Using your SMSF to purchase a property is a great way to diversify your superannuation income and make some tax savings as well. With the ability of your SMSF to borrow money for investing in property, you can increase the net worth of your fund quite significantly over the years if you choose a good investment.
For an easier explanation of how this works, we'll give you 5 simple steps to take when you decide to buy an investment property through your SMSF using borrowed funds. But first, let's take a quick look at what lenders look for before they decide to lend to an SMSF.
- How much deposit your SMSF can put towards the property. Most lenders require at least 30% of the value of the investment property.
- How much rental income the property is likely to fetch. This rental income will determine whether your SMSF is able to make the necessary loan repayments.
- How much and how frequently you make contributions to your SMSF. This also helps to determine whether your SMSF is able to meet its loan repayment obligations.
- Whether investing in property is part of your SMSF investment strategy and whether this is written into the trust deed of your fund.
- Lastly, the structure of your SMSF must be compliant with both ASIC and ATO rules.
Here are the 5 simple steps you should take if you intend to purchase an investment property with your SMSF:
1. Make Sure Your SMSF Fund Is Compliant
You need to clearly outline in your SMSF investment strategy that one of the fund's key objectives is to invest in property. This also needs to be outlined in the trust deed.
The trust deed and investment strategy must clearly explain how the fund will manage this diversification into property investing as well as the risk involved and the return expected. Other things to put in writing may include how long the property will be held for and what would happen if the members' circumstances change.
2. Talk To A Mortgage Broker Or Your Preferred Lender To Obtain Loan Pre-Approval
Because SMSF investment loans are generally slightly more restrictive than normal mortgages, it's a good idea to get pre-approval before you even go out to look at any properties. You also want to consider the different types of SMSF loan products available so that you be can sure you're choosing the one that is right for your purposes.
Ensure that you only look at non-recourse loans as these will protect the other assets in your SMSF in the event that the fund defaults on the loan and the lender has to sell the property to recoup monies outstanding.
If at all possible, avoid giving a personal guarantee as this would mean that if the fund defaults on the loan, the lender can then seize your personal assets or dock your wages if there is a shortfall when the investment property is foreclosed on.
It is probably better to offer a higher deposit or pay a slightly higher interest rate to satisfy the lender if they are looking for a personal guarantee.
The loan structure itself can often be quite complicated so if possible, try and deal with an SMSF loan specialist to avoid a lengthy delay in settlement.
3. Next It's Time To Find A Property To Purchase
There are certain rules which apply to the type of property that you can purchase with your SMSF. These include:
- The property must be established. An SMSF is not allowed to purchase land for development or develop or refurbish an already established property which would significantly change the character of the property. An SMSF can however purchase a property and restore it or purchase a new property off the plan.
- The property must be purchased 'at arm's length', meaning it cannot be purchased from a relative, friend or acquaintance at below market value.
- Also the property cannot be rented to one of the trustees or any relative or acquaintance. However, once the trustees reach retirement, the title of the property can be transferred into their own name and they can live in it.
- If purchasing a commercial property however, and the trustee runs a business, he or she can rent the property as a business premises as long as rent is paid at market value and not below.
4. You Need To Set Up A Security Trust For The Property
The legal title of this investment property needs to be held in a security trust until the loan is paid in full. The security trust must have an independent trustee who is not a trustee of the SMSF. This can be a friend or relative or more appropriately, a corporate trustee. This means that you need to establish a proprietary limited company of which you are the director. Ensure that the trust deed is correctly set up to avoid any unnecessary stamp duty or tax liabilities.
5. Now You're Ready For Settlement
At this stage, loan contracts will be drawn up and will be exchanged between the seller and the trustee of the security trust which hold legal title to the property. Now the SMSF can pay the deposit, the legal costs and the stamp duty.
Once the loan is in place, the SMSF is responsible for making loan payments as well as paying council rates, land tax, property management fees and insurance premiums. Of course, the SMSF also receives all the rental payments from the property.
So as you can see, investing in property through your SMSF need not be difficult. You just need to ensure that your property falls within all the guidelines and that you make sure that you have all the relevant information that you need to make the right decision.
It's also a good idea to speak to a mortgage broker who is familiar with this type of investment and can guide you in finding the right lender.