Buying property? Take this SMSF health check

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If you’d like to invest in property using your SMSF, you’ll need to ask yourself a few questions to determine whether your self-managed super fund (SMSF) is healthy enough to finance the purchase.

Financing the investment can be broken up into two main elements:

a) ‘Setup’ – funding the deposit; and
b) ‘On-goings’ – meeting the loan repayments and maintenance costs.

Here’s what you need to consider:

The setup stage

How much do I need in my SMSF to buy property?

Most advisors recommend the SMSF hold a minimum of $150,000 to $200,000 in order to invest in property safely and responsibly. Switzer recommends at least $200,000.

There are a number of reasons for this level of funding, but the main ideas are as follows:

Diversification – As most investors will look at property starting from approximately $350,000, a minimum of $200,000 allows you to allocate a sizeable deposit to a property purchase, leaving you with sufficient funds to allocate to cash and equities as well.

Lower levels of debt – Where you may typically borrow up to 80% or 90% of the value of the property from a bank in the general market, most advisors and risk profiles would prefer you to lower your exposure to debt within your retirement fund, limiting the loan to 50% to 70% of the value of the property.

The advantage of such a strategy is that it reduces mortgage-stress and allows you to hold the asset with a much lower year-on-year outlay. The disadvantage is that property investment in your SMSF may require a much larger deposit compared with the general market.

How much should I allocate for a deposit?

Again, this can depend on the financial advice you are receiving and the advisors appetite for risk, however there are also general market limitations on SMSF loans that you will need to consider.

Loans to SMSFs are considered ‘limited recourse’ by the banks. This means that the bank is ‘limited’ to seizing only the asset that the loan is attached to and can’t gain access to other assets you may also own.

As a result, lending institutions have a limited range of products for SMSFs, some ranging as high as 80% but many peaking at 70% to 73%. This means that for a purchase price of $500,000, a minimum of $100,000 should be considered as a deposit, plus costs. You can find out more on SMSF loans here. [insert link]

What if I don’t have the funds for a deposit?

Buying property through your SMSF can be a very tax-effective way to build a property portfolio, so if you don’t have the funds for a deposit straight away, you may want to consider lending the deposit to your SMSF rather than miss out.

There is no limit to the amount you can lend to your SMSF and you can do so at an interest rate equal to or less than the ‘market rate’ of interest. Having said that, there are strict rules you will need to satisfy. You can find out more about this strategy in Lend to your fund at a low interest rate.

The ‘on-goings’ stage

Do I have the funds to service my loan?

Many people find they may not have been able to afford a property purchase in the general market, but because of their compulsory super contributions, they now have a portion of income that can go to paying for the shortfall between the rent (income) and the loan repayments (expense).

As a general rule, 1% to 2% of the property’s value is a good benchmark to use as an ‘out of pocket’ expense for the first four or five years on a property investment, at least until an increase in rent can compensate more effectively for the loan repayments and the ongoing maintenance and levies.

Achieving a much higher rent return and contributing a larger deposit will reduce this cost dramatically though, so you should consult your accountant or planner to determine a number of scenarios that will suit your financial position.

Can I meet the repayments as I move into the pension phase?

As you move into retirement, the opportunity to service your investment loan out of your own pocket will decrease dramatically. If you have ventured into property at the end of your working career, then it’s essential you have a plan for servicing the shortfall in your investment, at least until the rental income has increased sufficiently to make the property cash flow positive.

For a diagram showing the property timeline, please click here or read Are you too old to invest in property using super?

It’s essential to consider both the setup and ongoing costs of a property investment in order to make an informed and educated decision on whether you should own property in your SMSF. Making allowances for these factors will put you in a superior position when you do decide to invest.

If you feel confident you meet all the above conditions, then you’re ready to take the next step.

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. Anyone should consider the appropriateness of the information in regards to their circumstances.

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