Buying an investment property with your SMSF using borrowed funds can be quite a complicated procedure and there are certain rules which need to be followed to satisfy the borrowing requirements. We'll discuss these in more detail a little later but first let's find out what type of property you can purchase with your SMSF.
What Type Of Property Can You Purchase With Your SMSF?
- Residential Property – Your SMSF can legally purchase a residential investment property as long as it is rented out at market value. It cannot be rented to a family member or friend and the fund trustees cannot live in the property until they are retired and are receiving a pension from the SMSF. At this stage, the title of the property will be transferred to the trustees and you should be aware that this may incur a transfer fee.
- Commercial Property – Your SMSF can purchase a commercial premises which your business can lease from the fund as long as the rent is charged at market value. In doing this, your business can claim the rent which it pays for the property to the SMSF as a tax deduction.
- An Off-The-Plan Apartment Or Unit – Your SMSF can purchase a new apartment off-the-plan but it cannot invest in land in order to build on the land or subdivide it.
Your fund can of course, purchase a commercial property and rent it out to any business as long as the rent is charged at market value.
To put it more succinctly, any investment property that your SMSF purchases must be income producing so as to increase the total value of your SMSF until your retirement.
Now if you have enough funds in your SMSF to purchase an investment property outright, you could do this but a wiser decision would be to borrow some funds so that you can continue to diversify your SMSF investments.
For your SMSF to borrow funds for an investment property, there are certain rules that you need to follow. Let's discuss how an SMSF property loan works.
How Can Your SMSF Borrow To Purchase An Investment Property?
Firstly, in order for your SMSF to borrow funds to invest in a property, the fund has to have a reasonable deposit. Generally speaking, your fund will only be able to borrow between 70% to 80% of the total property value.
The type of loan that is available to your SMSF is called a Limited Recourse Borrowing Arrangement (LRBA). This LRBA ensures that the lender can only use the investment property as security and any other assets held by the SMSF cannot be used for security. This effectively protects the other assets in the fund in the event that the loan is in default.
Secondly, the property title cannot be held by the SMSF itself so a bare trust needs to be established by the fund to hold ownership of the property until the total loan has been repaid. The SMSF is then the beneficiary of the bare trust.
It should also be noted that the bare trust must have a different trustee to that of the SMSF. In some cases this may necessitate the need to set up a corporate trustee.
So to put it simply, the bare trust holds the title of the investment property but the SMSF receives all the rental income and must pay all the expenses and make the loan repayments.
What Criteria Do You Need To Meet To Qualify For An LRBA?
Lending policies do vary between lenders so it is advisable that you speak to a mortgage broker who is well versed in SMSF property loans but here are some standard requirements:
- Your SMSF must have the ability to purchase an investment property written into it's investment strategy and the trust deed. Most lenders will need a copy of both the SMSF Trust Deed and the Property Trust Deed.
- Your SMSF should have a minimum deposit of 20% to 30% of the property value and it must still have around 30% cash left in the fund which is a loan liquidity requirement of certain lenders, namely banks.
- The SMSF must be able to make the loan repayments for the term of the loan. To this end, lenders will look at the continuity of contributions made by trust members and the rental income. Generally , the higher the rental yield of the property, the more favourable the loan will be to most lenders.
- It is advisable to have the property positively geared if at all possible. This will help ensure that loan repayments and property expenses are easily met by the SMSF and will of course increase the value of your superannuation fund as well.
How Can A Mortgage Broker Help?
Talking to an experienced mortgage broker can help you to work through all the rules and requirements of an SMSF property loan. A broker can generally advise you on how much you can borrow and how much you need to have in your SMSF fund before you can even think about buying an investment property.
A mortgage broker can also advise on the type of property you should be looking at and what lenders consider the most favourable type of property investments.
You should also discuss with your broker how to best structure the property loan and whether you should consider a combination of an interest only and principal and interest loan or whether a straight principal and interest loan would be more advantageous. This will most likely depend on the interest rate at the time.
Before you decide to invest in property with your SMSF, it is pertinent to get both financial and legal advice to ensure that your SMSF meets all the requirements needed for it to purchase an investment property.
After all, it is your retirement fund and you want to ensure that you maximise the earnings to their fullest potential so that you'll have more than enough to enjoy a comfortable and enjoyable retirement lifestyle.