Borrowing to buy property through your self-managed super fund is an entirely different kettle of fish compared to buying properties outside a SMSF. Your Investment Property investigates how to do it
You look in horror at the television screen, as a bloke with a fishing rod talks about how he can’t afford to live much longer. He retired around the same time as the GFC did most of its damage, meaning the value of his superannuation fund plunged along with the shares it was invested in.
You don’t want to be in the same boat as this guy, especially if it means you have to wear a terry-towelling hat and fish all day just to feed yourself. But what are the alternatives? You’re not convinced by low-risk managed funds or guaranteed annuities, but you are interested in property and believe it is the best investment to secure your future. At this point in time, you can’t manage another investment property, but perhaps, if you could just access the money already accumulated in your super, you could make sure you retired comfortably, without paying any of your hard-earned dollars to some fund manager. The only way to take full control of your super is to establish a self-managed superannuation fund (SMSF).
YIP VIDEO: Super Property Concierge's Martin Jandera buying property through SMSF
SMSF property investing checklist
Before purchasing a property through your SMSF, it is essential to make sure you have the following:
At least $100,000 in your super – Lenders currently limit SMSF loans to a maximum LVR of 80%. You will therefore need enough for a 20% deposit, as well as stamp duty and a buffer of funds for maintenance and repairs. Every cost related to the property needs to come out of the fund
An established trust – In order to secure a loan, the property must be held in a separate security trust in which the SMSF has a beneficial interest, which can be set up by an accountant or solicitor. The trust deed must include provisions allowing for the purchase of direct property
Proof of advice – Lenders require written proof that you have discussed the investment with a solicitor, accountant or financial planner
An updated investment strategy –SMSFs are legally required to have financial plans laid out in an investment strategy. Make sure that property investment is part of your current strategy. If not, then amend your strategy
A legal understanding – You should make sure the law allows you to do what you are planning with your investment property. For example, some investors don’t realise that no family members or related parties are able to use the asset in any way. This means you can’t rent or sell the property to a family member, business partner or acquaintance. They can’t even stay there for a weekend and neither can you.
What are non-recourse loans?
Since 2007, it has been possible to borrow money on a limited recourse basis to buy property within your SMSF. The way a non-recourse loan works is that your SMSF fund is actually doing the borrowing for the property, not you. The SMSF borrows the money through a trust, which you can establish with the help of an accountant or solicitor.
Looking for help with SMSF? Get it here
“They can set everything up for you,” says Scott McCray, a Smartline personal mortgage advisor. “The trust then buys the property. It’s one trust per property, so if you want to buy another, you set up another trust.”
The advantage of a non-recourse loan is that if the SMSF is unable to make repayments, the lender can only access the assets in the trust, which is the single investment property. The lender is unable to go after your other personal possessions.
“The maximum loan to value ratio is 80%,” says McCray. “So if something goes wrong and the super fund can’t make the repayment, the bank can usually sell the property and get all their money back.”
Beware the personal guarantee
The risk may be minimal for lenders, but they still don’t like to be dictated to, so most banks require a personal guarantee from the SMSF trustee. The problem with this is that a personal guarantee will restrict your borrowing capability for investments outside your SMSF fund. What you may not realise is that it restricts it by the exact same amount that your SMSF borrows.
“If you borrow $400,000 in a super fund, that restricts you from personally borrowing $400,000 anywhere else,” says McCray. “So down the track, when your borrowing capacity might have been $600,000, you can only borrow $200,000. You might want to upgrade or invest at some stage in the future and you won’t be able to.”
A number of major lenders now allow borrowing within an SMSF and have similar policies. St George has enjoyed a reputation as the most flexible for borrowers over recent years and is the only bank that does not always require a personal guarantee.
In the long term, competition between lenders may be the death of the personal guarantee, but until then, make sure you are aware of the repercussions of SMSF borrowing.
SMSF friendly lenders
Lenders classifying SMSF loans as normal residential
Lenders offering SMSF loans through their commercial divisions
Tip: St George Bank does not require personal guarantees unless super contributions and rental income are insufficient to service the loan; or you are self-employed
SMSF lender requirements
When assessing your application for a loan within your SMSF, lenders only consider two things:
Current super contributions
These are basically your 9% per annum PAYG contributions or your personal contributions over the past two years if you are self-employed.
The expected rent of the investment property
The anticipated rental income of your investment property has to be verified with a letter from the real estate agent up front. If you are buying an existing rental property, you need to show proof of the current rent.
The consideration of just these two factors by lenders can be both advantageous and restrictive, according to McCray.
“Normally they would look at your car loan, credit cards and other factors,” he says. “It’s straight forward, but you can’t borrow as much.”
Because just 9% of your PAYG salary goes into regular superannuation, you would need a large salary and a decent amount of rental income to service a regular-sized loan. You are allowed to make extra contributions ($25,000 before tax, or $150,000 a year after tax), but if you want these considered by a lender at the application stage, you would have to have been making them already for two years.
You shouldn’t expect any added bonuses in your loan product warns McCray, who notes that lenders still enjoy the upper hand in SMSF borrowing.
“They don’t offer discounts on the loans at the moment,” McCray says. “The standard variable rate is around 6.8%, but most lenders discount that to roughly 6% [for loans outside SMSFs]. With the SMSF loans, they don’t discount at all. Then, they assess you at principal and interest rather than interest only, and add in a buffer of 1.5-2%, in case interest rates go up.”
Thinking about investing through SMSF? Get help here
All these factors make your assessment rate quite high, according to McCray, which means the amount you can borrow can be quite heavily restricted.
“I did the numbers for someone who was on a base salary of $115,000 and his wife was on $78,000,” he says. “Their borrowing capacity was only about $280,000, as opposed to around $1 million if they were investing outside their SMSF.”
Once you have satisfied the lender that your SMSF is in a position to service the loan, most will then require a statement from at least two professionals (accountant, solicitor, financial planner), to say that you have consulted them about the responsibilities and ramifications of buying a property within your SMSF.
McCray expects further competition between lenders to result in more loan product flexibility in the future, but in the meantime, borrowers can expect to do it tougher within an SMSF.
Picking the right time
Buying an investment property through your SMSF fund is nothing like buying one the old-fashioned way. Ordinarily, you can hang onto an investment property for a number of years, then sell and upgrade your house, renovate to add value, or choose a number of different other options. SMSF investments don’t afford you the same freedoms until you reach retirement age. Your fund can sell the property at any time, but you can’t access equity if the value increases.
“Under the current restrictions, you never know what will change with what you want to do,” McCray says. “Once you’ve got that loan in place, you can be held back. You might buy one within your super, then your circumstances change and you don’t earn as much money…all of a sudden you can’t go and buy a house.”
Because of such possibilities, McCray believes it best to establish yourself as a property investor before you take the plunge and borrow within your SMSF.
“I would say buy a home and then buy an investment property or two in your own name. Then you can pick one up in your super down the track,” he says, noting that such a strategy would be less risky.
Looking for help with SMSF? Get it here