Yes, you can use super to buy an investment property. But the process isn’t as straightforward as when purchasing a private investment property.
You can’t simply withdraw your super savings and invest in a property unless you’ve reached retirement age and can start withdrawing your super.
So, how do you do it? It’s possible through a self-managed super fund (SMSF).
While possible, it does come with its challenges. There are many rules, costs, responsibilities, and potential downsides and risks of buying an investment property through an SMSF that you must consider.
This guide seeks to educate you and provide you with the advice you need before choosing to invest in property through an SMSF.
What is a Self Managed Super Fund (SMSF)?
A self-managed super fund (SMSF), also known as DIY super, is a private super fund that helps you save up for your retirement.
All SMSF members are trustees and are responsible for investment and business decisions and compliance with super and tax laws and regulations.
Trustees may choose to invest through an SMSF due to added flexibility and control over how to spend retirement savings.
Also, SMSFs have wide investment choices, including direct property, company shares, units, and cash and term deposits. Super funds, on the other hand, have fewer investment choices and smaller investment menus depending on the fund.
Purchasing through a Self Managed Super Fund (SMSF)
Through recent changes in SMSF legislation in the recent years, there has been a noticeable increase in the popularity of people willing to self-manage their superannuation funds.
According to the Australian Tax Office (ATO) in March 2024, there were 616,400 SMSFs which was an increase from 609,301 the previous year.
And there’s a reason behind this growth — Australians are realising the numerous benefits and potential growth they can leverage by investing through an SMSF.
What Type of Properties You Can Purchase Through SMSF
If you’re an SMSF trustee, you must ensure that your SMSF complies with the super laws. If you breach the super laws, penalties may apply and you may be disqualified as a trustee and lose your SMSF administration rights.
Firstly, the property must pass the sole purpose test. This means it must be used to provide retirement benefits for the SMSF trustees. In other words, you and your relatives can’t live on the SMSF property.
The types of properties allowed are residential and commercial properties. They both have different rules and guidelines:
Residential Property
SMSF residential property must pass the sole purpose test. It can’t be lived by you, the trustees, or anyone related to the trustees, no matter the distance of the relationship.
You also can’t rent it on a short-term basis. For example, buying a beach home or log cabin and living in it during your vacation isn’t allowed.
On top of that, you can’t purchase a residential property already owned by you, any of the trustees, or relatives of the trustees into your SMSF.
Commercial Property
A commercial property used solely for business purposes can be purchased by the SMSF from a trustee or a related party at the market value. If the trustee is unable to show that the property is used solely for business purposes and that it’s reported at market value, then it’s a breach of the super laws.
An SMSF commercial property can also be leased out to a trustee or a related party. The rent must be paid directly to the SMSF, at the market rate (no discount), and paid promptly and fully on every due date.
The commercial property investment must provide retirement benefits to the SMSF trustees, which is the overarching function.
How to use Super to buy an investment property
There are 4 simple steps you can follow to buy an investment property with your SMSF, these include:
- Setting up an SMSF
- Drafting up an investment strategy as required by Super Laws
- Finding a property that meets SMSF requirements through a buyer’s agent
- Purchasing the property
1. Setting up an SMSF
To set up an SMSF, first decide whether you want an individual or corporate trustee structure
- Individual trustee – Made up of 2 to 6 members. Each member is a trustee and each trustee must be a member of the fund. A member can’t be an employee of another member (unless they’re relatives). Some state and territory laws differ when it comes to rules and regulations for individual trustees. Seek professional advice to understand how your local laws impact you.
- Corporate trustee – Made up of 2 to 6 members. Each member of the fund must be a director of the corporate trustee and each director of the corporate trustee must be a member of the SMSF. Directors of the corporate trustee must have a director identification number (Director ID). A member can’t be an employee of another member (unless they’re relatives).
For more information on this, read our guide on setting up an SMSF for property investing.
2. Draft up an SMSF investment strategy
An SMSF must have an investment strategy that details the fund’s investment objectives and the types of investments it intends to make. It’s a plan for how the fund will buy, keep, and sell assets to realise its member’s goals.
All investment decisions made by the fund trustees must align with this strategy. It’s a legal requirement under the Superannuation Industry (Supervision) Regulations 1994 (SISA).
The investment strategy must account for all members’s risk profiles and must be relevant to the fund’s specific circumstances and its members.
While there’s no specific form for the investment strategy, it needs to be in writing and must be reviewed regularly as circumstances change.
That said, here are factors to consider when developing an SMSF investment strategy:
- Individual fund member characteristics, such as age, risk profile influenced by retirement needs, and current financial or employment status
- What the fund’s investments will be made of and the investment diversification to reduce the fund’s risk. The major investment options include investment property, company shares, fixed-interest products, and managed funds.
