It’s not a surprise that SMSF Property investing is becoming increasingly popular. Statistics show that SMSF residential property investment grew 35% from $28.3b to $38.3b over the past fiver years.
However, with this increasing trend it’s important to weigh out your options to see whether it’s the best move for you. Investing in properties with super is highly subjective based on your objectives, risk appetite, and retirement goals.
In this article, we’ll cover off the pros and cons of SMSF property investing so you can decide whether or not it is worth it for you.
Can I Use My SMSF to Buy Property?
Yes, you can use your SMSF to buy investment property. However, the process isn’t as straightforward as when buying a property under your name. You can’t simply withdraw your super savings and use them to invest in a property before retirement age.
On top of that, there are various rules and regulations to follow, such as the sole purpose test, related parties, and many others.
Investing in a property through an SMSF is ideal for:
- Investors with a strong interest in property as a retirement strategy.
- Individuals who are comfortable with the complexities of managing an SMSF, including compliance and ongoing administration.
- Those with sufficient superannuation balances to cover high upfront and ongoing costs
Keep in mind that complying with SMSF rules and regulations is crucial. Non-compliance could lead to serious consequences, such as civil and criminal penalties.
To learn more about this make sure to read our article: Can I buy property with my SMSF?
Advantages of SMSF Property Investing
1. Grow Your Retirement Nest Egg
Once you’ve invested in a property, you can enjoy capital growth through the rising property prices. On top of that, you can lease the property to a non-related party and enjoy rental income. You can reinvest this cash flow or use it to repay the property loan.
2. Tax Benefits
There are various tax benefits to enjoy from SMSF property investments. For starters, rental income from the property is taxed at a concessional tax rate of 15% (instead of the nominal tax rate of 45%) during the accumulation phase. Once you’ve reached retirement age and the SMSF enters the pension phase, the income can become tax-free.
If you hold the property for over 12 months, any capital gains made on the property are taxed at a discounted rate of 10%. This is considerably lower than the standard capital gains tax (CGT) rate.
On top of that, there are numerous tax deductions you can enjoy, including:
- Loan repayment tax deductions
- Interest on loan tax deductions
- Property maintenance tax deductions
- Property management fees tax deductions
- Property depreciation tax deductions
Keep in mind that you need to stay on top of your property management to maximise these benefits.
3. Investment Diversification
Investing in SMSF property allows you to diversify your investment portfolio beyond the conventional investment options, such as stocks and bonds. This can help you spread risks and potentially build your cash flow over time.
You can also spread your risk across different property types, such as commercial and residential property. This can help you protect your investments from market volatility.
Real estate has been proven to be less volatile than stocks and bonds. Even during economic downturns, property values tend to be more stable and don’t sway as much as stock prices.
4. Retirement planning
Investing into property with your SMSF can help you secure a place of residency after you’ve reached retirement age. It essentially allows you to “save” for your retirement home through your superannuation.
While you can’t live in it before retirement, you can most certainly rent it out in the meantime. Allowing the rental income to contribute towards your retirement savings. Once you’ve reached retirement age, you can purchase & transfer the property from your SMSF and live it in.
5. Access to funding
While SMSFs aren’t allowed to borrow funds for investments, there are exceptions when it comes to property. This means you are able to take out a loan through an LRBA to purchase a property of your choice.
This is a huge benefit for property investors as that means you are able to borrow up to 70% to 80% of the property value, ultimately freeing up more of your super to diversify into other investments.
Purchasing a property through an LRBA also provides an extra layer of protection to other assets in your SMSF. This is because the loan is only limited to a single asset being the property, so if you end up defaulting on your loan your other assets are protected from the lenders.
Disadvantages of SMSF Property Investing
1. Impact on Liquidity
Properties are illiquid assets. It takes significantly longer to sell and offset property assets than it might take for other assets. Selling a property owned through an SMSF complicates the process even further since you don’t directly own the property. It might even cost you more to sell it.
This can be challenging if the SMSF needs to liquidate its assets to access funds for other investment opportunities or to meet pension requirements. The sale can also be affected by other market conditions.
2. Compliance Burdens
SMSFs are some of the most regulated entities in Australia. The Australian Tax Office (ATO) has a set of strict guidelines that every SMSF has to comply with.
Some rules to comply with include:
- Sole purpose test – The sole purpose test requires the SMSF to be used solely for providing retirement benefits for its members. In other words, you can’t use the fund’s assets for personal benefit.
- Related parties – You can’t buy the property from or lease it out to a related party. SMSF related parties include fund members and their relatives, including parents, grandparents, uncles, aunts, siblings, spouses, children, nephews, nieces, and business partners.
- Regular audits – SMSF must conduct regular financial and compliance audits to ensure the fund’s books are accurate and that the fund is operated and managed in compliance with the Superannuation Industry (Supervision) Act 1993.
Failure to comply with these regulations could attract penalties, loss of tax concessions, and disqualification of the fund.
