Why choose a property for your SMSF?

News
May 28, 2020

More than a million Australians now have their retirements savings in a Self-Managed Super Fund (SMSF), giving them control over where and how their money is invested. For business owners, SMSFs can offer particular advantages from allowing couples to consolidate their savings to borrowing to buy business premises.

Types of SMSF assets

Common assets for SMSFs include stocks and bonds, term deposits, gold and property. According to Australian Tax Office (ATO) data SMSFs, on average, invest the most in listed shares, and cash and term deposits. However real estate is gaining ground as the fastest-growing asset class. As of September 2019, SMSFs held about $35 billion in residential property assets and about $64 billion in non-residential assets.

Why choose property investment for your SMSF?

The introduction of new borrowing arrangements for SMSFs in 2007, followed by the Global Financial Crisis, saw property emerge as a relatively stable investment choice. It ticked boxes for capital growth, income generation and risk. Commercial property is particularly attractive to business owners, as there is potential to buy premises through an SMSF, then lease it back through the business. Even when this is not an option, commercial property can offer the security of longer leases. Residential property investment has grown too, although it accounts for just over 35% of SMSF real estate assets.

Regulations to be aware of

It is important to be aware of regulations around property investment. Commercial property bought through an SMSF and leased to a member’s business must be rented at a commercial market rate and paid on time, every time. Residential property is subject to stricter rules of use and cannot be lived in, or rented by, a fund member or anyone connected to them.

How we can help

Finding a loan that fits your needs is always top of the list, but SMSF borrowing requires niche products that may not be widely known. A good broker (that’s us) who understands your business and it’s needs can be an invaluable guide. In the past decade, as banks have come under tighter regulation, non-bank lenders have stepped in to meet demand with new loan products tailored specifically for SMSFs buying either residential or commercial real estate. Many of these lenders find broker channels the most effective way to get their latest products in front of the right customers. Loan products include a range of Limited Recourse Borrowing Arrangements (LRBA). An LRBA involves an SMSF trustee taking out a third-party loan to buy a property that is then held in a separate trust. Income generated by the property is paid to the trustee, but in the event of a loan default, the fund’s remaining assets are effectively quarantined. Creditors only have recourse to the property held in trust. LRBAs are one of the fastest-growing SMSF products with the amount of funds borrowed using LRBAs growing from just $497million in 2009 to $43billion in 2019.

An example of SMSF lending from a specialist commercial property lender, ThinkTank.

To help explain this, one of the lenders who specialise in this area, ThinkTank have put together an example of how an SMSF might work. Thinktank has been lending to SMSFs for the acquisition of property through Limited Recourse Borrowing Arrangements for some years now and approaching $500m in total advances. There are some basic regulations that apply to these types of loans that come from the Superannuation Investment Supervision Act 1993 (SIS Act) and everyone involved in the transaction needs to be familiar with these in order to help people arrange their financing. These include things like ensuring the property in question is a “single acquirable asset”, that it is acquired in the name of a “bare trust” and that the purchaser in the contract of sale is that “bare trust” even though the rent is paid to the SMSF Trustee. Thinktank can help you successfully negotiate these issues and how the ATO acts as the Regulator of this sector. In this case however we will focus on a standard case study of how an SMSF can be used to acquire an owner-occupied business premises and help plan for the retirement of the proprietors. Mr and Mrs Smith have been running a successful SME out of an industrial office warehouse for ten years which they own in their family trust to whom their company pays a market rent of $5k per month. The property is worth $1.2 million and they owe $600k to their bank against a registered first mortgage. The family business is profitable and supports them and their children comfortably providing for their family home on which they also have a modest residential mortgage having lived there for some years. They have also been wise enough to accumulate superannuation savings in industry funds over the years and have combined balances of $500k. Mr and Mrs Smith’s accountant recently suggested they consider establishing an SMSF and introduced them to a Financial Planner. After discussing their objectives with them, the financial planner prepared a Statement of Advice (SoA) outlining how the Family Trust could sell the business premises to their SMSF while rolling over their industry super funds and using $300k as equity and borrow $900k as an LRBA. An alternative to using the cash balance available in the SMSF would be to make a non-concessional in-specie contribution of part of the equity available in the property. While there is a limit of $100,000 per member per annum you can take advantage of the three year bring-forward rule. As always, seeking expert advice is essential. They accepted the advice and spoke to their mortgage broker and were introduced to Thinktank who provided them with terms for a 30 year loan with a 75% LVR with monthly Principal and Interest payments of $5,831. The monthly rent of $6k just covers the P&I payments but the Smiths plan to contribute their maximum $25k each year through concessional contributions as they are fully tax deductible. Between the rent and their contributions, they more than meet the 1.7 times Interest Cover Ratio (ICR) required and are contributing to their retirement savings. When they do retire and enter Pension Phase all the income earned in their SMSF will be tax free including if they choose to sell the property and any capital gain that might be earned.

Please note FMA does not provide tax, legal or accounting advice. Any information or examples provided in this document are of a general nature only and do not take into account the objectives, financial situation or need of any particular person and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Therefore, before making any decision, you should consider the appropriateness of the information with regard to those matters and consult your own tax, legal and accounting advisors before engaging in or considering the appropriateness of any transaction.

Please note this is a high level example for general use only which has been provided by ThinkTank Group Pty Ltd ABN 75 117 819 084 (ThinkTank). The example should not be relied on for the purposes of an application.

Any advice contained in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. Information in this article is correct as of the date of publication and is subject to change.