- Risks associated with buying, holding, and selling of the assets, and the potential returns of the investments in relation to its objectives and cash flow requirements
- How easily the assets can be liquidated to meet future fund expenses such as operating expenses and income tax expenses
- The current insurance needs of the trustees to arrange appropriate coverage (such as life, permanent, or temporary incapacity insurance)
3. Finding your perfect investment property
Before buying an investment property through your SMSF, you must consider various factors and prepare well to maximise long-term returns.
First, you need to get it right when it comes to various property factors, such as location (city and neighborhood), potential yield, tenancy rate (demand for rental properties), and maintenance or repairs needed plus expenses.
After that, you need to make yourself conversant with the types of residential and commercial properties you can invest in. They include:
- Established houses and units – You don’t have to buy new or unusual properties through your SMSF. You can also invest in an older house, unit, or townhouse through your SMSF. ATO laws now allow you to carry out extensive repairs on SMSF properties. If you choose this option, ensure you choose a good location with a profitable rental rate and enough money in your super to cover the purchase and repair costs. Also, keep in mind that older properties might require more maintenance which eats up into your profits.
- House-and-land packages – ATO regulations allow you to buy properties with land through your SMSF, as long as they’re all on one title. The good thing is that such properties are attractive to tenants and if new, you stand to enjoy tax depreciation deductions.
- Dual key properties – Dual key properties are made up of two separate units or houses on a single title. Since they’re on a single title, they follow the single asset rule. They can offer higher rental returns with dual cash flow and better security. However, these properties can have liquidity issues when you choose to sell. Not many potential buyers would consider them.
- Serviced apartments – Serviced apartments are also popular with SMSF investors due to the high potential returns. These properties also have a high tenancy rate and low volatility. Once you reach retirement age, you get an income-producing asset that pays off its expenses and your pension without having to sell it.
These factors may be a bit overwhelming for investors, especially those without extensive experience in property investing. That’s why you need to consult with a real estate expert to help you find the right property for you.
Wayfinder can help you find the perfect property to invest in through your SMSF.
4. Purchasing your investment property
Once you’ve gone through the steps, then the final step is to ultimately purchase the property. You can either purchase outright if you have the funds or you can take out a loan through an LRBA.
How Much Money You Need in Your Super to Buy Property
If you have enough money in your super fund to purchase an investment property outright, you might have more than enough. But that’s just in the ideal world. With rising housing prices in Australia, having more than enough super is an exception.
Besides, you’re not allowed to use the entire SMSF balance to purchase the property. You must have a liquidity buffer as required by ATO.
Generally, you need to have about $200,000 to purchase an investment property through an SMSF. This amount is optimal since it’s sufficient to cover the 20% deposit, associated costs, and ongoing maintenance and operation costs related to the fund and property itself.
For example, if you’re investing in a property worth $600,000, the $200,000 in your super is enough to cover the cost of setting up an SMSF, property deposit, and the bank fees
Should you need additional funds to secure the SMSF investment property, you can take out a Limited Recourse Borrowing Arrangement (LRBA) loan.
LRBA lenders may require a 10% minimum liquidity in the loan amount. As such, these costs often snowball fast, requiring you to have a significant super fund. However, other lenders don’t have minimum liquidity requirements, so be sure to ask.
Using our example, let’s assume an LRBA lender has a 10% minimum liquidity requirement. The loan amount is 80% of the property price, which is $480,000. The 20% deposit needed for this loan is $120,000. 10% liquidity of the loan amount is $48,000.
In this example, you need to have $168,000 in your super fund to purchase a $600,000 property.
This gives you a general idea of how much is required in your SMSF for a typical property investment.
What other costs are involved?
On top of the 20% deposit and 10% liquidity, there are other costs you need to factor in. Some of these costs are determined by the bank and lender.
These costs include:
- Stamp duty
- Legal fees
- Closing costs
- Advice fees
- Property insurance fees
- Agency fees
- Upfront fees
- Vacancy fees
- Ongoing property management fees
- Bank fees and loan expenses
While you may not have to pay all these fees depending on your situation and lender, it’s best to have them all factored in.
Can I Use the First Home Super Saver Scheme to Buy an Investment Property?
You can also use the First Home Super Saver (FHSS) scheme to purchase a property through super. This scheme lets first-home buyers make additional contributions to their super and withdraw later once they’re ready to buy a house.
The only caveat surrounding this is that you will need to live in the property for at least 6 to 12 months before you can turn it into an investment property.
Here are the eligibility requirements for FHSS scheme contributions:
- 18 years and above to access funds. You can start saving under the scheme before you hit 18 years.
- Must be a first-home buyer and never owned property in Australia before, whether residential property, commercial property, vacant land, or a lease of land. You may be eligible if you’ve owned before and the government determines you’ve suffered financial hardship.
- You must have never requested a release of funds from the scheme before
- You must live in the property for at least six months within 12 months of buying it, or after the property becomes livable.
