Recent media has focussed on the risks of investing in geared property by self-managed superannuation funds (SMSFs) and whether it is really the right long-term decision for a member’s retirement. It can be the right choice for some but it’s not for everyone. Opportunities come with risks which are the same as any individual’s decision to make a personal property investment. There are however some risks which are unique to SMSFs.
There’s no question that property can reward investors with capital growth and steady rental income. However, when it comes to property and SMSFs the investment needs to be carefully considered. This applies especially if borrowing is involved, due to the potential demand on the fund’s cash flow that is provided by a steady stream of contributions. In hard times if the property cannot be leased out, the cash flow from contributions can be used to pay for investment expenses.
The advantage of an SMSF investing in property is the generous tax concessions given to super. Rent from the property investment will be taxed at 15% and capital gains from selling the property can be as low as 10% while saving for retirement. If you decide to take a pension from your SMSF any rent and capital gains can be tax-free. On the other hand, because of these low tax rates the benefits of negatively gearing (expenses of the property are greater than the rent received) an investment property can be less than if you did this as a personal property investment.
Also, insurance and whether a large illiquid asset like property will suit the SMSF member’s needs for their retirement must be considered. Selling an illiquid asset like a property can also take time and involve higher costs than liquid assets such as ASX shares, which can normally be sold very quickly. The sale of the property may also result in a large inflow of funds all at once, rather than a steady stream of income. This needs to be managed carefully if an SMSF is to pay you a pension.
An SMSF can invest in residential and commercial property either directly if it is ungeared or by using a limited recourse borrowing arrangement where it borrows to purchase a property that is held in trust on behalf of the fund.
Limited Recourse Borrowing Arrangement (LRBA)
SMSFs are allowed to borrow to make an investment under some very strict rules which must be followed without exception. These arrangements are known as LRBAs and are most commonly used by SMSFs to invest in property. LRBAs involve complex rules and structures and require extensive legal documentation and bank loan approvals.
LRBAs essentially limit a lender’s rights against the borrower to the property that secures the loan. This means if an SMSF borrows to buy a property via an LRBA and the SMSF is unable to pay the loan, the lender can only seek compensation by taking possession of the property alone and is not able to access any of the fund’s other investments.
The LRBA rules limit the types of properties that can be acquired and what can be done to the property. Properties need to be single investments and limits apply to the types of, and how repairs and improvements can be made to the property. These rules are very technical and complex.
Does property suit your fund?
Investing in property to fund your retirement is an option that might be suitable for your SMSF but the complicated factors involved in SMSF property investment means you should seek out specialist SMSF advice to make sure it is done correctly.
If you are considering purchasing an investment property within your SMSF and require assistance or guidance to navigate the complexities of structuring the transaction correctly, please give me a call to arrange a time to meet so that we can discuss your particular circumstances and the suitability of this strategy.