Ask An Adviser - Should I Switch To A Self-Managed Super Fund To Invest In Property? (1)

Top answer provided by:

Ryan Scherini

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Hi Brent,

Thanks for reaching to Adviser Ratings, it’s great to see people upskilling their financial literacy. You raise a very prominent question, one that is often asked of me. Should I start a SMSF and invest in property?

Like most responses, it’s complicated and not a quick response. Firstly, and to keep this general, you have to unpack several points to be able to answer this for you. I’ve broken this down into 4 key parts:

-What is a Self-Managed Superannuation Fund (SMSF)
-Investing in Property (including debt) within a SMSF
-Risks of holding a single asset in my fund
-What happens when I retire?

What is a SMSF:

Unlike APRA (Australian Prudential Regulation Authority) regulated funds such as retail or industry funds, SMSF are regulated by the ATO (Australian Tax Office). Up to 6 people can be members of a SMSF. However, a key point unlike APRA funds is that all members must be trustees/directors of the fund. Whilst a SMSF can be appealing due to the perceived freedom, it comes with risks that equally need to be weighed up before opening a SMSF. Before setting up a SMSF you need to consider some of the following matters:

-What Trustee structure will you use (Corporate or Individual).
-Create your trust deed for your fund (i.e. the rule book).
-Arrange for your ABN & TFN to be setup for your fund.
-Setup a bank account for your SMSF.
-Arrange for the rollovers from your other funds to be accepted.

When setting up a SMSF, the setup as mentioned above can be quite costly, especially if engaging professionals such as an accountant, lawyer and/or financial adviser. Set up costs can vary from a couple of thousand to potentially over $10,000. Therefore, you should consider the aggregate balance of the fund and whether a SMSF is worth the setup costs compared to your current fund.

If you’ve decided this is the path you’re taking, consider the ongoing obligations of your role as a trustee of the fund:

1. Requirement to be a fit person to operate a fund. Meaning, you need to be financially literate around the rules of running the fund. Whilst you may use professionals, this will not be a defence if rules are broken. You’re ultimately responsible for what happens in your fund.
2. You’ll need to manage the investments and strategy within the fund. Do you have the skill and expertise to do this? What are the costs of outsourcing this? Do you have the time to commit to managing your fund?
3. You’ll need to ensure you keep regular minutes of activity and complete the fund’s financials each year in a timely manner. Do you have the time to manage this?

From my experience dealing with clients, the impact on their lifestyle is one of the biggest reasons I see clients wind-up SMSF years later. The burden on their time outweighs the original benefits they achieved of setting it up. Please ensure that you have an exit strategy for the fund.

Investing in property in a SMSF:

One of Australia’s great pastimes. Property continues to be an attractive asset class. However, prices are more expensive than ever before. As you’ve mentioned that you’d likely start a SMSF to invest in property in the next few years, I’ve assumed that you’ll likely not have enough capital to support the full purchase. Therefore, things to consider:

1. There is additional complexity that is required, in that you need to have a Bare Trust in a SMSF to borrow funds
2. You need to find a lender that has an appetite for lending to SMSF. These generally have lower lend limits than principal residences
3. Will the fund have enough liquidity (cashflow) to meet the ongoing repayments of the mortgage. Especially in periods where the property is untenanted.

There are also other rules to be aware of when purchasing property that you should seek advice on. Things such as what type of asset you're buying, whether you can improve/renovate the property.

Risks of holding a single asset in your fund:

For a lot of people implementing a SMSF to purchase property, it may be the only asset or a large percentage of the fund assets. It goes against general investing principles such as diversification, and not putting all your eggs in one basket.

Buying a particular property, in a specific location is also magnifying your risks to that location. Are there external risks, outside of your control that could impact the price negatively in that area (i.e. proposed public transport lines are delayed or shopping districts/schools not getting built). The price of property, like any assets fluctuates on the simple concept of supply and demand. In essence, you need supply (i.e. land release) to be low and demand to be high (i.e. people wanting to move to your area).

Another key mistake I’ve seen in my history of advising, is people acquiring single property in a regional town. Whilst this isn’t saying people haven’t made significant returns on this. You need to be aware of the enhanced risks. For example, if a mine site gets closed, the whole value of a town can be impacted, and you can get sudden shifts in demand and supply.

What happens when I retire:

The attraction for most people with property is that they see property as a great source of income in retirement. However, as already mentioned, property is capital intensive and the holding costs are also quite high. To provide you a worked example:

-Purchase a house for $600,000
-Rent the property for $550.00 pw ($28,600)
-Gross Yield (income / value) = 4.76%
-Rental Expenses $10,000 (rates, water, agent fees, insurance, maintenance)
-Net Yield ((income – expenses) / value) = 3.10%

When looking at the bigger picture, the rental income alone, will likely not be enough to sustain a comfortable retirement.

When you retire, most individuals will commence an Account Based Pension, this is because of the favourable tax rates. However, the Government has rules in place that requires you to draw a pension payment in line with your age. One important consideration of holding the property in your fund throughout retirement is whether:

1. Is the income from the rental enough to support your retirement lifestyle and minimum pension requirements
2. If you need to access capital to purchase additional items (i.e. cars, holidays, renovations, health costs). The liquidity of property is nil. You don’t have the ability to sell a room – it’s all or nothing. So you need to give consideration to how long it may take to get access to the capital and the costs involved with disposing the asset (i.e. agent costs, etc.).
3. Like the setup considerations, in retirement, how much time/effort do you want to give to maintaining your SMSF. Is it impacting your lifestyle? Remembering you can only hold the property asset if in a SMSF.

Brent, in summary, SMSF’s are setup often too rashly, without consideration to all the factors involved. You should consider your situations both short and long term and make sure things like the costs and effort of running the fund are worthwhile. Importantly, is your strategy going to outperform what a standard superfund would be able to achieve? There are lots of considerations before purchasing a property and I’d strongly recommend you seek independent advice before moving forward with this strategy.

While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.

Article by:

Ryan Scherini

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