Direct property and your SMSF
Having exposure to property in your self-managed super fund (SMSF) can help diversify the fund’s investments.
There are a number of ways to achieve this exposure. One way is to directly invest in property. Other ways include investing in listed and unlisted real estate investment trusts.
Each of these approaches has pros and cons and it’s important to understand what these are when forming views about your fund’s allocation to property as an asset class.
Real property is complex
Self-managed super funds are allowed to invest directly in property. But the rules that govern this process are complex.
According to the Australian Securities and Investments Commission’s (ASIC’s) MoneySmart web site, if an SMSF buys a property it:
- Must meet the sole purpose test of only providing retirement benefits to fund members.
- Must not be acquired from a member’s related party.
- Must not be lived in by fund members or their related parties.
- Must not be rented by fund members or their related parties.
Borrowing arrangements to acquire the property are also strict and onerous. The fund must only borrow to buy a property through a limited recourse borrowing arrangement that essentially corrals the fund’s other assets.
This is so that in the event repayments cannot be made the lender has no recourse to the fund’s other assets. It can only repossess the property to which the loan relates.
SMSF trustees must also consider the risks of investing in a property through the fund before buying real estate. Loans for properties to be held by an SMSF are typically more expensive that other mortgages.
The fund must also ensure it has available cash to meet repayments, and all paperwork associated with the property must be updated and correct. Additionally, trustees are not allowed to alter or develop the property until it has been paid off.
ASIC and the Australian Taxation Office are also extremely wary of lenders and property groups who work together.
As the regulator notes on its MoneySmart site, “Be cautious if someone related to the property you are planning to purchase offers to arrange your loan as sometimes unscrupulous advisers work in groups and recommend each others’ services.”
Buying property through an SMSF can make sense for some people. But it’s important to fully appreciate the complexity of the process before buying real property through the fund.
Nevertheless, there are advantages of investing directly into property. “You get to see the asset; it’s real and so people understand it,” says Mark Borg, principal and senior financial planner with MBA Financial Strategists.
“As well, most property creates income and capital gain and income is very important to most retirees,” he adds.
However, Borg says it’s important for SMSF trustees to remember real property has particular characteristics other asset classes don’t have. These include maintenance and other costs and the need to find tenants. There are also other risks SMSF trustees need to take into account.
“With many properties, the income produced versus the value of property or the yield is quite low, after fees and costs. As a result, they may not meet members’ income needs in retirements,” he explains.
The value of real property can also be a barrier. Many SMSF investors may only have the means to hold one property. This may over-expose the investor to risks such as the volatility of the property market and may mean the fund is not properly diversified.
“Direct property investments are illiquid. It is difficult to sell one room if you need some funds and it takes time to realise money in the event of a sale,” he adds.
Alternatives to direct property
There are options to gain exposure to property as an asset class that don’t involve directly buying real estate. Listed and unlisted property funds are two popular choices among SMSF investors.
“Property funds allow you to diversify across many properties, which are professionally managed. There are a lot of options in this area, and investors can choose between fund managers and sector,” Borg notes.
But as with any investment, it’s important to carefully choose funds with a good track record. Care should also be taken to ensure the asset helps fund members meet their investment goal.
The idea is to thoroughly research the sector and pick quality funds with experienced management teams.