Think carefully before using hard-earned equity from family home to fund a holiday home.
SMSF property investment owner - a rare beast
There is a very rare breed of Australian out there. They look like the rest of us, but they have a remarkable single-mindedness and a tenacious focus on the end goal. Yes, I am of course referring to the self-managed super fund residential property investor.
I say rare, because despite over a million Australians now having an SMSF, according to the Australian Tax Office, just four per cent of funds in this sector are allocated to residential property. The experience of recent years is that whilst the combination of residential property and super can work well, the additional complexity and extra safeguards one has to navigate to make it happen means all but the most persistent give up on the idea.
In one respect the failure of this channel to fire is a disappointment, as there are many Australians with sizeable super funds whose future financial security could benefit by a selective investment in residential property. But then again, the retirement nest egg is too important to allow the process to be laissez faire. It is right and proper that ASIC, the lead regulator in this area, prohibits estate agents and others without a financial licence from promoting the channel simply so they can sell their product.
But could you be one of the few for whom an SMSF-housed residential property would work? Here are the hurdles you’ll need to navigate.
Budget. Be careful if you have a small budget. Within their super fund, many prospective investors may only have access to a budget of $300,000 or so. The temptation is to buy cheaper properties in low-land value areas, which don’t perform. These people may be better off not investing in direct property.
Lending Restrictions. Investing in property via an SMSF became far more viable once the rules barring funds from borrowing were lifted in 2007. However, the borrowing terms are much tighter within a super fund than outside one. For instance, banks and other lenders recognise that small cookie-cutter apartments in high rise blocks are high risk, especially within an SMSF. Most banks refuse to lend on properties that are smaller than 40 square metres and sometimes up to 50 square metres inside an SMSF.
Although sensible overall, the rule is somewhat arbitrary, and rules out some good one-bedroom units including some period Art Deco apartments. So make sure the property is measured out!
The banks also want SMSF clients to have more of their own equity in a property investment than they require from other borrowers. Whereas the loan-to-value ratio limit for a conventional borrower might be 90%, SMSF investors often can only borrow a maximum of 70% of a property asset’s value. To illustrate this point, an investor seeking to buy a $500,000 property would need to have $150,000 in spare cash in their super fund before they could borrow the balance from the bank.
Adding value restrictions. Be careful of buying a run-down property within an SMSF with a view to renovating it with borrowed funds. The Australian Tax Office has ruled that borrowed funds can be used to reinstate features but can’t be used to ‘improve’ the property. So repairs and painting are allowed, and you can put in a new kitchen. But major improvements such as changing the layout by knocking down walls and building new ones or extending outwards or upwards using borrowed funds are out.
Title issues. SMSFs are subject to arcane super legislation which only specialist lawyers truly understand. One of the upshots of this is that when buying an apartment, any associated car parking space needs to be on the same title as the rest of the asset. So check with a conveyancing lawyer that any car parking spaces are on the same title as the associated unit or there is a clause with respect to the car space which says “registration of dealing with this unit is restricted” or similar.
If none of the above is a deal-breaker, congratulations, you may be one of the few. Nevertheless, do engage a reputable, independent accountant or financial adviser to look at your specific circumstances and advise you on the merits of establishing an SMSF and using it to invest in residential property. Richard Wakelin
If you'd like to talk to us regarding selecting the right asset within an SMSF, click here to make an enquiry.