SMSF Borrowing & Property Investment
Your (Life’s) Biggest Investment
Actively planning for retirement is one of the most important things you can do during your adult working years. It goes without saying that, the sooner you start accumulating retirement savings, the better off you’ll eventually be.
During your lifetime, a super fund is one of the biggest investments you can make. For instance, an average Australian household headed by someone of retirement age has a super balance of around $200,000.
Australia’s total superannuation industry surpasses two trillion dollars, which makes it larger than the country’s economy. This also makes the industry the world’s fourthlargest and there are numerous options when it comes to choosing where to invest your hard-earned retirement savings.
A well-managed superannuation fund can become a significant contributor to your retirement nest egg so it pays to put some thought into choosing the right one. You want your employer contributions to be invested in the way you choose and for your pay to then work as hard as possible to provide for a comfortable retirement.
Two Main Categories of Super Funds
There are two main categories of superannuation funds that you need to be aware of:
Retail
These types of super funds are owned by financial institutions and are open to the general public to join. These funds deliver profits to their shareholders and can be of three types:
- Master Trusts
- Corporate Super Funds
- Retirement Savings Accounts
Profit for members
The funds included under this general umbrella are ones that distribute their profits to members rather than shareholders. The two specific fund types include:
- Industry Funds
- Self-Managed Super Funds (SMSF)
Aside from an SMSF, other funds provide a limited amount of choice when it comes to picking where your retirement savings get invested. Usually, your choices are limited to pursuing a conservative, balanced or growth-based investment strategy and then allocating your funds between these three pre-defined portfolios.
The Most Flexible Type of Super Fund
Unlike the other fund types, a Self-Managed Super Fund (SMSF) gives you the maximum amount of flexibility with regards to where your retirement savings get invested.
When it comes to investing through an SMSF, you have an almost-unlimited choice of asset types to choose from. An SMSF truly allows you to take your destiny into your own hands and grow your retirement savings in the way you believe is best for your future.
Property Investment Through an SMSF
The law enables Australians to invest in property through their self-managed funds. Property is the fourth most-popular asset type right behind shares, cash and term deposits.
Who This Guide is For
This guide was written for existing trustees of an SMSF who wish to learn more about how to borrow to acquire property through their fund. It is also meant for those who aren’t sure what an SMSF is and would like to know more.
If you are currently an SMSF trustee then you will want to skip straight to the part of this guide that talks about borrowing to add property to your investment portfolio: “The Property Buying Process”
If you’re new to SMSF, it’s best to start from the beginning to gain an overview of just what a self-managed super fund is.
The SMSF Industry in Numbers
There are over 500,000 SMSF funds in Australia that control over half-a trillion dollars in assets. This represents more than 30% of all Australian super investments.
The Australian Taxation Office reported that SMSFs are now increasingly popular with all age groups. The last few years have seen significant growth with members as young as those in their mid-thirties.
Female membership is also growing and women now account for nearly half of the entire membership base.
SMSF members number over one million and that number continues to grow. Over four thousand SMSFs are being established each month by everyday Australians, which shows just how popular this type of superannuation option has become.
Are You Ready to Start an SMSF?
While the freedom and degree of control provided by a self-managed fund can be liberating, switching your current super over must be weighed up carefully. The growing popularity of SMSFs does not mean they are suitable for every type of individual or situation.
There are certain requirements and responsibilities that come attached to launching a self-managed fund. Answering the questions below will help you get a feel for the suitability of this fund type in relation to your particular circumstances:
Due to the numerous legal and administrative costs associated with running an SMSF, many industry commentators suggest that members should have accumulated superannuation of at least $200,000 before establishing an SMSF.
Administrating an SMSF doesn’t just cost money, it also takes up a significant amount of time. If you’re not prepared to either spend time on the paperwork yourself or hire someone to do it for you then another fund type may be preferable.
The legal compliance requirements of an SMSF should not be underestimated as not adhering to government regulations may get you in hot water. Among other things, this may lose you money. Unlike managed superannuation options, you are solely responsible for the actions of your fund and external annual audits are mandatory
As well as the legal burden, you are also solely responsible for the fund’s performance. While managed funds have professional financial managers responsible for defining and managing their investment strategy on your behalf, an SMSF places this responsibility squarely on your shoulders.
