We are not going a week without getting a distressed call from someone who has purchased an apartment with their SMSF only to find out that getting finance for it is extremely difficult and I thought it might help to discuss some of the things to look out for for trustees considering this kind of investment.
The most pain we witness is from SMSF who have purchased apartments off the plan, as they are locked in an unconditional contract and failing to settle would generally results in losing their 10% deposit and potentially being sued for damages by the developer. However, it is not uncommon to face similar challenges with existing apartments.
There is a lot to say about why one would not invest in an apartment in the current context, including oversupply concerns, high numbers of empty apartments in specific areas and lack of capital growth and relevance of their high tax efficiency for an SMSF.
But I would like to focus on the lending aspect of it and what hurdles might stand in the way of SMSF trustees investing in such properties.
There are two considerations in regards to high density which could complicate an SMSF loan application.
The first one relates to the actual suburb at large: some postcode have been blacklisted by lenders, be it formally or informally and if a property is located in one of those, these lenders will either not lend at all or lend at a reduced loan to value ratio. A typical example would be a CBD location in any of the capital cities or surrounding suburbs which planning rules allow for high rises.
The second one relates to the property itself and the building it is located in. Generally speaking and regardless of the postcode, if a building is over 4 levels and houses more than 50 apartments, it is likely that it will be deemed high density by most lender and the same restrictions would apply.
If a purchase is deemed to be high density, either by virtue of its postcode or its own characteristics, it is likely to shrink the pool of potential lenders that the trustee can entertain and result in higher interest rate and fees. It is also quite likely to require a higher deposit from the SMSF to make up for the lower loan to value ratio on offer.
For some things size do matter and apartments being purchased by SMSF is one of them. Any property with an internal size of less than 50sqm is going to be a challenge.
There are only a few lenders that offer SMSF loans for smaller apartments and they usually require everything else in the application to be very strong to make up for the perceived weakness of the property.
Don’t be misguided by real estate agents and note that most lenders will not include outdoor space, a car park or a storage area when ascertaining if a property meets their minimum requirements to secure an SMSF loan.
Unfortunately it is not uncommon to have to deal with a small floor plan in a high density setting, which is when the fun really begins…
This is a problem that is most specific to off the plan purchases and unfortunately all too familiar. It may be a case that the properties were sold at a premium or it may be the result of how bank valuers work but either way, more often than not, bank valuations do not match the purchase price of apartments which have been bought off the plan.
The first and somewhat least painful issue with a low valuation is that the SMSF loan amount will always be calculated against the lower of the contract price or bank valuation. For example, if a bank lends 70% loan to value ratio and the property was purchased for $500,000, you would expect to be able to secure a $350,000 SMSF loan for this purchase. However, if the bank valuation came back at $470,000 the bank will only lend $329,000 meaning that the SMSF will have to contribute an extra $21,000 toward the purchase.
The second and somewhat more lethal issue with a low valuation SMSF loan is that if the discrepancy between the contract price and the bank valuation is too high, generally above 5%, some lenders will simply refuse to lend against that security.
Once again, this is an issue that can be compounded if we are already dealing with a small property in a high density development. Unfortunately, these issue tend to feed on themselves.
Off the plan
Rightly or not, some lenders have decided that regardless of any other consideration, they would simply not offer any SMSF loans for the purchase a brand new property, be it an apartment or otherwise, in high density or not, small or big or even with a great valuation.
Special use properties
A definite no no would have to apply to serviced apartments or apartments located in a building from where serviced apartments are operating.
These have to be one the most difficult property to secure an SMSF loan for and unfortunately they are ever popular with SMSF trustees, particularly those getting closer to retirement and looking for an income stream.
It’s one of the few security for which the only option is either cash or related party loan.
Another really challenging property type, which generally encompass all of the above hurdles and more is student accommodation. Not unlike serviced apartments, they are quite popular with yield hungry older trustees but not at all with SMSF lenders. The only upside for them is that they are generally quite cheap and more suitable for related party loans or cash payments.
Don’t misunderstand my message here, there are some terrific apartments to invest in out there both completed or off the plan.
I just wish trustees were aware of some of the challenges awaiting them when they purchase this type of properties and that they were ready for them. Being ready means having some extra liquidities to contribute to the purchase if needed, being able to demonstrate a stronger servicing capacity and if possible avoiding smaller apartments and high density areas or developments.
From a lending perspective, trustees’ best chance to secure an SMSF loan for their purchase is to look for bigger apartment in smaller, boutique buildings.
Either way, if you have or are contemplating purchasing an apartment with your SMSF, give us a call to discuss the best way to finance it on 1300 781 680.
* The information contained in this blog is general information only. No part of this blog is to be construed as a solicitation to buy or sell any security or financial product. The author, in preparing this blog, did not take into account the investment objectives, financial situation and particular needs of any particular person. Before acting on any information or advice in this document, you should consider the appropriateness of it (and any relevant product) having regard to your circumstances. You should also seek independent financial advice prior to acquiring a financial product.