For many years, Australians have used superannuation funds as a safety net for their retirement savings. Today, members can use their super savings to invest in properties.
But it might not be for everyone. It comes with its own set of complexities and requirements.
There are various key financial considerations to make, such as super balance, liquidity, and diversification. For those wishing to take advantage of the potential of SMSF investment properties, it’s important to understand these requirements.
How Much Super Do You Need to Buy Property with an SMSF?
There’s no legal limit to the amount of super you need to have to buy an SMSF property. However, it’s generally advised to have between $200,000 and $500,000 depending on diversification and liquidity needs. This amount ensures that you have enough liquidity to cover ongoing costs and potential risks.
For example, let’s assume your SMSF is interested in a residential property going for $500,000. You’ll put down a 20% deposit of $100,000, purchase-related costs totalling $28,000, and liquidity reserves of $50,000. This means you’ll need to have a total super balance of $178,000 to purchase a $500,000 property comfortably.
Keep in mind that leaving a financial buffer for unforeseen costs like vacancies or maintenance is essential to protect your SMSF’s liquidity.
Upfront Costs for SMSF Property Investment
Deposit Requirements
SMSF investment properties typically have higher deposit requirements than private investment properties. This is because lenders view SMSFs as a higher risk.
SMSF loans require larger deposits compared to personal loans, often needing 20%-40% of the property value upfront.
For example, for a property valued at $600,000, the deposit requirement would range from $120,000 to $240,000.
While the higher deposit requirement may seem like a downside, it also has its advantages. The larger the deposit requirement, the lower the Loan-to-Value Ratio (LVR). This means you borrow less, reducing the future loan payments the SMSF will have to make.
Loan Considerations
If you need to borrow money to finance an SMSF investment property, you must do so via a Limited Recourse Borrowing Arrangement (LRBA). In this arrangement, the lender’s recourse is limited to the specific property bought using the loan should the SMSF trustees default. In other words, the rest of the SMSF and personal assets are protected.
Typically, most LRBA loan lenders will finance a maximum LVR of 60% to 80% for SMSF investment properties. This means that the fund needs to ensure it has at least 30% of the property value to place as a deposit.
On top of that, you’ll need to consider other upfront costs, such as loan application fees, valuation fees, legal fees, and stamp duty fees. Keep in mind that LRBAs have higher upfront costs, which can add up to several thousand dollars.
LRBA laws require SMSF trustees to create a separate holding trust, known as a bare trust, to hold the property until the loan is fully repaid. This often leads to higher administrative costs and documentation.
The higher interest rates and stricter terms compared to personal property loans can have significant effects on the SMSF’s cash flow and long-term financial health.
Other Upfront Costs
On top of the deposit and loan setup fees, there are other upfront costs that SMSF trustees must account for when investing in properties. They include:
- Stamp duty – Stamp duty, which can be a significant cost, varies depending on the state or territory. It typically ranges from 4% to 5% of the property value. This means that for a property worth $500,000, the stamp duty could vary from $20,000 to $25,000.
- Conveyancing and legal fees – Conveyancing and legal fees are costs associated with managing the property transaction. They also vary depending on the complexity of the transaction but can range between $2,000 to $4,000.
- SMSF setup and compliance costs – If the SMSF is newly established, there are additional costs associated with setting up and compliance. The establishment fee could be between $1,000 and $2,500 while annual compliance and audit costs could range between $1,000 and $3,000.
- Building and pest inspection – You need to ensure that the property is in good condition. A building and pest inspection ranges from $400 to $800.
Your SMSF must be able to cover these expenses. Note that these costs must be related to the property purchase.
Also, you must have this cash beforehand since some upfront costs, such as property inspections, valuation fees, and any insurance must be taken out before completing the property purchase.
Keep in mind that even with rental income, maintenance, and management costs can reduce your SMSF’s liquidity over time.
Ongoing Costs and Financial Commitments
Maintenance and Management Costs
Once you’ve invested in an SMSF property, there are costs associated with property maintenance and management.
If you decide to hire a property manager to take care of the day-to-day property management tasks, you’ll have to pay property management fees. This includes activities such as screening tenants, rent collection, and repairs and maintenance. These fees generally range from 5% to 10% of the gross rental income.
You’ll also have to pay for ongoing council rates. In some cases, property utilities such as water will be settled by the SMSF.
The SMSF also has to ensure that the property is well-insured. Building and landlord insurance can range between $1,000 and $2,000 annually, depending on the property type and location.
If the property is part of a strata or body corporate arrangement, such as an apartment or townhouse, you’ll also have to pay strata fees. These fees range from $1,000 to $5,000 annually, depending on the property and amenities offered.
Remember that even if the rental income covers the loan repayments, investors must still account for costs that can reduce liquidity over time.
Loan Repayments and Interest Rates
If the SMSF purchased the property through an LRBA, loan repayments and interest rates may be some of your most significant ongoing costs. You must ensure you meet loan repayments on time to avoid defaulting.
The repayment amount depends on your loan amount and interest rate. Interest rates range from 5% to 7%, which are higher than standard residential property loans. Due to the higher rates, SMSF trustees should factor in greater long-term interest costs.
For example, if you have a loan amount of $400,000 and an interest rate of 6%, your monthly loan repayments could be $2,400.
