Property investors…have you noticed the avalanche of information coming your way of late regarding ‘the new black’ when it comes to using residential real estate assets for your retirement fund?
Self Managed Superannuation Funds, or SMSFs for those who prefer acronym speak, are spruiked everywhere you turn right now. Some would suggest this could be to do with the incredibly high fees you’ll pay to financial planners for establishing and managing them. But that’s the skeptic coming out I guess.
Don’t get me wrong; SMSF structures have their place among certain investors, just as is the case with any type of investment vehicle and strategy. However, to think this is a viable option for all those who seek to use property to achieve financial freedom in the long term is to ignore the specific goals and needs of each individual.
So while the property acquiring SMSF proponents sing the praises of this structure, the Trilogy team would just like to add a little voice of reason and bring to your attention some of the lesser known facts, about what goes into the process of borrowing and buying bricks and mortar within your SMSF.
1. Inflexibility when it comes to refinancing. Essentially, a SMSF property loan cannot be refinanced, unless it is done so dollar for dollar. This means you cannot release any aggregate equity in the investment, as you could do with a property in a different type of structure, such as your own name, a trust, or a company.
While you might not be concerned about this at first glance, when you think about the power of leverage to grow your investment portfolio – borrowing against your accumulating capital growth to finance the acquisition of further real estate assets, this is definitely something to keep in mind if you’re considering an SMSF structure.
2. Inflexibility when it comes to improvements. There has been much made of amendments to legislation regarding the capacity for an SMSF to borrow, in order to complete renovations on the property held by the Fund.
In truth, the changes have only really provided clarity around existing rules. Basically, renovations must be paid for using existing cash from within the fund, you cannot do any works that would constitute capital improvements and/or change the overall structure or functionality of the building and construction loans are a definite no-no. In other words, there’s not a lot of room to move when it comes to manufacturing capital in your SMSF property from improvements.
3. Inflexibility when it comes to what you can purchase. You can only finance certain aspects of a property from within your SMSF. This is due to what the legislation and lenders will recognise as security.
For instance, if you buy an apartment with car spaces on a separate title, the fund can only borrow to purchase the apartment, which is the security. Hence you would need to pay cash for the car spaces. Further, lenders will not fund the cost of an included furniture package, even if it’s listed in the Contract of Sale, because finance is only for a single asset.
Some lenders also have postcode restrictions when it comes to financing a property within an SMSF, meaning certain locations are out of the question.
4. Forget about OTP purchases. Buying an apartment off the plan can be problematic for SMSFs. For starters, you cannot get formal loan approval with a full valuation until the property is completed and will therefore require a longer settlement of at least 28 days. Then there are the time restrictions, such as awaiting the issue of loan documents, which some banks will not do until the plan is registered. This can leave you with just two weeks to get them signed, returned and certified, cutting things very fine indeed.
5. More potential onus on the self employed. If you are self-employed and can fully service the property loan within your SMSF through your PAYG, rental income and employer contributions you’re in a better position than most, because your SMSF stands alone as being responsible for the repayments.
If you are not so fortunate though and your PAYG, etc is insufficient to cover the mortgage on the property within your SMSF, you will have to go personal guarantor. In this case, the lender will require you to provide a full Statement of Position. All of this paperwork must be completed prior to making an offer on any property, so you (and the banks) know where you stand from a personal financial perspective.
6. There are a lot of expensive boxes to tick. All lenders require you to have your financial planner sign off on any property investment acquisition made within your SMSF. This can sometimes mean preparation of a full Statement of Advice is necessary. Of course to save time and fees, it’s advisable to have this done by the original financial planner you consulted to help establish your SMSF, including the companies and Trust Deeds.
Lenders also require that you seek independent legal advice and have a solicitor – generally not the same one involved in the conveyancing aspect of your property transaction – give the purchase a tick of approval.
As with everything to do with SMSFs, both of these processes will incur costs. Then of course, you must factor in time around the purchase process in order to book the necessary appointments. You can potentially save some time and know what charges to expect if you pre-determine who you will consult during this step.
Importantly, make sure you qualify the solicitor you seek that all-important sign-off from, confirming that they have completed this part of the SMSF loan application process for previous clients. This is considered non-recourse borrowing, so they need to be experienced in this space.
Our team has had experience with numerous clients looking to finance the purchase of an investment property within their SMSF. Some of their suggestions to ensure a smoother process and correct compliance measures around these transactions include:
- Make sure the Contract of Sale allows for at least a 45-day settlement in order to get all of your ducks in the necessary row. If you’re purchasing off the plan, make settlement for 28 days after the unit title is issued, rather than the standard 14 days.
- Make sure SMSF deeds are written correctly to avoid issues with lenders. The original deed needs to give the Fund permission to purchase direct property. If the deed has to be amended to reflect this allowance, then it must have the correct ratification letters and amendments in place.
- There are additional legal costs associated with an SMSF loan, with the caveat to avoid stamp duty upon payout of the loan when it’s finalised.
Finally, make sure you consult the necessary professionals only after qualifying their level of experience in dealing with SMSF management and lending. We cannot stress how important this is, as non-compliance (whether intentional or accidental), can be very costly and potentially negate any financial advantages of buying property within the SMSF structure.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).