3. Borrowing Requirements
While also a benefit, the restrictions presented by taking out an LRBA loan can also prove to be a disadvantage to some. Due to the protection it provides to SMSF members when they default on a loan, most lenders are reluctant to lend. This reduces the amount of lenders who provide funding for SMSF property investments.
As a result, the interest rates and deposit required to service the loan is much higher than the usual personal property investment. There are also strict requirements that needs to be met such as what you can use the borrowed funds.
4. Restrictions on property use
It’s impotant to note that while you have the property in your SMSF there are strict rules set by the ATO about how you can use it and what you can do to the property. This ties into the compliance burdens noted previously, but most importantly you aren’t able to live in the residential property until you retire.
Renovations and improvements to the property must also be done in compliance with the rules set out by the ATO. So it’s imperative that you are aware of these restrictions before you invest.
Differences Between Buying Property with SMSF vs. Personal Name
Deposit Requirements
Deposit requirements are typically higher when buying an investment property through an SMSF. Lenders often require you to put down around 20% to 30% of the property value as a deposit. The deposit amount can go up to 40% for a commercial property.
On the other hand, the required deposit when buying property under your name is about 10% to 20% of the property value. Lenders are more flexible and have more loan options for investors buying private investment properties, which lowers the required deposit.
Taxation and Negative Gearing
Rental income from SMSF-owned properties is taxed at a concessional tax rate of 15% during the accumulation phase. Upon retirement, the income may become tax-free. However, the rules become stricter when it comes to negative gearing for SMSFs. Any losses from the property cannot be offset against personal income, unlike in personal property investments.
This can reduce immediate tax benefits and make SMSF property investments less attractive for those relying on negative gearing as a tax strategy.
Equity Growth Restrictions
SMSF members and trustees can’t use the equity built up in an SMSF property to finance another investment or renovate the property. The nature of SMSFs restricts access to the assets’ equity unless you sell the asset. Lenders also don’t allow refinancing of an SMSF loan to release equity.
Owning an investment property under your name allows you to leverage your equity in the asset as its value grows. If you have an active loan, you can easily refinance the loan to fund another investment, renovations, or personal expenses. This provides more growth potential and financial flexibility.
Development Restrictions
SMSF rules and regulations are strict when it comes to developing the property. You’re generally restricted from making any developments or renovations that alter an SMSF-owned property’s nature, using borrowed funds.
Any major improvements must be funded from the fund’s cash reserves, which limits the extent to which you can increase the property’s face or value through development.
There are no restrictions when it comes to developing a privately owned investment property. You can use borrowed funds to make major upgrades, renovations, or improvements, which could potentially increase the property’s value and rental income. This offers more freedom and flexibility.
Trust Structure Required
An SMSF requires members to set up a trust structure, with the SMSF acting as a trustee. Since you’re buying the property under the SMSF’s name, not your name, it needs to be established via a trust structure. In addition, if you borrow funds through an LRBA, you must set up a separate “bare trust” that will hold the property until you’ve fully paid off the loan.
This adds to the complexity, cost, compliance, and administrative requirements needed to purchase a property through an SMSF.
On the other hand, you don’t need to set up any trust structure when buying an investment property under your name. This simplifies the process and makes it less costly in terms of legal and administration fees.
What Types of Properties Can You Purchase with Super?
Residential Properties for Investment Purposes Only
Residential properties are a popular choice for SMSF investors. While you can invest in a residential property, note that it can only be for investment purposes. The sole purpose test prohibits SMSF members from gaining personal benefit from the assets.
The property must earn rental income or capital gains for the benefit of the fund.
Commercial Properties
An SMSF can invest in commercial properties. Commercial properties are properties used solely for business purposes, such as industrial buildings, warehouses, office buildings, or car parks.
Rules for SMSF commercial properties vary from those of residential properties. SMSF members and their related parties are allowed to rent the fund’s commercial properties for their businesses, provided the lease terms are at market rates and comply with the Sole Purpose Test.
This allows them to pay rent to their own SMSF, make them their own landlords, and enjoy the benefits that come with it.
Another benefit of investing in commercial properties through an SMSF is that commercial properties typically have longer lease periods than residential properties. This provides a stable, predictable income stream for the fund.
Vacant Land to Be Developed for Residential or Commercial Investment
SMSFs can also invest in vacant land. But just like other properties, the land must be for investment purposes only and for the benefit of the fund. This means the vacant land can be developed for residential or commercial properties.
However, developing the land can be complicated since SMSF borrowing rules restrict funds from borrowing finances for significant improvements or development. It can only be done using the cash in the fund’s reserves.
Note that developing the land is restricted if there is an existing loan.
Speak to Wayfinder about SMSF Property Investing
By now you should be well aware of the pros and cons of SMSF property investing. If the pros outweigh the cons for you and you’d like to learn more about how you can leverage your Super to grow your retirement nest egg and diversify your investment then our team is always available to help.
Our comprehensive suite of SMSF buyers agent services make the process smooth for you, especially for busy professionals who don’t have time to do the rigorous work that’s required to find the perfect property.
Contact our expert SMSF Buyer’s Agent today for a free consultation, or call us now at 1800 853 079.