Buying a Commercial Property with Super: Your Guide

Commercial properties have always been a great option when it comes to real estate investments. But can you invest in commercial properties through your self-managed super fund (SMSF)?

The answer is yes. And there are numerous benefits to doing so, such as tax concessions, long-term capital growth, and asset protection.

However, it’s not that straightforward. You just don’t contact the selling agent, negotiate the price, pay for it, and have it transferred to your name. There’s the right way to do it while prioritising compliance and careful planning.

In this guide, we’ll look at who SMSF commercial properties are suitable for, why you should consider this investment option, a step-by-step process to do it, and important considerations.

Who Should Consider Investing in Commercial Property Through an SMSF?

Target Investors:

Investors who would benefit the most from investing in commercial properties through SMSFs include:

Experienced investors – Investors with a solid understanding of the real estate market and SMSF regulations can leverage the potential for higher returns that come with commercial properties.
Investors seeking diversification – Commercial properties provide portfolio diversification, allowing investors to mitigate risks by spreading their investments across different asset classes.
Investors thinking long-term – Commercial properties typically take longer to realise returns fully. This makes them suitable for investors planning for retirement and looking to hold their SMSF assets in the long term.
Investors seeking higher rental yields – Commercial properties offer higher rental yields compared to residential properties. This makes them suitable for investors looking for a higher consistent income.

SMSF commercial properties are more suitable for funds with a balance of $200,000 or more.

Particularly Beneficial for:

When it comes to particular groups that are better suited for SMSf commercial property investments, self-employed individuals often find this investment option advantageous. This is because they can rent the SMSF commercial property back to their own businesses at the market rate.

Generally, two specific groups of self-employed individuals benefit from this strategy:

Business owners:

- - Can purchase their business premises through SMSF
  - Rent the property back to their business at market rates
  - Business claims rent as an expense
  - SMSF receives rental income to pay off any loan

Medical professionals:

- Often have significant superannuation savings
- Can purchase their practice premises through SMSF
- Multiple practitioners can pool resources using unit trusts2
- This investment strategy offers potential tax benefits and asset protection but requires careful consideration of SMSF regulations and long-term investment goals

Why Should You Buy Commercial Property With Your SMSF?

Build Your SMSF Faster

Investing in a commercial property using super can accelerate the growth of your super retirement savings. This is because commercial properties tend to offer higher rental returns compared to residential rental properties. Higher rental income means higher cash flow which your fund can reinvest or use to repay any loans used to acquire the property.

In addition, if the property’s value appreciates over time, your fund benefits from the capital growth, which boosts your retirement savings even further.

Borrowing through your SMSF for commercial property investment (though under strict conditions) also amplifies returns. While borrowing also comes with its risks, it enables your fund to buy a larger or more costly property than your fund could otherwise afford.

Securing Long-Term Tenancy

Commercial properties have a greater potential for long-term tenancy than residential properties. The average tenancy period for residential properties is 6-12 months, while that for commercial properties is 3-10 years.

Long-term tenancy periods mean your fund enjoys consistent, stable, and predictable rental income, which is great for investors focused on steady, long-term growth.

Also, buying the premises on which your business operates provides more security. By leasing the property back, you not only provide a stable income stream for your SMSF but also reduce the risks associated with finding new tenants.

Enhanced Asset Protection

Purchasing commercial properties through your SMSF provides a high degree of asset protection. For starters, SMSF properties are safeguarded from your creditors. Creditors can’t access your SMSF assets to settle your personal debts in case of bankruptcy or legal action.

This can be a huge benefit for business owners in high-risk industries who want to protect their assets from potential claims.

Similarly, SMSF properties shield your personal wealth from business risks. If your business undergoes financial hardships or market changes, your SMSF assets remain secure, as long as all legal and tax compliance rules are followed.

Tax Benefits

Investing in properties through your SMSF provides numerous tax benefits. The rental income from SMSF-owned commercial properties is taxed at a concessional tax rate of 15% instead of the marginal tax rate. If the property is held for more than 12 months, any capital gains are taxed at a reduced tax rate of 10%.

Once the SMSF enters the pension phase, the tax benefits become even more mouthwatering. Any rental income and capital gains from SMSF-owned properties become tax-free. This can lead to big savings for the SMSF if it’s paying a pension to its members.

Another tax benefit of investing in commercial property through your SMSF is property depreciation. The depreciation of the building and fixtures reduces the fund’s taxable income, thus maximizing the tax efficiency.

Step-by-Step Guide to Purchasing Commercial Property With SMSF

Step 1: Setting Up or Managing Your SMSF

Before embarking on the process, you need to set up the SMSF correctly in line with the Australian Tax Office (ATO) guidelines. First, you need to decide whether the fund with implement an individual trustee or corporate trustee structure. Each option has different administrative and compliance requirements.

After that, you need to create a clear investment strategy outlining the types of investments you intend to make through your SMSF, including the allocation to commercial properties. An SMSF investment strategy should consider the members’ risk tolerance, retirement timelines, and financial objectives.