If you are considering establishing an SMSF, you should obtain independent legal and financial advice.
SMSF vs Other Super Funds
As the previous section outlined, setting up and running an SMSF requires a substantial degree of forward planning and financial commitment. Yet, once you get past the initial set-up hurdles and gain access to good advisers, a self-managed fund can become a good alternative to a managed super fund. Following is an outline of how an SMSF can help you prepare for a comfortable retirement:
(Almost) unlimited choice of investments
Unlike a managed fund, you are not limited to any one single investment type or asset class. You can invest in a broad range of assets and investments with your SMSF fund: from the direct purchase of company shares through to a smorgasbord of alternative investments.
This includes borrowing to acquire property directly through the fund. You can also invest and divest your investments quickly depending on how they’re performing. Such expediency is not usually possible with a large managed fund.
Full visibility into your fund
Your super is often the largest investment you’ll make after buying a home. Just like being able to add value through renovations can be important to you as a property owner, having a say in how your retirement funds get invested may be just as, if not more, important. Unlike investing with a managed fund, you know exactly what your retirement money is doing and can influence this directly.
Cost savings
Because the fees of an SMSF are fixed to a certain degree, once your self-managed super balance reaches a certain critical mass, the fees that your fund will have to pay may be less than those of a managed fund in a comparative sense. Other cost benefits may come from the ability to consolidate fund members’ accounts into one SMSF.
Asset pooling
An SMSF allows you to create an ‘investment pool’ where the savings of up to four members are added together to form one single lump sum amount. From a property perspective, this gives you the option of being able to purchase a property that would otherwise be beyond the reach of any one individual fund member.
No capital gains
Most SMSFs are set up in such a way that their members only start to benefit from the fund’s capital asset growth after members have reached their pension age, which may reduce or eliminate capital gains tax.
Own your business’s real property
Business owners have the ability to own their commercial premises though their SMSF. One advantage of this strategy is that it enables the business to free up capital whilst continuing to occupy the property as a tenant.
If any of these benefits resonate with you then an SMSF may be the right fit.
Your New Obligations
Being the trustee or the director of a corporate trustee involves taking on a number of obligations that you wouldn’t otherwise have as the member of any other super fund. Your responsibilities are written out in your SMSF’s trust deed, which all members of your fund must sign.
The SIS Act
Certain provisions of the Superannuation Industry (Supervision) Act 1993 must be included in the deed and be adhered to by the trustee(s). Some of these requirements are as follows:
- To act honestly with regards to any matters related to the fund
- To exercise the same care, skill and diligence as would be the case in any other organisation that invests money on behalf of its members
- To act in the best interests of all fund beneficiaries
- To prioritise the interests of the fund’s beneficiaries over and above those of any outside party
- To act fairly in relation to all members of the fund
- To keep the money and assets of the fund separate from any personal funds of the trustee, employer-sponsor or their associate
- To ensure that no contracts signed or other actions performed hinder the trustee’s ability to exercise their duties or power
- To have an investment strategy in place
- Give members access to information on the fund
Additional Obligations
In addition to the above requirements that are prescribed by statute, these are some of the other obligations that must be met.
As you can see, there is a lot to know when it comes to running a self-managed super fund. You either have to be prepared to put in the time to set up and run your fund or pay professionals to do it.
Actively Administer Your Fund
The trustees of an SMSF must diligently administer the fund, which involves maintaining accurate accounting and complying with the Australian Taxation Office’s reporting requirements.
“Pass” the Sole Purpose Test
Meeting the requirements of this test comes down to ensuring that the fund’s sole reason for existing is to benefit members during their retirement.
Know Rules for Contributions and Benefit Payments
There are conditions attached to accepting contributions and paying benefits that the fund’s trustees need to be aware of.
The Nuts and Bolts of SMSF
Before considering property investment through an SMSF, it pays to be clear on what an SMSF is. These are the core features that distinguish an SMSF from other superannuation funds:
- The sole purpose for operating the fund must be the provision of retirement benefits to its members.
