If you’re like the many other SMSF members who primarily hold property in their super fund, you may be breaking superannuation laws and exposing your fund to high levels of risk. But don’t panic — there are steps you can follow to ensure your SMSF remains compliant while minimising risk.
Can my SMSF invest solely in property?
It’s important to note that while a single asset strategy is not prohibited, the grounds for investing solely in property — or any other asset class — must be clearly justified and documented in your investment strategy to demonstrate that your fund is complying with legislation. Looking further than compliance, there are also investment risks that could impact the value of your SMSF. Investing in one asset class leaves you open to concentration risk and liquidity risk, in addition to a few others.
Diversifying your portfolio by investing in a range of asset classes can reduce these investment risks and make for less volatile returns. With that being said, capital growth and returns associated with property have historically proven to be lucrative and stable. So is it feasible to invest heavily in property? And how can you protect your fund? We have a few tips.
Lack of diversification leaves you open to concentration risk. Basically, it’s like putting all of your eggs in one basket — if something happens to that basket, all of your eggs will be affected. Similarly, suppose the property market is impacted and you don’t have any other asset classes to rely on for growth and returns. In that case, you could find yourself in a very tricky situation. But diversification doesn’t always need to be across asset classes — you can diversify your property portfolio by investing in various classes of property.
Tips for diversifying your property portfolio in your SMSF:
Invest in different types of property.
Amid COVID-19 we saw commercial property significantly impacted. Office spaces were emptying, there was reduced traffic in shopping centres and motel rooms were going unused. These are just a few of the factors that influenced a decline in commercial property value. On the flip side, there was a housing crisis with the demand for rental properties being much higher than the supply. This led to increased rental income for residential property owners. By investing in different types of property, you can reduce the volatility in your returns.
Types of properties available to SMSFs:
- NDIS housing — a social-minded investment backed by the Government.
- Commercial property — it’s possible to lease the property out or gain tax benefits by having your business lease the property from your SMSF.
- Residential property — the booming population means there is a growing demand for housing.
- House and Land packages — some investors choose to build a house designed for capital growth in an area that’s going to boom.
Buy in various locations.
By spreading your properties out across the country or your state, you reduce the risk of location-specific factors impacting your investments. For example, if you invested solely in an area prone to flooding, you could find yourself having to pay for repairs or risk your properties being left vacant.
Hold properties varying in price
By holding properties of high and low values, you have the ability to slightly reduce liquidity risk. For example, if you needed to sell a property to meet your cash flow needs, you would have the opportunity to liquidate a lower value property to cover your cash flow requirements, while keeping higher value properties to generate income and capital growth.
Everyone knows it takes a substantially longer time to sell a house than it does to make a withdrawal from a bank account. With that in mind, holding primarily property in your SMSF can pose significant liquidity risk, especially if the properties are geared, or you’re in the pension phase — liquidity risk being the risk of not having enough liquid assets to fund cash flow needs. Depending on whether you’re in the accumulation phase or pension phase, there are some tips to take on board to help you manage liquidity risk.
Tips for managing liquidity risk in your SMSF:
Make contributions while you’re still working
If your investment properties are geared, and the rental income doesn’t cover the loan, it’s entirely possible to use your employer super guarantee or personal contributions as a source of funds. Just be sure to have adequate insurance in case you find yourself unable to work.
Keep cash in an offset account
To manage cash flow and liquidity requirements, cash can be kept in an offset account to reduce the amount of interest paid on SMSF loans. An offset account provides a double benefit by reducing your interest expense and providing a quick and easy cash account to pay for costs related to your SMSF.
Clear debt before pension phase
The tax-free earnings made during the pension phase will likely be a welcomed benefit that comes with changing from the accumulation phase to the pension phase, but you’ve suddenly lost the ability to contribute to your fund. This is why it may be important to clear any loans you might have over your assets or have a strategy in place to pay off the debt once your pension has commenced. If property is your only asset class, you may need to review your investment strategy in regard to the amount needed to commence your account-based pension.
A Sound Investment Strategy Is Essential To Avoid Disciplinary Action
While investing in a single asset class is technically allowed, you must clearly show in your investment strategy that you have considered all of the factors set out by Regulation 4.09(2) of the SIS Act. This means that the investments you use must be in line with your objectives and have been chosen, giving careful consideration to risk, returns, liquidity, capacity to repay liabilities, diversification and insurance. Simply put, it’s fine to invest heavily in property as long as you can demonstrate that your circumstances and expectations regarding risk and returns are fulfilled with a single asset strategy.
For example, if you are still working, have a high tolerance to risk, are seeking a high rate of return and have an industry fund with a diversified portfolio, then your decision to hold only property in your SMSF could be perfectly justified. You just need to clearly demonstrate the reasoning in your investment strategy.
Keep Your SMSF Compliant
While there are no rules regarding the asset allocation of an SMSF, there are rules that state your asset allocation matches the investment strategy of your SMSF. This is why it is absolutely vital to have an investment strategy tailored specifically for your SMSF.
Each year your auditor will be checking that your fund had a relevant investment strategy in place and that its investments were in accordance with the strategy. They’ll also check that the strategy has been reviewed during the financial year in question. So be sure to keep your documentation up to scratch or you could face having your SMSF reported.
So while in some cases, it may be entirely feasible to invest solely in property, make sure you’re taking the necessary steps to remain compliant and minimise your risk.