FHSS scheme eligibility is evaluated individually so couples, siblings, or friends can exercise their individual rights and partner to buy the same property.
Rules & Regulations surrounding SMSF Property investing
Compliance and Regulatory Requirements for SMSF
We’ve already looked at the sole purpose test SMSF requirement. On top of that, you must comply with these rules and regulations:
- Market value rule – All SMSF investment properties must keep the “arm’s length” which means that the property must be bought at the market value and all leases should reflect the current market rate
- Property registration – SMSF investments should be made in the name of the fund, not your or any trustee’s name
- Property acquisition costs – The SMSF must cover all the property acquisition costs we’ve looked at. The costs must be directly related to the purchase of the property and must comply with super laws and regulations.
- Borrowing arrangements – If you don’t have enough funds in your super to complete the property purchase, you may secure financing through an LRBA loan.
What is a Related Party?
You can’t use your SMSF funds to purchase a property from a related party. Also, you can’t rent the property out to a related party or transfer your existing residential investment property into your super fund.
Related parties in SMSF include:
- All fund members
- Each member’s relatives
- Each member’s business partner
- Those business partners’ spouses or children
- Employers who contribute to the SMSF on behalf of a member
- Any company controlled or influenced by any member
- Any trust controlled or influenced by any member.
A relative of a member refers to a parent, grandparent, sister, brother, aunt, uncle, niece, nephew, lineal descendant, spouse, or adopted child of any member.
Borrowing Rules and Limited Recourse Borrowing Arrangements (LRBAs)
If your SMSF opts in for an LRBA loan to buy the property, there are a few rules and regulations you have to comply with. They include:
- The recourse of the lender or anyone else against the SMSF trustee for default on the LRBA loan is limited to the acquirable assets
- LRBA funds can’t be used for property improvement. Only repairs and maintenance are allowed.
- You’re not allowed to replace an original asset or make improvements to the extent that the property’s features change or the property becomes a ‘different’ asset
- You can only borrow over a single asset or a collection of identical assets with the same market value
Pros and Cons of buying property with SMSF
Pros
- SMSFs are tax-effective structures with numerous tax benefits. They’re taxed at only 15%. You also qualify for a capital gains tax (CGT) if you own the property for at least 12 months. Once you retire all rental income and capital gains become tax-free.
- SMSFs give you greater control over how your super savings are invested. For example, while many public funds are restricted to property trusts, SMSFs allow you to invest directly in residential property.
- Due to technological advancement and stiff competition among competitors, SMSFs have become a cost-effective option. Most of the operating costs are fixed. The more the fund grows, the more the proportional costs are reduced.
- Since you’re both a member and trustee, you’re aware of where your super savings are invested and how those investments perform. This increases the level of accountability.
- SMSFs provide asset protection in case of bankruptcy or claims by creditors. In most cases, SMSF assets aren’t considered “property” under the Bankruptcy Act.
Cons
- Being an SMSF trustee means you bear the responsibility of making all investment decisions. You should ensure you understand investment decisions since a poor investment hurts your fund and other trustees’ retirement benefits.
- SMSFs may experience cash flow challenges. The assets must generate enough revenue to cover the expenses. It might also cost more to invest in a property through an SMSF.
- Funds with lower balances have higher costs. The flat fees mean the proportional operating cost is higher when your SMSF has a lower saving balance.
- SMSFs are some of the most regulated entities in Australia. If you miss some details and you don’t get it right when setting up or operating the fund, heavy penalties may apply.
- SMSF members and trustees must permanently reside in Australia. If you reside or decide to move overseas, you could breach SMSF rules and regulations.
Who You’ll Need to Start Your SMSF Property Investing Journey
The process of SMSF property investing is complex. That’s why it’s important to build a team of professionals to advise you on the best investment strategies, rules and regulations to comply with, and common pitfalls to avoid.
These professionals include:
- Financial advisor – A financial planner or advisor will help you create a robust investment strategy based on trustees’ financial situations and one that aligns with the SMSF retirement goals.
- Accountant – Get an accountant with experience in SMSFs to help you comply with SMSF tax regulations and conduct accurate tax reporting
- Legal expert – A legal professional will help you navigate the legal aspects of property investing through SMSF
- Buyer’s agent – A buyer’s agent experienced in SMSF property investing will help you identify a suitable property for your SMSF. They can help you save money and time, and help you access properties and deals that might not have been publicly listed.
Start your SMSF Property investing journey with Wayfinder
Buying an investment property through an SMSF isn’t that straightforward. There are many factors to consider to ensure you do it right. Besides, SMSFs are heavily regulated. Failure to adhere to these rules and regulations can attract heavy penalties.
To avoid such an occurrence, it’s best to work with professionals from the start. This is why you need to consider Wayfinder Agency for expert assistance in SMSF property investments.
Contact us today to kickstart your SMSF investment property strategy on the right foot.
