We receive a steady stream of emails seeking information about investing in property via an SMSF. In response to this continued interest, we have revisited the popular question, is property a good investment for your SMSF?
The question (is property a suitable investment for an SMSF?) is an important one, and the need to ask such a question by readers, associates and even friends at social events, seems to have been triggered by the many negative, and positive, stories published about investing in property, or using an SMSF to invest in property, and the concern about property spruikers flooding the market and ripping off unsuspecting Australians.
Some individuals within the super industry believe when self-managed super fund trustees invest in property, they are creating a property bubble. Some in the large super fund sector have even claimed that property investing by SMSFs is dangerous for the economy. Others believe SMSF property investing only began in 2007, when the government permitted a restricted form of borrowing for SMSFs, known as limited recourse borrowing (more on this later in the article).
With so much misinformation in the marketplace, it is timely to once again ask the question, is direct property a suitable investment for an SMSF?
SMSF and property: the verdict
What do I think? In general terms, of course direct property can be part of a SMSF portfolio. Investing directly in real property has always been an option for SMSFs. Over the past 12 years or so, between 12 per cent and 16 per cent of all SMSF assets were allocated to direct property.
A second, and more important question, is whether investing in property is suitable for your SMSF. As a long-term property investor (outside of super), and as the author of DIY Super For Dummies, and as an SMSF trustee myself, my answer to this question is… it depends.
The answer to this second question depends on your fund’s investment strategy: including your risk profile, your desired rate of return, your need for diversification, the quality of the investment, the tax consequences of any investment decisions, and your fund’s cash flow requirements.
Can your super fund invest in commercial or residential property?
A property investment can deliver you two types of return: you receive rental income from tenants for leasing the property, and you can secure a capital gain on the sale of the property, if the property increases in value from the time of purchase.
As an SMSF trustee, you also need to allow for the time involved in managing an investment property, unless you choose to appoint a property manager. If you need to sell the property, it may take a few months and your fund may incur marketing costs, and other selling costs.
Your SMSF can invest in residential property, such as houses or flats, or you can invest in commercial or industrial property such as shops, offices, factories or a farm. The average SMSF asset allocation to commercial/industrial property has not changed in the past 12 years remaining constant at around 11 to 12 per cent of all SMSF assets.
Investment in residential real property has increased over 12 years; from a tiny 0.5 per cent of all SMSF assets in 2004, to 4.18 per cent ($28.2 billion) as at March 2017, based on the latest annual figures from the ATO. Apparently, this 3.7 percentage point increase in residential property investment, concerns the large super funds as a mystical sign hinting at a property bubble, although it is likely that the allocation to property may increase if more SMSFs choose to use borrowed money (see discussion in the next section).
Can your SMSF borrow money to buy property?
Purchasing a property however is a lumpy investment which means you need a lot more money to invest in such an asset compared with buying a parcel of shares or depositing your super in a bank account. Subject to your fund’s trust deed, if your SMSF chooses to partly borrow to purchase a property then note that the loan will not be a regular type of loan.
Before 2007, SMSFs generally could not borrow to invest, but now it is possible use a form of borrowing known as a limited recourse borrowing arrangement (LRBA). Limited recourse means if you default on your repayments, the bank can only take the asset with the loan secured against it, and not claim any of your other fund assets. Note that SMSF trustees can also purchase shares, or any other asset allowed by the super rules, using a LRBA.
Don’t let estate agents, property developers or other unlicensed individuals, who are not permitted to advise you on SMSFs, convince you that this LRBA is some magic pill that will deliver you impressive property returns. At the risk of stating the obvious, the LRBA is a financing arrangement, which is a loan that also costs money to set up, and is not the actual investment.
Currently, 3.82% of SMSF assets (as at 31 March 2017) are tied up in limited recourse borrowing arrangements, and based on previous ATO statistics, 99.9% of all property-related LRBAs are secured against Australian residential and commercial property owned by SMSFs, while a tiny proportion of SMSF fund assets are tied up in LRBAs secured against overseas real property. For a basic overview of LRBAs, see SuperGuide article SMSFs for Beginners: Can my DIY super fund borrow money?
Do your numbers before acting. For some individuals, it may be more tax effective to invest in property outside of super.
Note that you or your relatives cannot live in a residential property owned by your SMSF.
Note: LRBAs entered into after 30 June 2017 will be counted towards a person’s Total Superannuation Balance (subject to legislation). The outstanding balance of a LRBA will be included in a fund members Total Superannuation Balance. Why would the government be planning to introduce this change? Since 1 July 2017, anyone with a total superannuation balance equal to, or more than, $1.6 million will not be able to make non-concessional contributions, so the federal government doesn’t want Australians using LRBAs to circumvent the contributions rules (for more information about the Total Superannuation Balance rules, see SuperGuide article Non-concessional contributions: 10 facts about the $100,000 cap.
The following SuperGuide articles provide more guidance on what SMSFs can and cannot do in relation to property investment:
Want to know more about running an SMSF?
Become a SuperGuide Premium member and access expert guides for SMSFs, on topics such as costs, compliance, administration, investment, borrowing and pensions. Discover valuable SMSF, super and retirement strategies, the latest super rates and thresholds, contributions caps and more from Trish Power, author of DIY Super for Dummies.
Includes hundreds of articles, how-to guides, checklists, tips, calculators, case studies, quizzes and a monthly newsletter.
Find out more