Finding the worst house in the best street, doing it up, and then selling it in a capital gains tax free environment makes the idea of borrowing to invest in property look appealing. With the changes that now allow improvements to the property to be made from other super fund monies, Limited Recourse Borrowing Arrangements (LBRAs) have got a new lease of life.
Of course, the property has to go up in value by more than the net investment cost, and your fund will need to be in pension phase (perhaps by starting a transition to retirement pension) to eliminate any capital gains tax.
Setting up a Limited Recourse Borrowing Arrangement takes a bit of work, and involves a number of upfront costs. If you have the time, it will pay to shop around, so here is what you should be looking for.
Westpac, St.George, Commonwealth, NAB, Bank of Queensland, Bendigo and Macquarie offer property loans to SMSFs. ANZ is strangely not yet in this space. There are also some non-bank lenders including Liberty Financial and Home Loans Limited.
With the exception of CommBank, all banks require the SMSF trustees to arrange their own ‘bare trust’ to hold the legal title to the property (more on this later). CommBank provides an integrated product called ‘Super Gear’ (see SSR 29 December 2011).
LVRs and interest rates
So how much can your fund borrow? Known as the ‘Loan to Valuation Ratio’, the table below sets out the maximum amount you can borrow from the major lenders as a percentage of the property’s value:
Depending on the structure of the SMSF, some lenders will advance more to a corporate trustee structure (C) than an SMSF with individuals as trustees (I). For example, Westpac (on residential property) will lend a maximum of 80% for a corporate trustee and 72% for an individual trustee structure.
Where residential property is provided as security, most of the banks charge their standard ‘home loan rates’, with the variable rate currently around 6.80% per annum. (CommBank applies a margin of 0.50% to their standard home loan rate). If using commercial property, it will definitely pay to shop around as commercial rates are quoted. On larger amounts, bank bills based funding (at a margin) is available.
To demonstrate that your fund can service the loan, a test is applied by the banks. The interest cost on the loan is calculated (at the current rate plus a margin of 1.5% to 2%), and to meet this, the sum of 80% of the property’s rental income plus concessional contributions plus the fund’s other investment income will need to exceed it. Again, some banks don’t place much credence in the fund’s other investment income from shares or term deposits.
St.George offers an ‘interest offset facility’, which makes good sense as most SMSFs will hold cash for liquidity and other purposes. The other banks are yet to follow suit in this regard, and is probably a key driver behind St.George’s leading share in this market.
Most banks will not lend against certain types of properties. Common exclusions are serviced apartments, small apartments under 50 square meters, vacant land and unit trust structures. Only some banks such as CommBank cover rural properties.
Documentation and fees
Documenting a LBRA can lead to a lot of costs, and frustration, so it will pay to establish upfront with the lender the application requirements, what any third parties need to do, and the expected costs. Let’s start with the costs:
- lender’s application fee (ranging on residential from $495 for BOQ to $1,500 for St George to a flat 0.8% for CommBank);
- lender’s monthly fee (typically $8 to $12 per month);
- legal fees to your solicitor to establish the bare trust (the bare trust usually needs a corporate trustee);
- lender’s fees to review bare trust and SMSF trust deed (some lenders charge a separate “legal review fee”, some lenders include the review fee in the application fee if a “preferred panel solicitor” is used);
- property valuation fees;
- financial planner or accountant’s fee (most lenders will require some form of certification from a planner or accountant that investing in the property is consistent with the fund’s investment objectives); and
- legal fees to review guarantees (most lenders will require personal guarantees from the members of the SMSF to the bank).
Find the right person
While this is a growing market, LBRAs are complicated to establish, so knowledge within the banks is scattered. Most of the banks deliver these loans from their business banking areas, so start with a business banker. Alternatively, find a home loan expert who specialises in this area – more than likely to be attached to a branch in the CBD or major commercial area. Some of the mortgage brokers are also active in this arena.
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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.