You may have noticed all the buzz recently about the huge growth in everyday investors like yourself using their Self Managed Super funds to purchase investment properties. There’s good reason for this growth and this article will provide a quick overview as to whether you too can take advantage of this opportunity and if so, how it all works and whether it’s something that you should perhaps consider….
Why the hype?
Recent legislation changes now allow Self Managed Superannuation Funds (SMSF) to borrow money directly to enable them to purchase properties, which was previously not allowed. Most people do not have a SMSF and usually have their superannuation paid directly into either an Industry or Retail fund of their choice.
An SMSF is effectively your own Superannuation Fund that is managed and administrated by its members, who in this case is yourself and up to 3 other members (family or friends). On establishing a SMSF all of your existing superannuation and any future Superannuation contributions are paid directly into the fund for the members to invest as per their investment strategy.
There are now in excess of 430,000 SMSF established inAustralia, with over 800,000 members. The growth rate has been averaging in excess of 20% per annum for the past 5 years.
What are the benefits?
With that sort of growth you would assume that there must be some major benefits to establishing a SMSF and there certainly is:
Benefit 1: Control
You obtain control as to how you invest your funds. This means that you have much greater flexibility in determining your risk profile, investment strategy, investment selections and investment timing.
Benefit 2: Lower fees
Retail Superannuation fees are averaging around 2.5% of the funds balance, regardless of the balance amount. With a SMSF the fees tend to be substantially lower and as the balances increase the fee’s decrease as a percentage, which means major cost savings.
Benefit 3: Tax benefits
SMSFs provide a whole range of extra tax benefits that just can’t be obtained by investing via a retail or industry superfund. You can be far more selective in your investments to assist with reducing your individual tax liabilities, which in turn enhances your funds returns. This is something that just can’t be achieved via a large group fund. Another major tax benefit is that you’re not required to pay your contributions tax immediately which allows you to use those funds to enhance your future returns.
Benefit 4: Ability to use borrowings to enhance returns
Quite simply, you are unable to purchase property or borrow to invest in property via a retail or industry fund.
Benefit 5: Ownership
With a SMSF you are the owner of the fund. With a retail or industry fund, you are not the owner of the assets – you simply have an entitlement as a member. If the retail or industry fund was to suffer a liquidity event the possibility of having a freeze on your funds is real.
Benefit 6: Consolidate multiple accounts
By bringing all the members accounts together into one fund you are effectively doing away with management fees on all these accounts. Refer to benefit 2.
Benefit 7: Accumulation and Pension fund in one
When you come to the stage in your life where you decide to convert some of your superannuation fund into a pension, and at the same time you still wish to make contributions into your super, you will only have one account to handle with a SMSF. With a retail and industry funds you will be required to have two separate accounts. Two separate accounts = two sets of fees.
Benefit 8: Ability to make “In Species” contributions
Most contributions into Super tend to be cash; however with a SMSF you are able to make contributions by transferring other assets into the superfund including shares and commercial or business property. You can’t do this with a Retail / Industry fund.
Benefit 9: Succession planning
A SMSF will allow you to transfer your assets to your beneficiaries in the event of the member’s death which allows those assets to remain under the SMSF tax advantaged umbrella.
Why invest in property via a superannuation fund?
There a number of benefits as to why investing in property via a Superfund should be considered a part of an overall investment strategy…
1. To provide diversification to your superannuation fund.
Most Superannuation funds are predominantly invested in a combination of equities, share market listed property holdings, bonds and perhaps straight cash. As the past few years have indicated, this exposure can have a major impact on the value of your superannuation investments due to the volatility of the world’s share markets. It can also prove cheaper to run your own fund as opposed to what you may be getting charged from your current Fund Manager.
2.To provide leverage to your superannuation fund.
We all know that leverage is an excellent way to enhance the returns on your investments. If you’re invested in a retail or industry fund, there is no way of obtaining leverage on your investments.
3. To take control of your own funds.
This may not appeal to everyone, but to many the idea of being able to decide where their funds are invested and to manage those funds is quite appealing. Property is an investment class that most people feel comfortable managing.
4. Taxation benefits and flexibility.
Without going into too much detail, as this is an area that warrants it’s own article, purchasing property via a SMSF provides a number of taxation benefits both immediately and in the future that just aren’t achievable when you invest outside of super. For instance, Superannuation Guarantee Contributions (SGC) and Salary Sacrifice contributions to the SMSF are only taxed at 15%, whereas if this income was paid to the member as a salary it would be taxed at their marginal rate which is most likely above 30% and possibly as high as 42.5%.
5. Preserve after tax cash income.
The ability to use your superannuation guarantee payments to service any proposed loans means that you can purchase a property without impacting your day to day lifestyle.
How does the borrowing work?
Once your SMSF is established, and your existing superannuation is transferred across, you will be able to use the existing superannuation as a deposit. If you decide to invest in property and use borrowings to achieve this end, you will be required to establish a Bare Trust which will hold the property on behalf of the SMSF.
