Wed 05 Sep, 2018
Buying Residential Property With Your SMSF: A Complete Guide
Whether you’re a seasoned self-manager of your superfund or you’re looking to take control of your retirement savings in the future, this guide will explain how buying residential property with an SMSF can contribute to your wealth portfolio. Don’t worry, we’re not going to go full ‘The Block’ on you. We’ll simply break down the need-to-knows of residential property as an SMSF investment class, to help you decide whether it’s an avenue worth pursuing.
Why Residential Property?
Lots of Australians commence an SMSF because they are interested in investing in property. For many, property is an asset class they feel comfortable with and are quite knowledgeable on. After all, more than 1 in 10 Australians own an investment property. As an asset class, property does have a distinct benefit for many over investment funds and shares - simply because with an investment property, you have the ability to physically touch, feel and see it. It’s this simple concept that many people have an affinity with. No doubt you’ve heard stories from older friends and family members of buying a 4 bedroom place in Bondi 20 years back for something seemingly ridiculous like $350,000 and found out it’s now valued at $2.1m. Sure, these numbers seem amazing. But it’s important to remember that there are quite a number of factors that need to be considered when contemplating a property purchase. These include what effect having one large asset in your SMSF means for diversification, along with making sure you have considered all of the initial and ongoing costs associated with managing a property asset.
Costs Associated with Residential Property?
In addition to the cost of having a loan to assist you in purchasing a residential property with your SMSF, it’s important to consider the following costs:
- Stamp duty. This can be a lot more than you might think. In the above example, the NSW stamp duty for a $2.1m property in Bondi would be $100,990 on top of the purchase price;
- Rates, taxes and strata fees. You should investigate these costs as while some could be as you expect, larger unit complexes with pools, lifts and other amenities can have strata fees of $10-15,000 per annum, which will reduce your investment return;
- Regular maintenance and funds for a rainy day (or the day the hot water system breaks);
- Cost of insurance for your property, and potentially landlord insurance to cover against tenant damage;
- Cash buffer to account for periods where your property isn’t rented;
- Costs to manage your property. Are you willing to take care of finding and managing tenants or will you engage a professional property manager? Typically a professional will charge around 5-7% of any rental income you receive which in turn will reduce your investment return.
Benefits of Investing in Residential Property
While there are a lot of factors to consider, using property to grow wealth for retirement has been a great strategy for many Australians. Buying residential property with an SMSF can provide the following benefits:
- Low volatility. Property can be less volatile than other growth investments such as share markets which can go up and down;
- Regular cash flow from rental payments;
- Capital growth. If your property grows in value over time, you will benefit from reduced capital gains tax compared to that charged outside of the superannuation environment;
- Reduced tax. During the accumulation phase of your SMSF, rental income is taxed at 15% (vs your marginal rate of tax for non-super property investments). Capital gains tax is 15% in the first year, and is fixed at 10% afterwards. Once you retire and your SMSF is in the Pension phase, these taxes generally go down to zero;
- It’s a physical asset. You are investing in something you can touch and feel.
Risks of Investing in Residential Property
On the other hand, there are some risks to consider as well. Buying residential property with an SMSF can expose members to the following risks:
- Costs of purchasing. There can be additional costs when purchasing property such as conveyancing, stamp duty, pest and building checks, loan application fees etc.;
- Ongoing Costs. You’ll need to make sure your rental income and super contributions cover the ongoing costs. Costs like loan repayments, property maintenance, building insurance etc.;
- Interest rates. If you borrow to purchase a property, interest rate hikes can affect your SMSF’s cash flow;
- There may be times when your residential property doesn’t have a tenant;
- If you need cash in a hurry you can’t simply sell a bedroom, like you’d sell a portion of a share portfolio;
- Capital Loss. If the property market suffers a down turn, you can wind up owing more than your property is worth.
Borrowing to Purchase a Residential Property with your SMSF
There is a rule that an SMSF cannot borrow under the SIS Act. However, there is a very specific exemption where borrowing is conducted via what’s called a “Limited Recourse Borrowing Arrangement (LRBA)”.
An LRBA is a structure that means the property and therefore the loan are isolated from other assets in the SMSF.
In simple terms, this means if the SMSF cannot meet its loan obligations and the lender seeks to recover its loan, the lender only has recourse to the one asset (being the property) that’s held in the LRBA structure. So if you have $1m of cash in your SMSF but the property loan was to default, the lender is prevented from accessing any other monies / assets within your SMSF.
An LRBA can only be used to purchase a ‘single acquirable asset’. In other words, you need one LRBA for each and every property you hold within an SMSF that has a loan against it.