Loan repayments and interest rates have a significant impact on the SMSF’s cash flow and liquidity. Trustees must ensure that the rental income generated is sufficient to cover loan obligations. Also, have other assets and income streams to help you meet these payments in case of a shortfall.
Due to this, some lenders may require your SMSF to maintain an offset account or reserve fund to ensure it meets repayments in case of vacancies or tenant default.
Tax Considerations and Savings
SMSF trustees need to understand the tax implications and benefits of investing in properties. Generally, SMSFs are more tax-efficient compared to other investment vehicles.
The rental income generated from SMSF investment properties is taxed at a concessional rate of 15% when the fund is still in the accumulation phase. For example, if your property generates $30,000 in rental income annually, the tax payable would be $4,500, which is significantly lower than personal tax rates.
Once the fund enters the pension phase, the rental income becomes tax-free.
SMSF properties are also efficient when it comes to capital gains tax (CGT). If the fund has held the property for more than 12 months and decides to sell it, a reduced CGT rate of 10% is applied. If the property is sold in the pension phase, it’s exempt from CGT.
On top of that, many of the ongoing property expenses are tax-deductible. They include property management fees, loan interest, repairs, insurance, and maintenance. These deductions help reduce the overall tax payable on the rental income.
Key Financial Strategies for SMSF Property Investment
Financial Readiness and Liquidity
Before investing in an SMSF property, you must be financially ready and ensure liquidity. Start by evaluating the superannuation balance. You need to ensure the SMSF has enough capital to meet the upfront and ongoing costs.
Liquidity is also important to help the SMSF meet unforeseen costs, such as vacancy periods, repairs, or unexpected hikes in interest rates. The fund should meet a healthy cash buffer, which should generally be 10% of the property’s value. This should be sufficient enough to help the fund meet its obligations without selling its assets.
Also, avoid over-leveraging. While LRBAs are powerful tools, maintain an LVR of between 60% and 70% to minimise financial risk.
It’s crucial to maintain a balanced investment portfolio within the SMSF. Diversify your investment portfolio and allocate assets to shares, bonds, or other investments to hedge against property market risks.
Maintaining Rental Yield and Property Stability
Maximizing rental income and maintaining property stability is another strategy for ensuring long-term SMSF growth. Even before investing, focus on properties with a high occupancy and rental income potential.
You can ensure the property is rented out consistently by focusing on areas with a high rental demand. Look for proximity to schools, public transport, or commercial hubs.
To attract long-term tenants, stay on top of property maintenance and repairs. Keeping the property in great condition not only retains tenants but also maintains the property’s value. Besides, regular maintenance and repairs help prevent bigger issues down the line.
Also, consider diversifying your investment properties from residential to commercial properties and multiple locations to mitigate risks and stabilise the fund.
Working with Financial Experts
SMSF trustees need expert advice to navigate the complexities of SMSF regulations and compliance.
Some financial experts to work with include:
- SMSF accountant – An SMSF accountant will help you ensure property tax reporting and compliance with ATO regulations. They’re also crucial for claiming appropriate tax deductions.
- Financial planners – An SMSF-experienced financial planner can help trustees develop a long-term investment strategy and ensure that the investment property aligns with the investment strategy.
- Mortgage brokers – SMSF loans are highly specialized. A mortgage broker experienced with SMSF lending can help the trustees secure the best loan terms, interest rates, and conditions ideal for the fund’s situation.
Ready to purchase? Let Wayfinder find your perfect property
Now, we’ve walked you through considering the financial requirements of buying a property through your SMSF. If you’re ready to start the process, reach out to a trusted SMSF buyer’s agent.
Wayfinder has a team of experts experienced in SMSF properties. We’ll hold your hand and help you select the right SMSF structure, set it up correctly, and ensure it adheres to all legal requirements.
Contact us today and get started on the right foot.
Frequently Asked Questions
Can I Use My SMSF to Purchase Property Outright Without a Loan?
Yes, if you have sufficient funds in your super, you can purchase an SMSF property without a loan. In fact, this approach can be more beneficial as you avoid the complexities and costs associated with LRBA loans. You also avoid loan interest and simplify SMSF management.
However, it also has its potential downsides. Since you’re tying up a significant portion of your super savings to the property, your fund becomes less liquid. There’s also lack of diversification.
Are There Pitfalls to Watch Out for When Buying Property Through an SMSF?
Yes, there are numerous pitfalls to be aware of when buying an SMSF property. They include lack of liquidity, over-concentration in property, and difficulties meeting cash flow needs, especially if rental income decreases or the property is vacant.
On top of that, there are other considerations such as tax-related issues like non-compliance with SMSF rules, exceeding contribution caps, and the impact of high costs (e.g., setup and maintenance fees) on long-term returns.
To avoid these issues, maintain a healthy liquidity buffer, diversify your investments across different asset classes, and ensure compliance with all SMSF laws and regulations.
How Can Holding Property in an SMSF Affect My Long-Term Retirement Goals?
Holding property in an SMSF offers both benefits and downsides. SMSF properties can provide tax benefits, solid rental returns, and potential capital growth. However, SMSF properties are illiquid assets that may not be ideal for everyone.
It’s important to balance property investments with other asset types to ensure financial flexibility and long-term growth.
