SMSFs should consider commercial property investments: John McIlroy

There has been widespread publicity recently about Australians investing their super in geared residential property. Much of this publicity has centred on schemes being promoted involving self managed superannuation funds (SMSFs) and has attracted comment by ASIC and more recently the Reserve Bank.  

When using  an SMSF to invest in property the common mistakes being made are:  

• Not having enough super to start with and then having to excessively gear the property;  

• Creating a super fund which just has a single asset;  

• Buying the property before the structure is organised;  

• Not having a plan about how the debt will be repaid;  

• Investing in off the plan residential developments which generally increase the risk factor;  

• Not thinking about the wide range of property options there are.  

When properly researched and properly structured an SMSF investment in direct property (including gearing) can work very effectively. But most SMSF trustees generally focus on residential property and not other forms of property. Why not office, retail or industrial?  

An SMSF could directly acquire for example a small factory, a shop or an office. There are also other alternatives such as property syndicates and single property trusts which tend to focus on office buildings.  

A residential property investment may deliver around 5% rental income and usually this reduces to 4% or lower after expenses including property management costs. To make the gearing work you need to have an expectation of sound capital growth on top of this but this has been quite low over recent years.

With offices, factories and retail you would normally expect the income return to be significantly higher than residential property and this generally comes at the expense of a lower capital growth expectations. Income yields would normally be in the 7% to 9% range depending on the type and location of property.  

In times of low interest rates, cash rates at 2.5% and the prospect of medium term low rates, getting an income return of around 7% plus from shops, offices etc starts to look quite attractive particularly if you can minimise the risks with the investment. As with residential property a good tenant is highly important and the key with commercial property is to have a plan to be able to tweak the property to generate higher rental yields.  

One of the benefits of using non-residential property in an SMSF is that you can use your business entity to become the tenant - something you can’t do with residential.  

SMSF trustees should therefore think outside the box in these times of low growth, low inflation and low rates and higher yielding property is one of those key considerations. But do your research and importantly have a plan of how any debt will be repaid.