The decision to establish your own self-managed superannuation fund (SMSF) is an important step towards managing your own wealth. With an SMSF fund members have an investment vehicle that can be used to build a property portfolio, however investments must be in strict accordance with a fund’s investment objectives.
Before you start making any investments the Australian Tax Office (ATO) requires SMSFs to have an investment strategy that sets out the fund’s objectives and specifies the types of investments your fund can make. Your investment strategy should be in writing and reviewed regularly to ensure it continues to reflect the purpose and circumstances of your fund and its members.
Deviations from your investment protocols will be frowned upon by the ATO so check the wording of the strategy and if necessary have it modified before a property is purchased.
Investing in property may sound straightforward but there are many market and regulatory variables to consider. To ensure that your property investment is the right one for you and your fund it is recommended that you consult with qualified, appropriately experienced professionals.
Whether it’s a property adviser, financial planner, lawyer or accountant it’s important that your adviser has proven expertise with SMSFs.
Limited recourse borrowing
An SMSF can invest in real estate by borrowing money through a limited recourse borrowing arrangement or LRBA.
An LRBA involves your SMSF borrowing money to purchase a single asset, such as real estate, or a collection of the same asset with the same value, such as a parcel of one company’s shares.
While the LRBA is in place the asset is held by a Holding Trustee in a separate trust. Upon repayment of the loan the asset can be transferred into the name of the Fund Trustee.
Peter Townsend, Principal of Townsends Business & Corporate Lawyers, says the separate trust is an important safeguard provided by LRBAs.
“If the fund defaults on the loan then the lender is only able to exercise a power of sale over the particular asset in that separate trust, as opposed to over all of the assets of the fund,” Townsend says.
Consistent with the purpose of the fund being to provide benefits to members in retirement, an LRBA is generally about generating growth over a long-term investment.
Choosing the right property
Paul Nugent, director of Wakelin Property Advisory, says that to maximise investment returns the best types of properties to invest in are high-quality, high-growth assets.
“The opportunity to gear within an SMSF and the generous tax treatment of capital gains underpins the rule that property investors should invest in high-growth assets or not at all,” Nugent says.
“That means concentrating on established houses with period features or older apartments in the inner suburbs of our larger capital cities.”
By focusing on these assets, with their track record of strong and consistent capital growth of 7% to 10% a year over the life of the investment, such a strategy can potentially enhance the returns of the overall fund.
Selecting the right asset is always vital for property investment but is even more crucial when you buy within the super fund structure.
“The lack of flexibility and complexity associated with setting up borrowings means it is easier to make a mistake and the implications of those errors are more serious with SMSFs,” Nugent says.
“If you buy the wrong property and you have to sell for a loss the super fund has to take the hit. You can’t just top up your super to correct the shortfall, at least not without tax implications.”
Banks have tougher rules when assessing lending against a property within a DIY fund. They generally insist on properties that are larger than 50m2 and typically won’t lend more than 70% of the asset’s value.
Another factor to consider is that the ATO places restrictions on “allowable work”.
Any planned renovations and the way these renovations are funded must fall within tax office rules.
DIY funds can borrow to maintain and restore a property. This includes activity such as fixing the guttering or the roof or replacing an old and dated kitchen. However improvements such as the addition of new bedrooms or an extension can only be undertaken using cash within the super fund, not borrowings.
Work that effectively leads to a change of use for the asset, such as knocking down a house and replacing it with apartments, is not allowed within an SMSF.
The related parties rule restricts the purpose of SMSF investment properties.
Property investments within super must be completely at arm’s length and cannot be bought for the direct benefit of the trustees or any related party. Fund members cannot reside in a property purchased by their super fund, rent it to a relative or use it as a holiday home.
Australian Bureau of Statistics (ABS) house price data reveals that the combination of increased supply and curbs on investor lending is producing a balanced housing market.
The ABS’s Residential Property Price Index indicates that the weighted average across the eight capital cities rose just 0.2% for the December quarter – compared to annual growth of 8.7%.
The Property Council of Australia’s Chief of Policy and Housing, Glenn Byres, says house price growth nationwide is moderating, suggesting that the delivery of new stock in the market and caps on investor lending are having an effect.
National house price growth fell from 4.7% in the June 2015 quarter to just 0.2% in the December quarter.
Sydney – the market with the biggest affordability challenge – recorded negative growth for the first time in three years in the December 2015 quarter, falling 1.6%.
The housing industry has experienced record housing commencements, a stable rental market and stable house prices, according to Byres.
The value of residential construction work in the December quarter increased 2.8% to more than $16 billion, according to the ABS.
“We are seeing benefits of policies that have increased housing supply across Australia,” Byres says.
Wakelin Property Advisory’s Paul Nugent encourages SMSF property investors to take a long-term view when assessing the property market.
“Rather than crystal ball gaze into 2016, thinking about where prices will be in 10 years’ time – in 2026 – is more worthwhile,” he says.
“If you’re planning to invest in property this year, it should be with the intention to stick with that asset for at least seven years and ideally 10. Over that longer time frame, prices are far less volatile and more predictable than they are year-to-year.
“Choose a great asset and I can’t tell you whether it will rise or fall in value next year, but I’m very certain it will double in value after 10 years.”