Investing in property with your super has been extremely popular over the past few years, hasn’t it?
And the reasons why are far more interesting than it just being a bit trendy!
The main benefit is that super is an alternative avenue for property investing that has very little impact on personal finances or your future borrowing capacity.
Which means it’s almost like an extra property in your portfolio that you may not have been able to buy without using your superannuation to finance it!
It really can be a win-win situation….
But there are a number of ways that buying in your super is different than the more traditional system.
Let’s look at five of them, shall we?
1. You must have a reasonable fund balance
Just like any standard property purchase you need borrowing capacity, however, within the superannuation environment lending criteria is much stricter.
Generally, lenders won’t approve high loan-to-value ratios in excess of 80 per cent.
So, what I mean is that in order to borrow for an investment property purchase, you will need a reasonable fund balance.
At a minimum this is generally $200,000 or approximately 40 per cent of the investment property value.
Many younger investors may not have accumulated a big enough super balance to invest property.
2. You will need a self-managed superannuation fund (SMSF)
Here’s the thing…
You’re can’t buy direct property within retail or industry superannuation funds.
You’re also unable to purchase a property using your superannuation funds outside of an SMSF.
So you have to set up an SMSF to invest in property and there are establishment costs of approximately $3,000.
It makes sense, then, that if your primary reason for establishing an SMSF is to invest in property that you have a reasonable fund balance.
3. An appropriate trust structure must be established
Another major difference is that if you have to borrow to invest in property in your SMSF, a specific holding trust is required until the loan is repaid.
Even though your geared property investment will be contained in a specific holding trust (called a Bare Trust), the SMSF will have beneficial ownership.
This might sound confusing but stay with me!
This means that your SMSF will be credited with income and capital growth from the investment, while the trust has legal ownership.
Legal ownership can be transferred to the SMSF once the asset is fully repaid.
This structure is in place to protect other investments held in your SMSF.
But please, please listen to me on this next point….
You as the trustee are unable to sign any contracts to purchase property until the trust deeds have been properly executed.
You’re probably thinking, but what does that mean?
Unfortunately, I’ve seen too many investors caught out by signing a Contract of Sale in the wrong entity names.
And that makes the whole process longer and complicated – not to mention costly.
4. Source an appropriate SMSF lender
Just like standard mortgages, SMSF loans are subject to lending restrictions which will vary from lender to lender.
Unlike standard mortgages, however, there are a limited number of lending institutions that will lend to SMSFs.
Plus, due to the holding trust requirements, you will need a Limited Recourse Borrowing Arrangement (LRBA).
What’s an LRBA?
An LRBA limits the lenders liability to the asset within the trust and does not include any other investments within the SMSF.
Also as a general rule lending institutions will require 10 per cent of the proposed property value to remain in the SMSF as liquidity post transaction, which can be cash or managed funds.
That’s why having a cash buffer within the fund to allow for loan repayments and investment expenses would be very wise indeed.
5. Have an investment mindset
My final point is that an SMSF must satisfy the Sole Purpose Test.
What does that mean?
Well, it means your superannuation fund is maintained for the purpose of providing benefits to its members upon their retirement (or attainment of a certain age).
When selecting property, consideration of the income and capital growth potential may provide better long-term benefit to an SMSF than choosing a property based on somewhere you might like to retire, for example.
The bottom line…
So, as you can see, while there are many potential financial benefits to investing in property using your super, it can be more complex.
That’s why it’s so important to access professional advice from a qualified financial planner before you decide to go down this route.
Unfortunately, too many investors have been led down the garden path by self-serving property spruikers and bought properties in their super when this didn’t suit their financial circumstances, or when the properties were not investment grade.
The good news is ASIC is now trying hard to prevent this from happening.
The Bottom Line…
You must understand whether buying property in an SMSF is the best strategy for you and your long-term financial hopes and dreams.
Otherwise it might end up looking more like a financial headache rather than a stepping stone to financial freedom.
And no one wants that, do they?
Ken Raiss is director of Metropole Wealth Advisory and gives independent expert advice for property investors, professionals and business owners. He is passionate about real estate investing and small business and is a regular commentator for Michael Yardney's Property Update.
To read more articles by Ken Raiss, click here
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.