7 Key Considerations for Using Your Super to Invest in Property

Investing in property through your superannuation can be a smart way to build wealth for retirement. However, there are several important considerations and rules to understand before you proceed. Here’s a detailed look at the key points:

1. Setting Up an SMSF and a Bare Trust

To invest in property using your superannuation, you need to use a Self-Managed Super Fund (SMSF). If you don’t already have an SMSF, you’ll need to set one up. Here’s what you need to know:

• SMSF Setup: Establishing an SMSF involves various steps including registering the fund with the Australian Taxation Office (ATO), creating a trust deed, and setting up a bank account for the SMSF. The costs for setting up an SMSF can range from $1,500 to $3,000 or more, depending on the complexity and professional fees.
• Bare Trust: When an SMSF invests in property, a bare trust (or custodian trust) must be established to hold the property on behalf of the SMSF. This structure is required to comply with the borrowing rules under superannuation laws. Setting up a bare trust typically costs between $500 and $1,500.

2. Property Types and Usage Restrictions

An SMSF can invest in both residential and commercial properties, but there are strict rules about how these properties can be used:

• Residential Property: The property cannot be lived in by you or any other member of your SMSF, their relatives, or associates. It also cannot be used as a holiday home. This ensures the investment solely benefits your retirement savings.
• Commercial Property: SMSFs can invest in commercial property, including your own business premises. This is often referred to as "business real property" and must be used wholly and exclusively in one or more businesses.

3. Loan-to-Value Ratio (LVR) and Funding Costs

When borrowing to invest in property through an SMSF, the following financial aspects need careful consideration:

• LVR Limits: Lending can be done up to 90% Loan-to-Value Ratio (LVR) for both residential and commercial properties. This means your SMSF needs to have a deposit of at least 10% of the property's value.
• Covering Costs: The deposit, stamp duty, legal fees, and any other associated costs must be paid using the funds within your SMSF. If your SMSF doesn’t have enough funds, additional contributions can be made to cover these expenses, adhering to the contribution caps set by the ATO.
• Minimum Balance: Typically, even for a modest SMSF investment property, the minimum balance required is around $200,000. This amount covers the deposit, stamp duty, and upfront costs, while also leaving some remaining liquidity in the fund. Ensuring sufficient liquidity is crucial for covering unexpected expenses and maintaining the financial health of the SMSF.

4. Higher Interest Rates and Cash Flow Management

Loans for properties purchased through SMSFs often come with higher interest rates compared to standard property loans. This impacts the overall financial management of the property investment:

• Interest Rates: Expect to pay higher interest rates, which means the rental income from the property may not cover all loan repayments and associated costs.
• Cash Flow: Be prepared to either contribute additional funds monthly to cover shortfalls or make a larger upfront deposit to reduce the total loan amount. This ensures the investment remains financially viable.

5. Superannuation Preservation Rules

All funds within an SMSF, including those generated from property investments, must remain within the superannuation environment until you reach the eligible age for drawdown:

• Funds Retention: If you sell a property, the proceeds must stay in the SMSF and cannot be withdrawn until you meet a condition of release, typically retirement.
• Long-Term Planning: This necessitates a long-term investment strategy, focusing on retirement benefits rather than short-term gains.

6. Leveraging Equity in SMSF Properties

Leveraging equity from existing properties is not permitted under SMSF lending regulations. Here’s how to manage equity:

• No Equity Access: Unlike traditional property investments, you cannot access the equity built up in an SMSF-held property to fund further investments. This limitation can impact your investment strategy if you rely on leveraging equity for growth.
• Realising Equity: To use the equity in an SMSF property, you must sell the property. The equity realised from the sale remains within the SMSF and can be used for subsequent investments.
• Future Investments: If sufficient equity is realised from the sale, it may be enough to fund deposits for multiple properties. However, it’s crucial to check that the SMSF’s servicing and borrowing capacity are adequate before proceeding with new investments.

7. Diversification of Investments

Diversification is a key principle in any investment strategy, and it’s no different when using your superannuation to invest in property:

• Seasoned Investors: Typically, investors who choose to use their super to buy property are already seasoned property investors who have experienced a level of success and want to diversify their super into property.
• Maintaining Diversification: Consider keeping your established retail or industry super fund open to maintain a level of diversification across other asset classes. This approach ensures that you are not overly exposed to the property market.
• Financial Advice: Talk to a financial advisor about what other investments can be run within your SMSF alongside property. Options could include shares, bonds, or managed funds, which can help spread risk and enhance returns.

Conclusion

Investing in property through your superannuation can be a powerful tool for growing your retirement savings, but it requires careful planning, understanding of the rules, and financial discipline. Setting up an SMSF and a bare trust, adhering to property usage restrictions, managing higher interest rates, ensuring compliance with superannuation preservation rules, understanding the limitations on leveraging equity, and maintaining diversification are all critical steps to ensure your investment strategy is successful. Always consider seeking professional advice to navigate these complexities effectively.