrades must be funded from existing SMSF savings. This rule prevents investors from significantly increasing the property’s value using borrowed money.
• Repayments must come from the SMSF: The loan repayments, property maintenance costs, and other expenses must be covered by the SMSF’s income. This means the fund must have enough rental income, contributions, or cash reserves to meet all financial obligations without relying on external funds.

Selecting the right property for your SMSF

• Residential properties: Buying a house or apartment through an SMSF is a common option, but it comes with tenancy restrictions. You cannot rent the property to a family member, even at market rates. Moreover, residential property investments rely heavily on rental demand and capital growth to be financially viable.
• Commercial properties: Several SMSF investors select commercial properties because they typically generate higher returns through rental income. If managed correctly, the SMSF is allowed to let the business enterprise of a fund member occupy it and, as a result, produce a solid cash flow return. Commercial property is more exposed to vacancy spells and takes time to sell; therefore,
• Strong rental demand: the success of a property in an SMSF depends largely on the location. There may be an implication that the areas where there is strong demand for rental properties generally have low vacancies, hence a steady level of rental return. Research has to be comprehensive in rental returns, vacancy, and local trends before one buys a property.
• Repayments must come from the SMSF: It would be crucial in the long-run growth of the SMSF for it to contain a selected property with sustained price appreciation. Infrastructure development, population growth, and economic stability are some key factors that might influence an increment in value. A well-identified property can greatly increase the total assets of an SMSF.
• Liquidity considerations: Property is an illiquid asset. It takes time to sell, unlike stocks or managed funds. SMSF members who retire and need to withdraw funds must have enough liquid assets to cover pension payments. Investors should consider diversification to maintain fund liquidity.

Conclusion

Seek professionals. If you are ever considering this approach, consult with the SMSF mortgage expert, accountant, or adviser, for it must be in relation to your other long-term financial goals.  You get to make just the right call that will help maximize the potential while avoiding pitfalls.

Are you interested in discussing your SMSF investment strategy? OM Financials can assist you through that process. Visit our website or call us on 0478 876 967; book an appointment to discuss matters with our team.