Step 2: Choosing Your Purchasing Path

You have a few options to follow when purchasing a commercial property through an SMSF. they include:

Cash purchase – Your SMSF can have sufficient funds from member contributions or by rolling over funds from existing superannuation accounts. A direct cash purchase can be more straightforward without the complexities associated with borrowing.
Borrowing – If you don’t have enough in the fund’s cash reserves, you can access funding for SMSF commercial property investment through a Limited Recourse Borrowing Arrangement (LRBA) loan. With this type of funding, the lender’s recourse is limited to the purchased property. Other SMSF and personal assets are protected. This option isn’t as straightforward as a direct cash purchase. The fund has to setup a bare trust to hold the property until the loan is fully repaid. On top of that, LRBAs have strict regulatory requirements.
Indirect purchase via unit trusts – With this option, the SMSF buys the property through a unit trust. This option is more complex due to its procedures. You’ll have to set up a separate unit trust and then buy units in the trust through the SMSF. This involves transferring the funds from the fund to the trust. The unit trust then buys the commercial property directly without having to borrow money.
In-specie transfer – An in-specie transfer involves transferring the commercial property to your SMSF. If you own a commercial property through your business, you could buy it through the SMSF. There are also rules and regulations to comply with if you choose this option.

Step 3: Conducting Due Diligence

Due diligence is important to ensure your investment aligns with the investment strategy and helps the SMSF achieve the members’ retirement goals.

You will need to obtain a property valuation to ensure that you’re not overpaying for the commercial property. This is important especially if you’re obtaining an LRBA since it’s a requirement.

Also, inspect legal and zoning requirements to ensure the property meets local council zoning laws and regulations. You must check if there are any legal encumbrances, such as restrictive covenants or easements, that could affect the property’s value or use.

After that, evaluate the property’s potential rental income, capital growth, and market demand for the specific type of commercial property you’re purchasing. Consider market trends, tenant demand, and the location’s development to evaluate the income stream’s stability and reliability.

Step 4: Finalising the Purchase

If the due diligence meets your requirements and expectations, you’re ready to finalise the purchase. By this point, you must have identified the suitable purchasing path for your SMSF and investment strategy.

If you’re obtaining financing through an LRBA, ensure you’ve completed all the necessary paperwork, including the property valuation and purchase agreement.

Hire a solicitor to ensure that the purchase is compliant with all SMSF rules and regulations.

Also, ensure that the commercial property’s title is registered correctly in the name of the SMSF (if buying by direct cash transfer) or holding trust (if buying through an LRBA) and that all paperwork is done correctly.

Don’t forget to account for the stamp duty and other associated costs, such as loan establishment fees and legal fees. These should be paid from the SMSF funds.

Step 5: Leasing and Management

The final step is to lease and manage the commercial property to generate income for the SMSF. As already mentioned, you can lease the property back to your own business. If not, you’ll have to find a suitable tenant.

Either way, ensure that the property is rented at the market rate and complies with the SMSF rules, especially if leasing to a related party. Related-party leases must comply with market rates to avoid ATO penalties

Note that you must conduct regular property valuations in line with SMSF rules and regulations. This is to ensure that the property’s current market value is reflected in the fund’s financial statements. It’s also important for calculating rental yields and tracking the property’s performance in the SMSF portfolio.

Also, continuously review the investment strategy to ensure the property aligns with your investment and retirement goals.

Work with an expert SMSF buyers agent

There are many factors and legal requirements to consider when buying a commercial property with your SMSF. That’s why it’s important to consult with an SMSF expert to ensure the property aligns with your investment strategy and doesn’t breach SMSF laws and regulations.

Wayfinder can greatly assist busy investors such as yourselves and help you save time and stress in finding the perfect commercial property for you. We’ll also help with all of the steps to ensure a smooth process.

Compliance and Legal Considerations

Sole Purpose Test and Related Party Leasing

All SMSFs in Australia must adhere to the sole purpose test. The sole purpose test requires that all SMSF assets must be purchased and maintained for the sole purpose of providing retirement benefits for the fund’s members, or their dependants in case of death.

The sole purpose prohibit SMSF members from gaining personal benefits from the fund’s assets before reaching the pension phase. For example, members can’t use the SMSF commercial property as a workspace or for other personal business purposes unless it’s done through a formal lease agreement and at the market rate.

Under superannuation laws, leasing an SMSF commercial property to a related party is allowed, provided the arrangement meets the market conditions. The related party must rent at the market rate and the terms must be in line with what a third party would agree to in an arm’s-length transaction.

Non-compliance with the sole purpose test and related party rules can attract severe penalties, such as fines, civil and criminal penalties, or disqualification of the fund.

Stamp Duty and Property Title Transfer

Stamp duty is a state or territory tax payable when transferring the property’s ownership. Stamp duty applies when purchasing a commercial property via your SMSF and the amount varies depending on the property’s location.

Stamp duty is a significant upfront cost that trustees need to factor into the total acquisition costs. Ensure your fund has enough funds to cover the stamp duty since it must be paid from the fund’s assets.

If you’re obtaining an LRBA, the stamp duty implications can be more complex. Since the property is bought through a separate holding trust, SMSF trustees must ensure that appropriate procedures are followed to avoid paying double stamp duty.

