Investing in property seems part of every Australian’s DNA. No matter where you buy, prices appear to be on a permanent skyward march with none of the unnerving fluctuations seen in other investments, such as the share market.
Ask anyone over the age of fifty what their best investment was, and inevitably they will answer, buying their own home. Their biggest regret? Not buying the house next door at the same time.
So where better to invest your precious retirement savings but in property?
For many, it’s the perfect set-and-forget strategy. Borrow funds to buy a property, rent it out to tenants, and let the rental income pay off the loan. Then in 20 years, you have your own home-grown nest egg.
It sounds like a great strategy to help build your retirement savings, particularly if you can use your superannuation to make it happen. Yet as foolproof as this might seem, there are several traps to be aware of.
Firstly, the only way to buy a particular house or apartment using your superannuation savings is via a self-managed superannuation fund, a so-called DIY fund. As you are the fund’s trustee, you will need to fully understand your responsibilities in running the fund, and be able to demonstrate to the Australian Tax Office that you have thought through all the pros and cons setting up and managing a fund entails.
Secondly, self-managed super funds can be expensive. You will need to pay for an accountant to lodge a tax return for the fund each year and ensure all appropriate compliance and regulatory paperwork is up to date.
Finally, there are also strict diversification rules in place for all superannuation funds, so a substantial balance within your fund will be required to allow the purchase of a single property outright and still hold some cash within the fund.
Alternatively, you can arrange to borrow within your self-managed super fund to acquire a property, but again there are many traps for the unwary if you do decide to go down this path.
Loans used within self-managed super funds to finance a property acquisition are a very particular type of loan and are referred to as limited recourse borrowing arrangements.
Reflecting the complexities of these loans, borrowing within a self-managed super fund is much more expensive in terms of the interest rate charged, and the amount able to be borrowed is usually restricted to 60 per cent of the property’s purchase price.
There is also a raft of other regulations governing buying property using superannuation savings, including the need to establish a bare trust, to hold the investment, or that you cannot, under any circumstance, rent the property yourself or a family member.
When buying an investment property, the usual challenges should also be considered in terms of finding the right property, a good quality tenant, and ensuring the property itself is maintained and kept in a suitable condition.
Due to the rules surrounding limited recourse borrowing arrangements, an SMSF that has purchased a property using limited recourse borrowing arrangements is prohibited from borrowing funds to improve the asset. While the SMSF is unable to borrow to make improvements, it is possible to use other sources of funds. If an improvement is to be funded by the SMSF members, it’s important to remember that the value of the improvement counts toward the contributions cap. If you are thinking about renovating or repairing your SMSF property, you need to make sure you’re not breaching any rules.
None of these issues are insurmountable. They simply mean that for those looking to use their retirement savings to invest in property, getting good advice is critical to ensure it is done correctly.