- The maximum number of members allowed in a fund is six.
- Every member must be a trustee of the fund. In cases where there is a corporate trustee, each member of the fund must be a director of the company. In either case, no trustee is to receive financial compensation for their services.
- Single-member funds with individual trustees need to have two trustees, one of whom is also a member of the fund. If there is a corporate trustee, the fund member must be the director and secretary of the company.
- For both single and multi-member fund structures, no member of the fund can be employed by another member except if they are relatives.
A Glossary of Important Terms
SMSF trusts are fairly complex and there are a lot of new terms that you will need to understand. Below is a list of the ones that you’re most likely to come across. It pays to refer back to this list when reading through this guide.
SISA
SISA, or the Superannuation Industry (Supervision) Act 1993, lays down the legal framework that an SMSF has to comply with. It also outlines how these rules are to be enforced and the anticipated penalties should these rules not be complied with.
Trust Deed
Every SMSF must have a trust deed which is a document that sets out the general rules by which the fund is to function. All trustees have to adhere to the rules of the trust deed so long as these don’t go against any Australian superannuation laws. The SMSF is established when the trust deed is signed.
Trustee
The trustee of an SMSF can be a real person or a legal entity and they hold full responsibility for all decisions made by the fund on behalf of its members. Anyone over 18 years of age can be nominated as a trustee of an SMSF. The only reason someone can’t become a trustee is if they are a “disqualified person” under SISA.
Corporate Trustee
If a company acts as the SMSF’s trustee then it is referred to as a corporate trustee.
Bare Trust
Any property acquired by the SMSF with borrowed money must be held in a separate trust known as a bare trust. This trust holds the legal title to the property until such time that the loan is repaid after which the SMSF obtains legal ownership.
Member
A fund member is someone for whom contributions are made. This person is also known as the fund’s beneficiary.
Member Contributions
This is what members contribute into the fund. These contributions can be of two types: before tax (self employed and PAYG contributions) or after tax (non-concessional contributions).
Non-compliance
When any provisions of the SISA are breached, this is known as non-compliance. The SMSF may be exposed to penalties imposed by the Australian Taxation Office. If a breach occurs, there may also be tax consequences for the SMSF.
Pension Phase
This is the period when your fund pays you a pension or income. The period prior to this is known as the accumulation phase.
While there are many more specialised terms that you will have to learn in order to understand how SMSFs work, the ones outlined should give a basic understanding of this specialised area of the superannuation industry.
Gearing Your SMSF Property
In the investment world, gearing is the practice of purchasing an asset with borrowed funds. Gearing can be of two types: negative gearing and positive gearing.
Applied to property investment specifically, gearing is widely used by investors to fund rental properties with the help of a mortgage.
A property is considered to be positively geared if the return from the rental income on an annual basis is greater than the costs of owning it. The resulting profit is considered taxable income by the ATO so, as a landlord, you need to plan for this in advance.
Negative Gearing
Negative gearing, on the other hand, is when the annual income you receive from a rental property is less than the cost of owning it. From a taxation standpoint, this results in a loss that can be offset against your personal income.
In the case of an SMSF, the loss cannot be offset against your personal income due to the fact that members’ income is made outside of the fund.
SMSF Tax Benefits
In general, an SMSF is taxed in the same way as an individual with the main difference being the tax rates that apply. Unlike your personal tax rate, which can be as high as 46%, the tax rate for an SMSF is a flat 15%*.
This means the highest amount of tax you’ll have to pay on your rental property income also equals 15%. In addition to this, expenses such as: maintenance fees, insurance, interest, local government rates, etc., can be written off by the SMSF.
Asset Protection through Limited Recourse
Unlike borrowing money to purchase a property in your own name, a property purchased by an SMSF may only borrow to acquire a property by using a limited recourse borrowing arrangement (LRBA).
An LRBA provides protection to trustees by limiting the recourse that a mortgage lender has to just the property being purchased under the agreement, and not to the other assets of the SMSF.
The Business Benefits of SMSF Property
For the owner of a small to medium-sized company, the ability to transfer business real property into their SMSF provides some unique advantages.