Also, the property title transfer must be done correctly. The title should reflect the ownership of the commercial property by the SMSF. If an LRBA is involved, the property is held under a bare trust and the SMSF is beneficial owner.

Ensure that the holding trust is set up correctly since errors can lead to legal issues and compliance breaches.

Ongoing Management and Audits of Your Commercial Property

Property Management Options

Effective management is key to ensuring your SMSF commercial property delivers consistent returns and adheres to super laws. You have two options when it comes to SMSF property management; self-management or hiring a property manager.

Self-management gives you direct control over the property’s daily management including lease negotiations, tenant selection, rent collection, and property maintenance. However, you must be dedicated if you choose this option. It requires your commitment in terms of time and expertise.

The advantages of self-management include:

Full control over investment property decisions and tenant selection
Cost savings since you don’t have to pay property management fees

On the other hand, the challenges include:

You must have a solid understanding of property management and SMSF regulations
Higher risk of non-compliance, such as a lack of property documentation

You can also choose to hire a property manager or management agency. This option ensures the rent is collected on time, the property is well maintained, and tenant relationships are managed professionally.

Property managers also help you conduct market rent reviews, which is important for SMSF compliance, especially for related-party leases.

The advantages of this option include:

Expertise in property and tenant management
Market rent assessments to ensure compliance with ATO rules
Less administrative burden for SMSF trustees

On the other hand, the potential downsides include:

Property management fees, which are usually a percentage of the rental income
Loss of direct control over the investment

Compliance Audits and ATO Reporting

Ongoing compliance is important for SMSFs that own commercial property. Failure to comply can lead to various penalties depending on the extent of the breach.

Here’s what you need to know when it comes to compliance audits and ATO reporting:

Annual financial statements and reports – Trustees are required to prepare annual financial reports and statements for the fund. The reports must include the property details, rental income, expenses, market valuation, and compliance with the investment strategy.
Independent audits – Each year, the SMSF is required to engage an independent auditor to review the fund’s financial reports and assess its compliance with super laws. The auditor checks whether rent is paid at market value, whether property maintenance and management are done in line with the investment strategy, and the fund’s compliance with LRBA laws.
ATO reporting obligations – SMSFs are required to lodge annual returns with the ATO. The return must reflect the fund’s rental income, property-related expenses, and any capital gains or losses if the property is sold.
Regular property valuations – SMSF trustees must also obtain regular independent property valuations. This is to ensure that the rental income aligns with the market rate, especially for related-party leases.

Challenges and Additional Considerations

Liquidity Concerns

One of the major concerns of investing in a commercial property through an SMSF is liquidity. Commercial properties are illiquid assets. They take a long time to sell, especially in a slow market.

If your SMSF needs to access cash fast to meet its obligations, such as member pension payments, property expenses, or loan payments, it may not be able to do so. This can especially be problematic as members approach retirement and require a steady income stream.

The SMSF can also experience cash flow issues if the property stays vacant for extended periods or if a tenant defaults on rent payments. Remember, the SMSF still has to meet its obligations even when the rental income is disrupted.

To mitigate liquidity and cash flow issues, SMSF trustees can follow these tips:

Diversify SMSF assets into liquid investments, such as shares
Ensure the fund’s investment strategy strikes a balance between growth and liquidity
Have a plan in place for vacancies or rent defaults

Economic Risks

Commercial properties are sensitive to broader economic and market conditions. During economic downturns, the demand for commercial spaces tends to decrease, which leads to lower rental income and property depreciation.

If you’ve taken out an LRBA, any changes to interest rates can have significant consequences. Rising interest rates mean you pay higher loan payments, which reduces your fund’s cash flow and profitability.

Many businesses struggle during economic downturns. Since commercial property tenants are businesses, you could experience more rent payment defaults or longer periods of vacancies. Also, finding new tenants is harder during such periods.

To mitigate these risks, SMSF trustees can follow these tips:

Diversify portfolio to reduce overreliance on commercial property
Regularly review the property market and economic trends
Consider long-term leases with reliable tenants

Final Considerations

Commercial properties are feasible investment options for most SMSFs. Owning and renting out business premises can be a solid and reliable way of building a consistent income stream and safety net for your retirement.

You can enjoy various benefits by investing in commercial properties through your SMSF, such as building your SMSF faster, securing long-term tenancies, enhanced asset protection, and numerous tax benefits.

On the other hand, you need to be aware of some considerations, such as liquidity concerns and economic risks.

The most important thing to remember is that regularly reviewing the SMSF’s investment strategy ensures it aligns with long-term goals.

Ready to purchase your ideal commercial property? Let Wayfinder Guide You

Purchasing a commercial property through an SMSF involves coordinating multiple areas, which may be a bit overwhelming for you. That’s why you need to consult with an experienced SMSF buyer’s agent with a solid understanding of SMSFs and investment properties.

Wayfinder’s team is experienced and skilled when it comes to SMSF investment properties. We’re ready to hold your hand to help you make the right investment choice in accordance with your investment strategy and super laws.