Self-managed super is not always a good way to buy property: Margaret Lomas

Self-managed super is not always a good way to buy property: Margaret Lomas
Self-managed super is not always a good way to buy property: Margaret Lomas

Self-managed super funds are the new kid on the block, and it didn’t take long for the hungry opportunists to jump on this band wagon and set up at property shows all over the country promoting the use of a self-managed superannuation funds to buy property. 

Why is this? My theory is that these people, who benefit from both the fees to set up the funds and the commission on the property they subsequently sell to that fund, saw very quickly that, while some people did not have the equity or borrowing capacity to buy a property in their own name, those same people may well have significant funds tied up in public superannuation funds, which could be accessed legally by setting up their own funds. This then increased the number of people to whom property could be sold, and provided a brand new market for their property products. 

I am not against a self-managed superannuation fund for the right person, as long as it has been set up under the right circumstances. However I believe that there are significant drawbacks, many of which are never outlined during the selling phase, that all investors must be aware of before they make the possibly incorrect decision to set up one. Here are just a few. 

Borrowing

Changes to the Superannuation Industry Supervision (SIS) Act in September 2007 now mean SMSFs can borrow to purchase real estate, using a structure established for this purpose, as long as certain conditions are met. There are various loan products offered which enable these purchases to be made. 

There are a number of issues with these loans:

 

  • It is not a straight loan to the superannuation fund – there must be a trustee who buys the property on behalf of the fund, who becomes the legal owner, while the superannuation fund becomes the beneficial owner that is, the entity which benefits from the asset.
  •  Loans to superannuation funds are known as non-recourse loans. This means that, if the loan is not repaid, the capacity of the lender to recover the outstanding money is limited to what they can recover by selling the property which those funds bought. They cannot touch any other fund assets. This seems good on the surface, but it means that the loan to valuation ratios are usually quite low, around 60%, to allow a suitable margin to pay costs and to account for any falls in the market value. This means that the super fund will need to have the remainder of the purchase price, plus costs available.
  • Each security property can only be used once – even if it grows significantly in value, its equity cannot be leveraged into further property. This means that each time a super fund buys a property, it must have the cash available to cover 40% of the purchase price, plus costs. If you consider that most people have less than $100,000 in superannuation, this means that their super fund can probably buy only one property. I consider the major strength of a property investing strategy is the ability to compound growth through leverage, and one property does very little for your financial future.

 

There are some benefits too:

  •  As a trust structure, assets within this fund can pass more easily to beneficiaries.
  •  If you own your own business you can borrow to buy your business’ real property (but not operating assets) using the super fund.
  •  You will pay a maximum 10% capital gains tax upon eventual sale of a property, and if the property is sold during the pension phase there is no CGT.
  •  You pay a maximum 15% income tax on rental income.
  •  Other super fund assets are secure as the lender does not have recourse to the other assets.
  •  Interest expenses may be claimed as tax deductions by the SMSF, which can potentially reduce your SMSF’s tax liability. 

To set up and run your own SMSF, it is required by law for the SMSF to be a complying fund. You will need to consult with a financial adviser to check on the eligibility of your fund under the SIS Act. Severe penalties apply for non compliance under this Act. 

In addition, you have to have an articulated investment strategy in place. It must reflect the purpose and circum -stances of the fund and take into account: 

  • How to maximise its member returns, while taking into account the risk
  • Diversification of the long-term investment strategy; and
  • The ability of the fund to pay benefits as members retire, as well as other expenses incurred by the fund.

If a fund becomes non-complying, its income tax rate will go up to 45%, and it will also incur 45% tax on all of its assets, at the start of each year that it is in breach. This will cause the fund to have a tax bill it probably can’t pay, and this may cause the property to be sold.

Remember also that for many, property is a long-term hold, and eventual sale may not even feature, which will reduce some of the benefits that buying a property using a SMSF may bring in the short term. 

You can’t live in any property that your super fund buys and you can’t rent one from your super fund, so the idea of buying a holiday home for your own use is out. You also cannot transfer personal assets into a superannuation fund, and so there is no opportunity for your super fund to take ownership of any residential property you already own.

On balance, I think there is little benefit to be gained from the average person setting up a self managed superannuation fund for the principal objective of investing in property. The compliance procedures to ensure that your fund isn’t in breach of legislation can be costly and cumbersome, and these added costs can reduce some of the other benefits significantly.

Margaret Lomas is a best-selling author and writes and hosts the popular Property Success With Margaret Lomas and heads up the panel on Your Money, Your Call, both on Sky News. This article is an excerpt from her latest book, Investing In the Right Property Now. For more information about the book, click here

Margaret Lomas

Margaret Lomas

Margaret Lomas is a best-selling author and writes and hosts the popular Property Success With Margaret Lomas and Your Money, Your Call, both on Sky News. She is the founder of Destiny.

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