Transferring your business premises into an SMSF may provide a number of benefits. Any property purchased by the SMSF from a related party must be at the current market value.
Minimise tax
Similar to non-commercial property, business real estate will only be taxed at 15% or 10% (if held for more than a year) and exempt from tax after the fund members are in pension phase.
Protect one of your largest assets
Should your business go into bankruptcy or be subject to litigation, your property will be protected.
Be your own landlord
If you are looking to purchase new premises, you can have the peace of mind knowing that you can be your own landlord.
Access business equity
By purchasing a commercial premise through your SMSF, you can free up your business capital.
Ready To Self-Manage?
So, you’ve decided that an SMSF is a great way to save for retirement and that you would also like to acquire property through your fund. As you would have gathered by now, an SMSF requires a serious commitment of time and personal resources in order for it to live up to its financial potential. Running a fund is fairly admin-intensive and process-driven, and starting one is no different. Following are the steps that you need to follow in order to get your fund up and running:
Step 1
First and foremost, be fully aware of all of your responsibilities as a trustee of an SMSF. Given the amount of intricacies involved, it’s best to consult with a professional holding an Australian Financial Securities Licence (AFSL), qualified as an SMSF adviser, who can guide you through the process.
Step 2
Decide on whether you wish to have individual or corporate trustees and then decide on the number of members. You can have up to four members in an SMSF and most people usually choose their family members.
Step 3
Have your trust deed prepared by a professional.
Step 4
Ensure all paperwork is completed diligently and the fund is properly structured from a taxation perspective. You’ll need to get tax file numbers for all members and register the fund with the Australian Tax Office.
Step 5
Take care of the administrative side of things. Pay attention to such things as opening a bank account and obtaining insurance for the SMSF. Also, if applicable, advise your employer how to make contributions to your new fund.
Step 6
Most importantly, figure out the investment strategy for your SMSF and start putting this into play immediately.
The Property Buying Process
As someone looking to buy property through your SMSF, establishing your fund is only the first step. It’s important to be aware that the process of borrowing for a property through your SMSF is different to applying for a home loan as an individual.
One of the main differences is that an SMSF home loan is slightly more difficult to process from a lending perspective. Here are the steps you need to follow in order to acquire commercial property:
Obtain loan pre-approval to ensure you don’t potentially miss out on the right property due to a lender’s approval process.
Find a suitable investment property that is in line with your fund’s investment strategy.
Create a bare trust and complete all of the relevant legal documentation, including appointing a bare trustee for the property.
Obtain unconditional approval for your loan to ensure you don’t get any unpleasant surprises at the wrong moment.
Negotiate the final price with the vendor and, once you come to an agreement, exchange contracts with them.
Settle the purchase of the property.
If you want to speak to an independent non-bank lender to assess your options, get in touch with one of our Mortgage House lending specialists for a no-obligation chat.
How Much Can You Actually Borrow?
Now that you know what the process of borrowing to acquire a property through your SMSF involves, you may be wondering how much you can actually borrow.
Most lenders are prepared to lend your SMSF from 70% to 80% of property’s value. This may be slightly lower for commercial property.
The majority of lenders add an interest margin to their SMSF rates to account for the added risk and complexity of an LRBA. So the interest rate is often higher than an average home loan rate.
It definitely pays to shop around as these rates can differ significantly from lender to lender.
What Lenders Want to See
Depending on whether you’re dealing with a bank, a mortgage broker or a non-bank lender, the lending criteria may differ quite considerably. It especially varies in terms of how each lender evaluates your ability to repay the loan.
Here is a general outline of what you can expect a lender to assess in your application:
- The fund’s net assets must generally be equal to or greater than $200,000
- Your fund’s deposit needs to be at least 20% - 30% of the loan value
- Proof of sufficient income in the fund to make regular loan repayments, which is assessed by looking at an SMSF’s tax returns over a two-year period
- The expected rental income generated by a property will also be taken into account when assessing your ability to pay the debt
- The frequency and regularity of members’ contributions may be taken into account
- Whether your fund is compliant with relevant superannuation and tax laws
- Many lenders require the SMSF have a corporate trustee
- A minimum of 10% of the fund’s assets is required to be held as liquid assets (bank accounts, shares etc.)
