Should You Be Buying an Investment Property Within Super?
Written by Lance Swansbra
Investing in property through superannuation is a strategy that has gained popularity among Australian investors, it’s something people ask us about regularly. This approach allows individuals to control their retirement savings while potentially benefiting from property appreciation and rental income. However, like any investment strategy, it comes with its own set of advantages and disadvantages. This article explores the pros and cons of buying an investment property within a Self-Managed Super Fund (SMSF).
Understanding SMSFs
A SMSF is a type of superannuation fund that allows members to manage their own retirement savings. Unlike traditional super funds, SMSFs give individuals more flexibility to choose their investments, including property, shares, and other assets. SMSFs can have up to four members, and they must comply with strict regulations set by the Australian Taxation Office (ATO).
Pros of Buying an Investment Property Within an SMSF
1. Tax Benefits
One of the main attractions of using superannuation to invest in property is the favourable tax treatment. Superannuation is taxed at a rate of 15% on income, which is lower than the marginal tax rates for most individuals. Furthermore, any capital gains made from the sale of the property are taxed at a reduced rate of 10% if the asset is held for over a year. In retirement phase, when superannuation including a SMSF is in pension mode, income and capital gains can be tax-free, significantly enhancing overall returns. Keep in mind, if the property is going to be negatively geared (e.g. the annual expenses of the property exceed the annual taxable income), you may benefit from owning the property outside of superannuation.
2. Control Over Investment Choices
Investing through an SMSF provides a high degree of control. Fund members can choose specific properties that align with their investment strategy, whether residential, commercial, or industrial. This is often attractive to business owners as they may be able to use their superannuation to buy a property and then lease the property to their business. The main consideration here is that if the business gets into trouble, your superannuation may also be negatively impacted. Also remember that any lease between a business and a SMSF needs to be at market rates, e.g. if the fair rental on a building is $1,000 per week, you can’t lease it for $50 per week or $2,000 per week.
3. Diversification of Retirement Assets
By including property in an SMSF, investors can diversify their retirement portfolios. Property can behave differently from other asset classes like shares or bonds, potentially reducing overall portfolio risk. This diversification can be particularly beneficial during market downturns when property may hold its value better than equities. Keep in mind most ‘regular’ super funds are highly diversified and if the property is going to be the main asset of the SMSF, you could end up with less diversification than your current fund.
4. Potential for Strong Rental Yields
Investment properties can generate consistent rental income, providing a steady cash flow for the SMSF. This income can be reinvested, help to repay debt, or used to cover fund expenses, contributing to the growth of the retirement savings. Additionally, well-chosen properties in high-demand areas can offer strong capital growth, further enhancing returns. A good buyer’s agent can help you to find a property that’s going to be well suited to superannuation.
5. Borrowing Options
SMSFs can borrow to invest in property through Limited Recourse Borrowing Arrangements (LRBAs). This means that the lender's recourse is limited to the property itself, protecting other fund assets. This borrowing strategy can amplify investment returns, allowing SMSFs to acquire properties they might not be able to purchase outright. Remember when you’re borrowing to invest, investment losses will also be amplified! Also, interest rates via a LRBA will often be higher than regular investment loans and there’s a reduced number of lenders that will consider lending to a SMSF.
Cons of Buying an Investment Property Within an SMSF
1. Regulatory Complexity
Managing an SMSF comes with significant regulatory obligations. Trustees must adhere to strict compliance requirements, including annual audits, tax returns, and compliance with superannuation laws. This complexity can be daunting, and you should be prepared to spend additional time and energy managing a SMSF when compared to other types of superannuation funds.
2. High Setup and Ongoing Costs
Establishing and maintaining an SMSF can be costly. Initial setup fees, ongoing accounting and audit fees, and legal costs can add up, particularly if the fund has a small balance. You can easily spend around $2,200 or more setting up a SMSF and ongoing costs generally exceed $3,300 p.a. These costs may outweigh the benefits for individuals with limited investment capital. As a rule, you don’t want to consider establishing a SMSF unless it’s going to have a starting balance of at least $200,000 and in reality, a balance exceeding $500,000 is preferable.
3. Limited Liquidity
Real estate is generally illiquid, meaning it can take time to sell a property and convert it into cash. This lack of liquidity can be problematic, especially if the SMSF needs to access funds quickly for emergencies or unexpected expenses. It’s key here to retain a cash reserve within the SMSF, perhaps three to six months of expected SMSF expenses. It can also become a problem where the members of the SMSF have retired, and the property is the main asset of the SMSF. If the property becomes untenanted for an extended period of time, the SMSF may not be able to fund pension payments to the members. Unlike stocks or bonds, property sales involve significant time and effort.
4. Market Risks
Investing in property carries inherent market risks. Property values can fluctuate based on economic conditions, interest rates, and local market trends. If the property market declines, it could lead to significant losses, affecting the retirement savings of SMSF members. If you’re going to be investing in property, you should really be planning on holding the asset for at least seven years, that way if the property market retreats, you have time for it to recover.
5. Restrictions on Use of the Property
SMSFs must adhere to strict regulations regarding the use of properties. For example, trustees cannot use the property for personal purposes or rent it to related parties. This means that investment properties must be treated purely as investment assets, which can limit flexibility. If you’re borrowing to invest within a SMSF, further rules apply around not using borrowed money to improve the property.
6. Challenges of Property Management
Owning an investment property involves ongoing management responsibilities, including maintenance, tenant relations, and compliance with local laws. For SMSF trustees, this can add a layer of complexity and stress, particularly if they are not experienced in property management. This is where an expert property manager can really help.
Conclusion
Buying an investment property within an SMSF can offer a range of benefits, including tax advantages, greater control over investments, and the potential for strong rental yields. However, it is crucial to weigh these advantages against the drawbacks, such as regulatory complexities, high costs, and market risks.
Investing in property isn’t always the golden ticket to financial freedom. Before deciding to invest in property through an SMSF, individuals should carefully consider their financial goals, risk tolerance, and ability to manage the complexities involved. Consulting with financial advisors or property investment specialists can also provide valuable insights and guidance.
Ultimately, investing in property through an SMSF can be a powerful strategy for building retirement wealth, but it requires a thoughtful approach and a clear understanding of the associated risks and responsibilities.
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The information in this article is general information and does not take into account any person’s individual situation. You should always do your own research, or seek professional advice to assist you in making an informed decision about what suits your needs.