How do you use your superannuation funds to buy a property?

Welcome to Finance and Fury, The Say What Wednesdays Edition – Where each week we answer your questions

Today’s question comes from Cameron

We are a couple, both aged 30 with approx 70k in each of our super accounts. We are interested in SMSFs with a view to purchasing property. How would one get started? What sort of costs are expected? Do couples pool their super?

Buying Property in an SMSF  

1. First, you need a SMSF – self-managed super fund
   1. An SMSF is a private superannuation fund, regulated by the Australian Taxation Office (ATO) that you manage yourself. 
      1. All other funds are managed by APRA – Australian Prudential Regulation Authority – the regulator of financial organisations (Banks and supers)
   2. SMSFs can have up to four members. All members must be trustees (or directors, if there is a corporate trustee) and are responsible for decisions made about the fund and compliance with relevant laws
      1. Two types of SMSF – Pooled and Segregated –
      2. Most are pooled for simplicity – where you can pool your funds together for the purchase of the same asset – i.e. a property –
      3. Still have individual member benefits – where your component of the super is allocated to you
   3. When you run your own SMSF you must:
      1. Carry out the role of trustee or director, which imposes important legal obligations on you
      2. Set and follow an investment strategy that is appropriate for your risk tolerance and is likely to meet your retirement needs
      3. Have enough time to research investments and manage the fund, keep comprehensive records and arrange an annual audit by an approved SMSF auditor
      4. Organise your own insurance
      5. Use the money only to provide retirement benefits.

1. Who is it appropriate for?
   1. Large Combined balances
   2. Hands-on – and willing to take on trustee burdens
   3. Wanting to buy property
      1. You can get Direct shares or Term Deposits in other super accounts which aren’t SMSF
2. Who sets this up?
   1. Accountants normally are the ones that would help to set up an SMSF, however, they would probably need to have a limited AFSL to do so. Depending on what they charge (which can vary) and the structure of the trustee, the costs can range from $2,000 to $4,000. This is then similar each year for the audits and returns to be completed.
   2. Given a combined balance of around $140,000, the ongoing administration costs would be over 1.5% p.a. which may hurt the long term performance. This is why ASIC have a benchmark of $200,000 for combined funds at which point SMSFs become more viable due to the accounting costs.

Buying the Property:

1. Must meet sole purpose test – Provide retirement benefits to members
2. Must not be lived in by a member or related party (family)
3. Must not be acquired from a related party of a member
4. Must not be rented by a fund member, or related party
   1. BUT – Business real gets around these rules
   2. Business real – if you own and run a business you can operate out of a property your SMSF owns
   3. You pay rent to the SMSF at market rates – Arm’s length transactions

Property purchased with a loan – Limited Recourse Borrowing Arrangement (LRBA)

1. Borrowing or gearing your super into property involved very strict borrowing conditions – called a ‘limited recourse borrowing arrangement’.
   1. You can only purchase a single acquirable asset with a limited recourse borrowing arrangement
2. Bare Trust – Set up to own property – And the trust is inside the SMSF
   1. Has the loan so that the property it the sole collateral of the loan
   2. Property has to be single acquirable asset
      1. No change of character to property – You can’t make alterations that change the character of the property until you pay off the SMSF property loan.
      2. Not suitable for developments, renovations etc.
   3. The deposit requirements for property also are around 20-25% of the purchase price and there are only two lenders in Australia which provide a mortgage inside of an SMSF.
3. Due to Bare trust – Geared SMSF property risks include:
   1. Liquidity requirements – This is where the Investment Strategy of an SMSF needs to specify the cash balance requirements and that the contributions into the SMSF can cover the mortgage repayments (in case the property is not tenanted for an extended period.
      1. Depending on age – ranges from 10-15% at lower end to 40% in cash balance
   2. Higher costs – SMSF property loans tend to be more costly than other property loans.
   3. Cash flow – Loan repayments must come from your SMSF. Your fund must always have sufficient liquidity or cash flow to meet the loan repayments – Employer contributions
   4. Hard to cancel – If your SMSF property loan documents and contract aren’t set up correctly, you can’t unwind the arrangement. You may have to sell the property, potentially causing substantial losses to the SMSF.
   5. Possible tax losses – You can’t offset tax losses from the property against your taxable income outside the fund.

4. When it works well
   1. Decent balances – ASIC guidelines of $200k minimum – technically no minimum – but makes it viable
      1. The more the better – Flat fees of $2k p.a. plus investment costs
   2. Can Diversify into other investments
      1. Comes back to having enough to spread it around
   3. Have other sources of income inside SMSF to offset deductibility – if the property is slightly negatively geared
   4. The property: Commercial real – own it yourself and lease it to yourself
      
      
5. What Won’t work – Risks of Buying property
   1. Property is heavily negatively geared
      1. Deductions are lost if no additional income earned by SMSF to offset it
      2. Also, the maximum rate of tax is 15% for accumulation
   2. Not much in super – the only asset is a property
      1. Not diversified
      2. The big risk to your retirement balances
   3. Not making lots of contributions
      1. Sometimes the property income won’t cover costs
      2. Need to have an employer or personal contributions to meet cashflow requirements
   4. Need to renovate – Can’t make changes to the property until the loan is paid off
      1. If you need to renovate you will be stuck
   5. Hard to wind up SMSF
      1. Loan documentation (if not set up properly) would require the sale of the property before SMSF can be closed

If you are looking at doing it, seek advice! One thing not to muck up your retirement

Thanks for the question – Don’t forget that these episodes are open to anyone who has a question – go to www.financeandfury.com.au and get in touch through the contact page!