A lender will generally also require personal guarantees from the members as additional security for the loan. At Mortgage House, we require personal guarantees in all cases regardless of fund assets.
What You Can’t Buy Through an SMSF
Due to the highly-regulated nature of self-managed funds, it’s not possible to purchase just any type of property. There are certain restrictions with regards to what property a fund can own.
For instance, an SMSF cannot borrow to purchase the following types of property:
- Any property that the SMSF intends to subdivide or redevelop
- Property that belongs to a related party, the definition of which is broad and includes members or their associates
- Owner-occupied property, unless the property is commercial
- A holiday home that either yourself, relatives or friends will use
The Importance of Keeping Accurate Records
With all of the rules and processes outlined in this guide, you may be thinking that there is a lot of administration work that goes into keeping your SMSF compliant. In fact, what is outlined in this guide is just the tip of the iceberg when it comes to keeping your SMSF in the taxation office’s good books.
Your SMSF must pay for an annual audit, which will show whether it complies with the many laws that regulate the superannuation industry.
If your fund, for any reason, becomes non-compliant then the Australian Taxation Office may investigate matters further. Breaches that are of a substantial nature will attract fines and tax penalties.
It always pays to be proactive about addressing potential issues before they lead to serious consequences. Keeping accurate records of all of the fund’s activities is one way of ensuring that you’re on top of all compliance requirements.
Types of SMSF Admin Tasks
The following are some of the most common administrative requirements that your fund will have to meet:
- Maintain accurate records of all investment decision that were made, which includes keeping copies of such things as sales and holding balance confirmations, dividend notices, purchase orders, as well as bank and tax statements
- On an annual basis, the fund must pay for an audit of its activities to confirm that the SMSF complies with superannuation law and that its accounting is in order
- Ensuring your trust deed continues to meet current legislation requirements, some of which change regularly due to the ever-evolving nature of the industry
With the amount of work that goes into remaining compliant, it is extremely difficult to keep on top of everything without the help of specialist advisers.
You want to have a good team of professionals on your side who can help you navigate the often-turbulent waters of the self-managed super industry.
Assembling a Trusted Team of Advisers
Running your SMSF is an undertaking similar to starting a company in that you need to have a team of competent people working together in order to achieve success.
Any complex endeavour requires a group of specialists who, when working in tandem, can reach a certain goal. In the case of SMSF property investment, your fund’s goal is to help its members achieve a comfortable retirement.
Whom To Bring On Board
The team that can help you achieve this goal may consist of the following professionals:
- An administrator of the SMSF can help with the general operation of the fund and ensure that all compliance is carried out in the prescribed manner.
- A solicitor can help you prepare the initial trust deed and then keep it up-todate with emerging legislation. They can also review any contracts that your fund enters into to ensure these are SISA compliant.
- An accountant and taxation professional - who can be one and the same individual or firm - can look after your day-to-day bookkeeping needs as well as prepare annual returns and file tax returns.
- You will need to appoint a Licenced Financial Adviser with an Australian Financial Services Licence (AFSL) who can advise on your investment strategy and, for SMSF property investment specifically, guide you through the process of acquiring the right property.
While assembling such a team does cost money, the potential losses that you risk making by having a weak investment strategy or not complying with the law can be much greater. You need to view this as an investment into your retirement.
After all, that is what all of this is about – ensuring that you live out your golden years in comfort and leave something for future generations.
INTELLECTUAL PROPERTY STATEMENT AND DISCLAIMER
This guide is general in nature and may not apply to your particular circumstances. The information presented is current at the time of printing and may change without notice at the sole discretion of © Mortgage House 2016. All logos, graphics, text and information is owned by, or licensed to: Mortgage House Pty Ltd ACN 129091 372 and is subject to copyright. Mortgage House Pty Ltd ACN 129 091 372 is a credit representative of Mortgage House of Australia Pty Ltd ACN 081 508 054 (Australian Credit License 393283).