Australians love residential property, and so do a lot of SMSFs. Residential property offers SMSFs a sound diversification, relatively low volatility compared with other growth asset classes, and historically strong returns – with the caveat that an individual property carries a large degree of idiosyncratic risk.

The flipside to that caveat, however, is that residential property is an inefficient market that, to the expert buyer, offers the equivalent degree of idiosyncratic opportunity.

Here are five things that an SMSF should consider when assessing its property strategy.

1. Use the super tax concessions to the full

SMSFs gain huge advantages from holding a property in the concessional tax environment of superannuation. Once the property is in the super environment, capital gains tax and rent are taxed at the super fund rate of 15%, and when the fund moves to pension phase after age 60, where the property is backing the payment of a superannuation pension, the income from the property and capital gain on its eventual sale are tax-free. This means that if you wait until the pension phase before selling the property, you can legally take capital gains tax (CGT) on the final sale out of the equation.

2. Combine the tax concessions with the ability to borrow

SMSFs are allowed to borrow to buy property if the recourse for the loan is limited to the asset in question. Under the rules, there is a “single acquirable asset,” meaning that only one property at a time can be bought under each separate borrowing arrangement.

The lender can be a related party: this means that a person can lend money to their super fund to buy a property.

If the fund borrows to buy the property, it can claim interest payments as a tax deduction and potentially reduce tax liability. This gives the fund the ability to diversify its investment portfolio through prudent borrowing, while giving significant tax advantages as well.

3. Consider government-offered residential property packages

Defence Housing Australia (DHA) and the National Rental Affordability Scheme (NRAS) are federal government schemes that provide several benefits – and mitigate several prominent risks – and are thus worth considering by an SMSF wanting to invest in residential property.

Defence Housing provides housing to members of the Defence Force and their families, and offers investors the opportunity to buy individual dwellings and lease them back to DHA. Investment can be a lease of nine to 12 years or three to six years. Investors have no tenanting or management responsibilities and their rental income is backed by the federal government.

DHA costs a lot more than standard property management, but vacancy risk is virtually nullified. Also, DHA pays for total refurbishment of the property on the exit of a tenant – a cost not normally paid by a tenant.

NRAS is a tax-effective property investment in which investors rent approved houses at 20% below current market rates to eligible tenants, in return for a financial incentive of a minimum of $9,981 tax-free per house annually.

The tax advantages of SMSFs are particularly well-suited to NRAS. Cashflow is usually positive from the outset, out-of-pocket costs are minimal and there is a tax-free grant at the end of each year.

The drawback with both of these ownership structures is that you do not control your property.

4. Consider a syndicate to lower your entry cost

Property syndicates enable SMSFs to be involved in investments they could not make on their own. Most syndicates set up these days are SMSF-compliant, reflecting the huge demand from SMSFs for property investment. It is common to see syndicators offering a $20 million office building funded by SMSFs (and other investors) putting in anywhere from $50,000–$100,000 each, and enjoying 9%-plus yields for their trouble, with any capital gain on the building a bonus down the track.

An interesting alternative structure is DomaCom’s “fractional ownership” online property platform that is scheduled to be launched in the third quarter of 2013. Using the DomaCom platform, residential and commercial property will be made available by owners and developers, and SMSFs and other long-term investors will be able to buy (and sell) fractional interests in these properties. DomaCom will also lower the entry cost of property investment.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.