Once your Bare Trust is established, Lenders will then advance (subject to servicing guidelines) up to 80% of the purchase price to assist with the settlement of the property. The SMSF will then need to have sufficient funds to cover the deposit and settlement costs. It’s also important that the SMSF has some surplus funds available after settlement.
The loan will be serviced from a combination of the rent received, returns from other investments, SGC payments and any Salary Sacrifice contributions.
To comply with the legislation, the borrowings will have to be Limited Recourse borrowings, meaning that the lenders only have recourse against the security property in the event of default, thus protecting your remaining Superannuation assets.
Lenders Loan to Valuation Ratio’s and servicing guidelines differ significantly, as do the costs and the interest rates charged. It is essential that you have your finance sorted before you proceed with any property purchase.
What type of properties can the fund Invest in?
There are certain guidelines that need to be followed to ensure that your SMSF complies when purchasing property.
Residential property can be acquired, however it has to ensure that the following occurs:
– It’s acquired at “an arms length” transaction meaning no purchases from members or family
– It can’t be tenanted by a member or the family of any member
– It has to be tenanted at a commercial rate
– It can’t be purchased off the plan
Commercial or business property can also be acquired and the rules are different to residential property:
– The SMSF can purchase Commercial or Business property from the members, members family or associated entities
– The members can tenant the property from the fund.
– Commercial rent needs to be paid.
How much Superannuation do I need to make it worthwhile to establish a SMSF?
There is no minimum amount required to establish a SMSF, however you probably want to have enough funds to ensure that your management fees make it more cost effective than having your funds in a Retail or Industry fund.
Ideally, the fund should have a minimum of around $120,000.00 to $150,000.00 in Super amongst its members to make it cost effective and to have sufficient funds to allow for a deposit if you wish to purchase a property. Having said that, there are strategies that can be applied that make it cost effective to establish a fund with a smaller amount.
For instance, if a member, or members, are able to access equity from an existing property, they are able to loan these funds to the SMSF, providing it with sufficient capital to meet the deposit requirements. This strategy should only be considered if the members are confident in their ability to repay this loan through Super contributions and Salary Sacrifice payments.
Members can also transfer existing Commercial property into the fund, which is known as “In Species” contribution. This is a popular strategy amongst many small business owners.
How much does it cost to establish a SMSF and how much does it cost to run annually?
To establish a SMSF will cost anywhere from $500.00 – $1,200.00. A Bare Trust will cost a further $500 – $1000.00. The following annual costs will be incurred and will vary depending upon your accountant, planner and the number of transactions that you make throughout the year.
– Accounting fees
– Annual Filing & Compliance fees
– Audit fees
– Administration fee
– Investment management fees if you utilise the service of a financial planner.
You will find that as the fund balance increases the fees as a percentage of the assets should decrease. Initially, the Accounting, Audit, Compliance and Administration fees could run anywhere from $600.00 through to $3,000.00 depending on your accountant.
Various Strategies
One of the most appealing benefits of having your own SMSF is the flexibility that it offers. There are a number of strategies that become available to astute property investors once they have a SMSF. Following are a few examples:
1. Purchase as Tenants in Common with Individuals – Ungeared
This strategy allows the fund to join forces with an Individual/s to purchase jointly. It’s usually considered when the individual/s are able to draw equity from another property to contribute towards the purchase. Under this structure, the security property must remain unencumbered.
Why use this structure? Often members do not wish to allocate all of their funds directly to one asset. This structure allows the fund to be exposed to property, but without the requirement of owning the property outright. Over time the fund can purchase the interest of the members either on a gradual basis or all at once if they have sufficient funds.
2. Purchase via a Unit Trust – geared
This strategy allows the fund to be invested directly into a Private Unit Trust with other investors, some of who may be members. Under this structure, the Unit Trust is able to gear the security property. It’s very important to be aware that this structure does not breach the “In House” asset rules, which basically means that the Trust can not be controlled by the fund or fund members.
Why use this structure? Once again it allows diversification into property without having to commit a large amount of funds, which in turn enhances diversification. It may allow the fund to obtain exposure to a certain type of property that it may not be able to achieve on its own. It may allow the fund to be diversified in a number of different types of properties. For instance, we’ve seen a number of these arrangements where a group of people have come together to purchase a holiday rental property that would normally be out of their financial reach. The property is rented to the general public on a short term basis and the members are also able to rent the property. If they owned this property directly via the fund, this would not be allowed.
All of the above is intended as an introductory guidance into the benefits that are available with a SMSF and at no stage is this meant to be advice. Establishing, administrating and operating a SMSF is a serious investment decision and is carefully monitored and controlled by both the ATO and the SIS act.
It’s very important to discuss the suitability of whether establishing a SMSF is appropriate for your investment needs with a licensed professional. If you would like to discuss the suitability of establishing a fund with a licensed professional we are able to refer a number of such qualified individuals to you.
If you do have a SMSF, and would like to know more about investing in property, then contact us now. It can be quite confusing initially, and lenders have different lending criteria, so seeking experienced help will ensure you don’t make an expensive mistake. Also, by discussing your individual situation, will help to clarify anything that may have been hard to comprehend.