PLANNING TO BUY A PROPERTY IN YOUR SMSF? WHAT YOU NEED TO KNOW.
For some time now if you have a Self-Managed Super Fund you have been able to borrow from a Financial Institution to buy a property for investment purposes. Many SMSF’s have taken advantage of this option to invest in bricks and mortar, however before you start heading to property inspections and dreaming of building a property portfolio to support you in retirement, there are some things you will need to know about how lending to an SMSF works and which lenders will support this type of finance.
SMSF PROPERTY RULES
Buying a property inside a SMSF comes with a particular set of rules and regulations to which the trustee of the SMSF must comply.
- The property must not be lived in by fund members or any related party.
- The property must be acquired for the sole purpose of providing retirement benefits to fund members.
- The property cannot be rented to fund members or related parties.
There is one exception to the rules above and that is where a SMSF purchases a commercial property that is to be occupied by a fund member’s business. The business can occupy the commercial premises but must be paying market rent.
Buying property inside a SMSF also comes with higher costs. To enable the SMSF to buy a property a special holding trust needs to be established, and the property is placed in the name of this holding trust, so there are additional costs for this to be set up.
SMSF members are also required to obtain legal and financial advice as part of the buying and borrowing process.
Borrowing for property using your SMSF comes with very strict conditions, and as such not many lenders currently offer loans to SMSF’s. These loans are classed as ‘limited recourse loans’ which means that if a SMSF defaults on a loan, the lender’s only recourse to repay the debt is limited to the property asset held in the SMSF. They cannot access any other assets within the SMSF.
Loans to SMSF’s are more costly to lenders who participate in this market, so interest rates and establishment fees applied to these types of loans are significantly higher than loans provided for buying property in your personal name. Be aware that rates above 6% are common for these types of loans. There is no correlation between the rate applied on a standard Home Loan and the rates applied on a SMSF property loan.
SMSF’s are solely responsible for meeting the repayments on the loan. Rental income from the investment property combined with super contributions on behalf of the fund members are the primary sources used by lenders to determine the borrowing capacity of the SMSF. The cash liquidity position of the fund is also a contributing factor, as there must always be sufficient cash in the fund to meet the loan repayments even when the investment property is vacant.
Lenders are therefore more conservative when it comes to gearing levels for loans provided to SMSF’s. Most lenders will not allow a SMSF to borrow more than 80% of the property value, however this will depend on the type of property being purchased. In some instances, say for commercial property or residential property in some regional areas, the percentage may be reduced to 70% and potentially lower, so the SMSF would need to contribute more cash towards a purchase than a natural person.
Furthermore, a property purchased within a SMSF cannot be altered or renovated to change the character of the property until the SMSF loan is repaid. Borrowed funds can be used to cover repair and maintenance costs, but any alterations or renovations which are classed as improvements must be paid for through the accumulated funds of the SMSF and cannot change the asset type. For example, a property originally purchased as a standard residential home cannot be altered to become a medical practice as this changes the asset type to a commercial property.
Due to the highly regulated and specialised nature of this type of lending, most lenders in the market do not offer SMSF lending as part of their suite of products. However there are a few lenders still remaining in this market, such as Latrobe Finance, Liberty and Think Tank.
There are also a number of private lenders who offer these products, however it is always best to speak with a mortgage broker who has experience in these types of transactions, as they will be able to help you navigate the complex lending process and ensure that you are able to access the most appropriate product to suit your needs.
BEFORE YOU START LOOKING FOR A PROPERTY TO BUY….
If you have a SMSF, or are thinking about establishing one, please ensure that you get the right team of experts to provide you with advice before you make the decision to buy property and borrow through your fund. That would mean speaking with your financial advisor to determine whether to buy property would align with your investment strategy, and getting legal advice to ensure the SMSF structure is in place to allow for a property to be held in the fund.
Should the advice suggest that buying property inside your SMSF is the best option for your retirement planning strategy, and finance would be required to facilitate this, ensure that your mortgage broker has experience in SMSF lending. Due to the complex nature of these transactions a lot of mortgage brokers have not participated in this market. At SHL Finance we have assisted many SMSF’s through the complex finance process and work with your financial advisor to ensure the lending solution aligns with the investment strategy.
Please call Reece Droscher on 0478 021 757 for any SMSF lending requirements.