A common investment choice amongst SMSF trustees is to purchase direct property within their fund. Whether it be a commercial property purchase, or residential property on the Australian real estate market, property investment within the self-managed super fund environment may provide both capital growth potential and rental income, to help grow the member’s retirement savings over time.
If you’re looking to buy property in an SMSF and are unsure which option to choose, keep reading as we step through some of the considerations to be made when looking at investment in rental properties through your SMSF.
Buying an investment property with your self-managed super fund
In anticipation of purchasing property within their SMSF, some SMSF trustees may get lost in the excitement, however, it’s important to remember the strict superannuation laws around SMSF property purchases. Some of these include:
Compliance with the SMSF trust deed
SMSFs must adhere to strict compliance and regulatory requirements. Trustees must ensure the fund complies with the Superannuation Industry (Supervision) Act 1993 (SIS Act) and the fund’s trust deed. Some funds may need to update their trust deed prior to purchasing an SMSF property.
Meeting the sole purpose test
The primary purpose of an SMSF is to provide retirement benefits for members. Any investment, including rental properties, must align with this sole purpose. This means trustees cannot use the property for personal purposes or rent it to family members, as the fund should be established with the intent of solely providing retirement benefits to the fund members.
When borrowing for property purchases within an SMSF, the trustees must remember that they can only do so through a Limited Recourse Borrowing Arrangement (LRBA). An LRBA is essentially a separate property trust to limit the recourse of lenders if the fund defaults on the property loan, effectively protecting the fund’s remaining assets.
When using LRBAs, trustees must be aware of borrowing limitations and meet specific criteria. For example, trustees cannot improve the property with borrowed funds, and any borrowing must be within the fund’s ability to service the loan.
Investing in line with the fund’s SMSF investment strategy
Purchasing direct property must also align with the fund’s investment strategy. Like the trust deed, it too may require updating to ensure that the self-managed superannuation fund remains compliant.
Loan repayments must come from the super fund
It’s important to ensure the SMSF has enough cash or liquid assets to be able to keep up with loan repayments for the SMSF property mortgage.
Choosing between residential property or commercial property
Deciding between commercial or residential property for SMSF investment depends on the fund’s overall financial goals, risk tolerance and investment strategy. Both types of properties have their advantages and drawbacks, so it’s essential to consider these factors:
Residential properties typically have a larger turnover of tenants, as commercial leases are generally longer than residential leases, however, particularly in the current rental crisis in Australia, SMSF trustees must weigh up the risk of vacancy with a commercial premises vs. a residential property.
Residential properties tend to be more liquid than commercial properties, making it potentially easier to sell if the need arises. With that said, property isn’t particularly considered a liquid asset. It’s also important to understand the capital gains tax liability of selling property.
SMSF trustees consider the fund’s existing assets prior to making further investment decisions. The same is true of property purchases within an SMSF. While the fund may not have another direct investment property, it is likely that the fund may have exposure to other property investments within managed funds. Understanding the resultant asset allocation and level of diversification that your fund will have after purchasing a certain type of property is an important consideration.
Income generation is often a key consideration for any investment within a super fund, self-managed or not. The income generation potential exists for both residential and commercial property, however, the rental yields do differ, which is why researching rental yield against the property’s purchase price and local market should be high on an SMSF trustee’s list when conducting their due diligence.
Similarly, the capital growth potential for properties is also a key consideration for SMSF property investors. Residential real estate and commercial real estate operate in two different markets, offering different capital growth potential.
In-house assets and arm’s length provision
The ATO’s ‘in-house asset’ rules prohibit SMSFs from leasing or renting properties to a related party of the fund, including members of the fund, their relatives, or any entities or companies associated with them. Doing so would be considered a breach of the regulations, which could result in severe penalties, including the fund losing its concessional tax status. This rule often puts a dampener on SMSF trustees hoping to buy a family holiday house within their fund.
To remain compliant with SMSF regulations, all transactions involving SMSF-owned assets, including commercial properties, must be conducted at arm’s length and on commercial terms. This means that the rent charged for a commercial property owned by your SMSF should be at the market value and not favourably adjusted for related parties.
Expertise in property investment
For SMSF trustees with limited experience in investment properties in particular, it is prudent to see qualified professionals, such as a financial adviser, before proceeding with SMSF property investment. The SMSF trustee’s expertise does play a role in determining whether they should purchase property within the fund and whether this should be a residential or commercial property, or other property investment.
Qualified and experienced advice may be beneficial for your overall SMSF management.
Get the right lending structure for your SMSF property with SMSF Loan Experts
When borrowing money within your SMSF for property investment, your fund’s unique structure and setup deserves a lending arrangement to match. Contact the team at SMSF Loan Experts before you borrow money to invest in an SMSF rental property.