The rise of the SMSF investor

** Originally published on www.ripehouse.com.au.

Over the past 10 years to 2014, residential real estate investing in Self-Managed Super Fund (SMSF) has increased from 0.5% of SMSF assets to 3.53%, an analysis of Australian Taxation Office figures by SuperGuide shows.

The main reason for this increase in Australians spending their retirement fund on the property is a desire for more control over where their money goes and a change in the laws in 2006/2007, Lawlab Legal Director Richie Muir said.

When the laws changed a decade ago, it suddenly allowed SMSFs to borrow to buy real estate. Before this time, people could still buy homes in their super fund – but they’d need to have all the funds up front. By allowing Limited Recourse Borrowing, it suddenly meant many more Australians had the necessary funds to invest.

“It opened up a whole new market,” Mr. Muir said, allowing many Australians to buy with a 30% deposit.

“But the regulators didn’t want situations where people were investing and potentially using all their super as it’s meant to be a pension later in life. They created rules around super borrowing, around the asset,” he said.

That is, it’s not the same as heading into buying a property in your own name. Before you even consider what property you want to purchase, you need to work out how to set it up and ensure it is structured correctly.

To buy a property, and borrow, the SMSF itself is the borrower. But the owner of the property is actually a bare trust – also known as a security trust or a custodian trust.

“The separate trust is set up just to purchase the property so that if the SMSF defaults on the loan, the bank can only go after that asset rather than the other assets [in the fund],” he said. Setting this up can be complex and can cost up to several thousand dollars. A simple online SMSF can cost $800 – but it is unlikely to allow the trustees to borrow to buy real estate

Unfortunately, some SMSF-hopefuls get this wrong upfront. Not setting it up before purchasing can lead to needing to rescind on sales contracts, delays, non-compliance, paying stamp duty twice and incurring fees to restructure the fund.

The deposit itself also needs to come from the SMSF and not individuals themselves, this can take time and needs to be planned in advance, which might have some rethinking an auction day bid on behalf of their SMSF.

“For the loan security documents, the borrower needs to be the SMSF, rather than the bare trust. The lenders will often have strict requirements for borrowers to get independent legal advice,” Mr. Muir said

“They [may] need personal guarantees and some even require advice from a SMSF specialist lawyer, to say it is correct and complies with all the laws. This costs money and can cause delays.”

This is one of the reasons why off the plan properties are some of the more commonly bought in an SMSF structure, VJR & Associates and Keshab Chartered Accountants’ Jeremy Iannuzzelli said.

“There’s no limitation on what type of property you can buy, you just need to focus on the growth,” he said.

But there are limitations on what you can do with the property when you’re borrowing to buy it. Altering the property substantially – so any redevelopment or structural renovations – is out of the question. This is another reason many investors consider new properties when buying in an SMSF.

Similarly, you can’t rent it to your friends or family and you can’t buy a holiday home to use yourself – it needs to be for investment purposes and managed at arm’s length.

And while the power is in your hands if you DIY your super, you are still “subject to legislation … to parliament changing laws at different times,” he warned.

For those who are prepared to put in the effort, particularly high-income earners, there are however substantial tax breaks available, Property Tax Specialists Principal Adviser Shukri Barbara said.

Someone earning $180,000 plus a year paying 49% in tax, would instead be taxed 15% on any extra contributions into their super. And as the contributed money is considered income by the superfund, having a negatively geared property can bring this tax bracket down even further.

But he warned that setting up an SMSF without $200,000 to $300,000 or more available probably wouldn’t work, given the money needed for stamp duty, legal fees and to cover any vacancies.

“It’s worth getting an experienced financial planner who can take everything into consideration,” he said.

Richie Muir

Legal Director

Richie is an experienced and commercially astute lawyer specialising in property law. He leads lawlab’s team of legal advisors and is the go-to problem solver for complex or unusual matters.  Having spent many years living and studying in Europe he now calls Brisbane home. Outside of work he juggles his time helping bring up his 2 young daughters, playing football and developing property.