Since legislation changed in September of 2007 enabling Self Managed Superannuation Funds (SMSF’s) to borrow for the purpose of acquiring property, this form of investing in property has slowly grown in popularity. While it has taken some time for lenders to get themselves comfortable with the space, 2012 has seen a huge increase in the number of products available and accordingly these transactions have become hugely more popular. While there are numerous advantages to using leverage to acquire property through an SMSF in terms of tax minimisation (particularly for those in or approaching a transition to retirement phase), there are a few pitfalls to avoid when applying for loans for these transactions. The following list is far from exhaustive, as the loan process is generally more complex and involved than a regular loan, it provides a starting point for those looking to go down this track:
- Ensure you get your structure correct
The number one cause of delays for SMSF applications are delays in getting the correct structure set up, so it is prudent to have the borrowing structure set up prior to entering into a contract. It is recommended that you do this in consultation with a financial adviser and/or accountant who is familiar with borrowing through Super. A solicitor who understands the documentation is a must. The borrowing structure for these transactions consists of a new trust being set up (called a BARE Trust), whose trustee is the actual borrower and holds the property as custodian for the Superfund while the loan is being paid off. The deeds for this document as well as the deed for the Superfund need to worded in a way that allow borrowing against property. Once again a solicitor familiar with this documentation should be able to assist and it is very important to have such a consultant available if you are going through with one of these transactions.
- Make sure your settlement period is long enough
Typically these transactions take at least twice as long as a regular loan transaction so 30 or even 45 day settlements will put you under enormous pressure. The settlement period should never be less than 60 days on these transactions and it is recommended that they be at least 90 days in case of delays, which are common due to the number of issues that can arise with the documentation involved in these loans.
- Be aware of servicing
SMSF Loans are generally limited recourse, meaning that individual guarantees are limited to the property that is securing the loan. Therefore servicing is generally derived principally from the rental received from the property being purchased, although regular Super contributions can usually be counted for servicing. This means that only properties that are likely to deliver a reasonable rental income would be suitable for these transactions. If you are looking at buying a residential property through an SMSF, a full guarantee can be provided enabling servicing from income outside the Superfund to be included, but I am not aware of any products that allow this for acquiring commercial property. This means that non-income producing property such as land or development sites are not suitable.
- Be aware of the limits of what you can do through your SMSF.
While I am not an expert on what is and what is not able to be done through an SMSF under the SIS Act, lending in this space is almost exclusively for “set and forget” type facilities. You will not have flexibility to borrow extra funds or vary your loan in any way. Thus, if you are looking at a property that you may want to develop or add value to in the future, I would think twice before acquiring through your SMSF. You can only borrow to acquire property and will not be able to refinance debt in your Superfund.
- Know the costs.
While there can be great tax benefits to borrowing through an SMSF, the cost of borrowing and putting together the deal is inevitably much higher than a regular loan transaction. Banks will charge interest rates up to 2% higher than their normal rates and you will need to pay for the extra legal and accounting costs as well as financial advice (which is generally a requirement). Make sure you are aware of these costs and that they are weighed up against the benefits of using this structure before proceeding. In summary, the most important thing to remember before going down the track of leveraging property through your SMSF is to keep yourself educated as to the process and to ensure that doing so is in line with your overall investment strategy. Surrounding yourself with appropriate advisers who are experienced and knowledgeable in dealing with SMSF borrowing is the first step in this process.