How to buy property through super
IT'S A STRATEGY THAT IS BECOMING INCREASINGLY POPULAR EVERY YEAR, USING YOUR SUPER FUND TO PURCHASE AN INVESTMENT PROPERTY...
There is no doubt that Australians have a love affair with residential property, and after the release of the Core Logic August 2015 Housing Market & Economic Update it seems this affair is getting out of control. Residential real estate across Australia has now ballooned out to $6.0 trillion. This means that residential real estate is now 3 times as large as superannuation!
Do I think Australians are overweight in residential property? Absolutely.
Has this stopped thousands and thousands of Australians from making it their primary investment choice and prospering from it? No it hasn't.
I have no intention of weighing into the property vs shares debate because quite frankly, my personal opinion is that they are both solid investment strategies. Ultimately what investing comes down to for me is that I can sleep at night with my investment choices. And I know for a lot of people, they are just a lot more comfortable investing in property then they are with shares.
So if you happen to be one of those people, this article will seek to enlighten you on the basics of how it is possible to own an investment property through super in addition to outlining some of the risks you need to consider.
SETTING UP AN SMSF
First up, the thing you need to know about this strategy is that you can't call up Australian Super, MLC or whoever your superannuation is with and tell them you want them to buy an investment property for you. What you will need to do is set up a Self Managed Superannuation Fund (SMSF) as you are able to borrow funds under this type of arrangement.
Now, although this is the first step, getting the SMSF set up correctly is the first mistake that people will find themselves in when embarking on this journey, both in terms of setting up the structure correctly and getting the right type of advice...
One thing you need to know about an SMSF is that you essentially become the CEO of your super fund which means that you are responsible for handling all of the compliance and investment decisions that come along with it. The superannuation industry is one of the most heavily regulated industries and there is a truckload of red tape associated with it. If you make an incorrect investment choice, if you do not lodge tax returns every year, if you don't get regular audits etc then you will be the one that has to deal with the ATO and their penalties can be extremely harsh.
For this reason, I would strongly urge you not to try and set everything up yourself. Instead get in contact with a qualified accountant or financial planner who has experience in SMSFs and can handle all this for you.
Which leads me to the next thing you need to consider...
COST
A typical superannuation fund will likely cost you somewhere in the vicinity of 0.5 - 1%. So if you and your partner have a combined balance of $200,000 this will be around $2,000 p.a.
If you were to go to an accountant or financial planner to set up and then manage your SMSF, as a rough guide you would be looking at around $5,500 for the initial set up and then $2,500 p.a. to manage it for you.
As such, in terms of costs, if your balance is less than $200,000 the cost associated with an SMSF would appear very expensive then a regular super fund.
How big should your super balance be before you set up an SMSF?
I guess I've answered that question for you in terms of cost but the other thing you need to consider is the deposit required in order to purchase an investment property and how much cash you are happy to have left over.
What sort of property you are looking to purchase will obviously dictate what the purchase price will be but let's work off $600,000.
If you want to purchase an investment property outside super, the banks are happy to lend you 90% LVR and up until the recent APRA changes came into affect you could even get up to 97%.
However, in regards to SMSFs, the banks are extremely nervous about what sort of headline they would create if they were forced to take a mortgagee possession of your property and essentially ruin your retirement savings. So, in order to reduce the chances of your SMSF defaulting on loan its repayments, they have restricted their LVRs down to 80% and again, with the recent APRA changes, some lenders such as St George and Westpac have reduced their maximum exposure down to 70% so I'll work off the lower LVR as well.
When purchasing a property there are a number of fees associated with it such as stamp duty, lender and conveyancing fees. As a rough guide, a quick way to estimate what these fees would be is to multiply the purchase price by 5%.
In our $600,000 example, this would mean that fees associated with the transaction would be $30,000. As such, in order to settle on the property you'd need to come up with $630,000.
Now, if the banks will only lend 70% of the purchase price or $420,000, it means that you'll need to come up with $210,000 to cover the difference.
Let's say that you have a combined super balance of $220,000. Obviously if you were to purchase the investment property, it will mean that you will have very little funds left over to pay for everything else.
In addition, the other thing you need to consider is the fact that instead of having a diversified portfolio of shares, you now only have one asset, essentially putting all your eggs in one basket so it goes without saying that you would need to research your property purchase extremely well.
And that last point is really where the most pain has come from in the SMSF investment property world. Investors who believe that property is the golden ticket to wealth creation and then get conned into buying some sort of off-the-plan property in an area of Australia they have no idea about.
JUST SCRATCHING THE SURFACE
I think it goes without saying that this is only a very basic outline of what you need to consider before purchasing an investment property through super. There are still many, many other things you need to be aware of which I haven't covered such as:
- How the banks assess income to approve the loan
- Correct structure to purchase the investment property
- The fact that you need to provide personal guarantees and the implications behind this
- Different tax rules that govern superannuation
- What you can and can't do to your property once you've purchased it via an SMSF
- Limits banks place on redraw and borrowing extra funds
- What you need to do if you want to purchase another property in your SMSF
The goal of this post was not to be an all encompassing guide to SMSF property. Rather, it has been written with the intention to get your brain thinking about this type of strategy so that you can begin looking into it further.
Kind regards,
Tim Russell