Benefits of an LRBA
- SMSF could borrow additional funds to assist buying a property that is dearer than the assets of the fund would allow it to buy outright;
- SMSF might have greater diversification by not using 100% of its assets to buy a single property asset;
- Buying a property with pre-tax money. By making concessional contributions into your super ie salary sacrifice, you can use pretax dollars to pay down the loan on the property and this might pay the loan off faster than outside the super environment
Risks of an LRBA
Borrowing to purchase a property within your SMSF is a strategy employed by many. However, it’s important that you understand the relevant risks and associated consequences, which can include:
- As with all lending/gearing, the investment returns depend on the rental income you receive and the capital growth of the property being greater than the borrowing and ongoing costs to maintain the property;The higher the level of borrowing against the value of the property, the greater the risk that costs could be higher than your returns.
- Establishment costs like stamp duty can add up significantly, these can reduce your superannuation balance and means it will take quite some time to recoup these costs before you start to see positive capital growth of your property;For example, buying a property for $500,000 in NSW will come up with a Stamp Duty of $17,990, therefore you will need the value of your property to increase by 3.6% before you start to generate true capital growth.
- While a property is in an LRBA structure you are prevented from significantly changing it. So it’s generally best to avoid unrenovated property through your SMSF. Once the loan is paid back, you are free to renovate as you see fit.;
- Rising interest rates can also impact the returns of the property. A significant increase in rates could mean the rental income might not be sufficient to cover the loan repayments and you might have to contribute additional funds from your pre or post tax salary in order to meet your loan repayments.
- The value of the LRBA might impact your total super balance or transfer balance cap. These are complex issues and should be discussed with a professional.
Nutty tip: Not every property can be purchased by an SMSF. For residential properties, you can’t acquire a property from a related party, the property can’t be lived in by any member of the SMSF or their related parties, the property also can’t be rented by a related party.
|SMSF Loan (LRBA)||No Loan|
|Value of Property||$300,000||$100,000|
Property Value Increases (ie Market Rises) by 10%
|Capital Gain for SMSF||30%||10%|
|Equity in Property||$130,000||$110,000|
Property Value Decreases (ie Market Falls) by 10%
|Capital Loss for SMSF||(30%)||(10%)|
|Equity in Property||$70,000||$90,000|
Borrowing to purchase a residential property through an SMSF
John has $150,000 of cash in his SMSF and as an employee, earns an annual salary of $100,000 per annum. He has decided that his SMSF would like to purchase a residential property which he intends to rent out.
3 bedroom residential property in NSW
Purchase Price: $350,000
Historical Rent: $350 p/w
John used funds in his SMSF to cover stamp duty and a deposit of 30%.
As a result, his SMSF via an LRBA has a 70% loan to purchase the residential property, and John’s compulsory super contributions + rental income is sufficient to cover the loan repayments and operating costs of the SMSF.
It’s important to note that changes to deposit, loan size, and income can dramatically change this outcome. If the property was un-rented for an extended period or John’s personal income was, for example, $55,000 per annum, his super contributions + rental income wouldn’t be sufficient to cover the loan repayments, property and SMSF operating costs.
Purchasing a $350,000 Property in NSW
|Property Cost / Value||$350,000|
|Bank Loan||$250,000||LVR 71%|
|Stamp Duty & Transfer Fees||$11,518||Paid from SMSF|
|Legal & Conveyancing||$3,500||Paid from SMSF|
|Total Acquisition Cost||$365,018|
|Deposit from SMSF||$100,000||Paid from SMSF|
|SMSF Balances||Before Property Purchase||After Property Purchase|
|Cash / Other Investments||$150,000||$34,982|
|Less Property Loan||$0||$250,000|
|SMSF Fund Income / Contributions||Monthly||Annually|
|Cashflow Positive / Negative||$347||$4,173|
|Compulsory Super Contributions (9.5% of salary)||$792||$9,500|
|Total Inflows (Money In)||$2,308||$27,700|
|SMSF Fund Expenses|
|SMSF Administration Fees (inc GST)||$121||$1,452|
|ATO Supervisory Levy||$22||$259|
|Property Loan Repayments (6% Interest, P&I)||$1,479||$17,748|
|Est. Property Running Costs (Insurance, Fees, Rates)||$350||$4,200|
|Total Outflows (Money Out)||$1,961||$23,527|
How to Start Investing in Residential Property
Buying residential property with your superfund is more complicated than traditional real estate transactions. Cutting corners or missing key information can be costly and legally complicated, so it pays to have a qualified team of legal specialists, administrators and accountants on your side to assist with every aspect of your SMSF – including property purchases and sales. You must ensure that the fees associated with the management of your superfund are worth it for your investment strategy and goals.
If you’re interested in learning more about how you can invest in residential property with an SMSF, download our free guide today!