A Borrower’s Guide To SMSF Loans

by Greg on November 9, 2015

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Self-managed superannuation funds (SMSF) provide you with choice and flexibility to take control of your super. A key strategy used by SMSF is investing in property using a SMSF Loan. Unlike industry and retail super funds, SMSFs allow you to invest in direct real estate. More and more Australians are taking advantage of the opportunity to borrow up to 80% of the SMSF Property value to invest in property.

Investing in property with an SMSF

Australian property markets have grown strongly over the last 10 years with a significant increase in median house values across all capital cities. Recently there have been an emphasis on the impact of SMSF Property on the property market with claims that SMSFs were pushing up property prices on the back of record low interest rates and the ability to obtain a SMSF loan.

There are contrasting views on the impact of the almost $600 billion SMSF market on property. Since 2007, SMSFs have been allowed to borrow to purchase a SMSF property. As SMSF members have learnt more about the benefits of borrowing to invest in SMSF property, we have seen a sharp increase in SMSF Property Investment and SMSF loans. This is also due to many Australians being unable to enter the property market outside super. Even with the SMSF property hype SMSF loans represent only 3% of the overall SMSF empire of $600 billion in assets.

A key reason SMSFs invest in SMSF Property is to take advantage of the key tax concessions including 15% tax on rental income in accumulation phase and potentially no tax in retirement. You can compare this to your marginal tax rate and see the benefits immediately.

Advantages of people using their SMSF to purchase property

There are a number of key benefits of borrowing to invest in property:

Potential for increased net returns
Investing in SMSF Property in a long-term strategy – similar to a loan term can be viewed by returns up to 30 years. SMSF Loans can allow your SMSF to acquire property, borrowing up to 80% of the property value. Each property will receive rental income and depending on the age of the property will generate a depreciation deduction improving your SMSF’s returns over the loan term. With an effective SMSF Strategy – it’s a perfect opportunity to take advantage of tax concessions to achieve long term returns for your SMSF property.

Diversification
Under Superannuation Law, you are required to document your investment strategy including diversifying your investments, liquidity and insurance.

SMSF loans provide the perfect opportunity to limit your cash investment and diversify your SMSF investment portfolio. A well-diversified portfolio can reduce portfolio risk and improve investment returns over your investment horizon (i.e. 30 years). SMSF loans can provide the opportunity to improve liquidity by investing in a wide range of assets.

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Compliance requirements

There are a number of benefits of borrowing to invest in property, however it is important to understand your compliance obligations.

SMSFs must comply with the Superannuation Industry (Supervision) Act (SIS Act). A SMSF may invest directly in real property as long as it is in line with the SMSF’s investment strategy.

SMSF’s can have investments in the following types of real property:

  • residential property, and
  • commercial property.

There are certain restrictions on acquiring property from a person or entity related to a trustee or member of the fund. There are also restrictions on the leasing the fund’s property to a person or entity related to a trustee or member of the fund. There is an exception which allows SMSF to acquire from and lease business real property to a person or entity related to a trustee or member of the fund.

SMSF loan V Cash Investment?

SMSF Loans enable you to leverage within your SMSF. You may not have enough funds in your SMSF to enable you to buy an investment property outright and therefore consider borrowing up to 80% of the property value. The decision will be driven by your risk profile and investment strategy, however with interest rates currently at record lows, SMSF Loans are becoming a popular option for SMSF investors.

How does it work?
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  1. SMSF is set up by an SMSF Specialist.
  2. A Broker will assist you to determine your borrowing power.
  3. Your SMSF selects a residential/ commercial investment property to purchase, then establishes a custody bare trust to purchase the property on behalf of the SMSF.
  4. Proceed with SMSF Loan application and formal approval.
  5. The property trustee pays the deposit and exchanges contracts.
  6. Once your loan is approved, settlement will occur.
  7. Your SMSF collects rent, pays the usual outgoings on the property and makes the loan repayments. It manages the property in the same way as any other real estate investment.
  8. The property is held in trust for the SMSF by the property trustee and once the loan is repaid, the legal title may be transferred from the property trustee to the SMSF, or the property may be sold.

The rules around borrowing through an SMSF are quite complex so you should speak to Redwood financial planner and professional tax adviser before deciding whether to borrow in order to invest within your SMSF.

How much can I borrow?

For SMSFs looking to purchase residential investment property, most lenders will restrict your loan to a maximum:

  • 80% of the property value for residential property
  • 70% of the property value for commercial property

Your loan value will be determined by meeting the serviceability requirements as well as liquidity requirements of the relevant lender. Depending on the security, the Loan to Value Ratio may be reduced for certain security such as off the plan, regional areas and rural properties. Investments such as land may be excluded altogether.

Importantly, product features (such as offset accounts) will differ between lenders, a Redwood broker will assist you to choose the most suitable lender with the most suitable rate and features based on your personal circumstances.

Is the Cheapest rate the best?

Generally, many Australians will be price sensitive to interest rates. However it is important to take a long-term view to your SMSF loan. Firstly SMSF Loans are charged a higher variable rate than your home loan. In an environment where we are seeing interest rates on home loan below 4%, the cheapest SMSF interest rate is 5.1% (variable). The highest interest rate is due to many factors including:

  • an SMSF is a Trust not an individual loan
  • SMSF Loans are limited recourse
  • SMSF require the establishment and review of a Custody Bare Trust

SMSF loans are unique and quite complex, it is important to seek advice from an SMSF Specialist & Broker prior to borrowing to invest in SMSF property.

The Best SMSF Lenders

Take the headaches out of SMSF Loans and engage a Broker can do the shopping for you. SMSF variable rates are falling as more lenders have entered the space. However it is not just the rate that will determine the best loan for you. The importance of an offset account is clear for many investors that hold property and have a large proportion of their SMSF in cash. An offset account is a transaction account linked to your loan. Over the loan term (i.e. 30 years), an offset account can save you thousands of dollars in interest.

For example, if your SMSF property is worth $300,000 and has an offset account of $40,000, the interest on your will be charged on $260,000 not $300,000. Therefore the offset reduces your interest payment. This includes a substantial benefit over the loan term.

Personal Guarantees
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SMSF loans should be limited recourse, and the Custody Bare Trust successfully protects your SMSF assets. Unfortunately, all SMSF lenders now require a personal guarantee. By definition, if you foreclose on the SMSF property, your personal assets may be in danger (limited to the value of the SMSF property). It is important to seek legal advice prior to signing your mortgage documents.

The bottom line on SMSF Loans

SMSF loans and purchasing property in an SMSF is a brilliant strategy, for the right person when advice is obtained from an SMSF Specialist. In considering SMSF Loans – the SMSF Investment Strategy, asset mix, taxation and risk profile will be assessed again the SMSF Loan product that will be most suitable for you.

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Ivan Filipovic

Ivan Filipovic is an experienced, independent Property, SMSF and Finance Expert and the founder of Redwood Advisory. Ivan has been educating and coaching investors for over 15 years and has built a successful property portfolio with a number of positive geared properties across Australia. Ivan provides valuable and honest guidance by educating Australians on how to invest successfully protect yourself with knowledge, contact Ivan today for a complimentary consultation on 1300 790 110 or email ivan[at]redwoodadvisory.com.au

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