How to buy a property through an SMSF

Many Australians have used funds that are ‘stuck’ in superannuation to purchase investment properties as a way to grow their retirement wealth. In this newsletter, I look at the process of purchasing property through a self-managed superannuation fund (SMSF).

1. The first step in the process is to establish an SMSF. This must be done with the help of a licensed professional to ensure the SMSF is compliant. There are a number of steps here including registering the fund, appointing trustees and opening a dedicated bank account. As part of the process, an investment strategy will need to be created – include property investing in this strategy.
2. The second step in the process is for the investor to speak to a mortgage broker about securing finance. Borrowing through an SMSF is more challenging than taking out a regular home loan outside super; because there are fewer lenders in the SMSF space, they have tighter lending conditions and they charge higher interest rates.
3. Third, the investor will need to establish a bare trust, which is a type of trust that can hold only one asset at a time. That's because, for technical reasons, an SMSF can't borrow money to buy an asset; instead, the bare trust needs to do it on the fund's behalf.

?

Limited-recourse borrowing arrangement explained

Most home loans have full-recourse borrowing arrangements, which means if the borrower defaults on the loan and the lender is unable to reclaim all its money by selling the property, the lender has recourse to pursue other assets belonging to the borrower.?

However, SMSF property loans have limited-recourse borrowing arrangements, which means if the borrower defaults and the lender is still owed money after the property is sold, the lender can't attempt to seize any assets outside the bare trust; and because the bare trust, by definition, will have only one asset, the lender must accept the loss.

?

Sole purpose test explained

Investors can use SMSFs to buy both residential and commercial property. Either way, the investment must comply with the sole purpose test, which means the sole purpose of the investment must be to provide retirement benefits to members of the SMSF.

That’s why a residential property cannot be rented out to a member, or one of the member's relatives or associates. Instead, it must be rented to another party on market terms.

The rules for commercial property are slightly different. Members are allowed to lease the property to their business; however, the business must pay a rent that matches the market rate.

?

Final note

SMSF property investing can be quite technical, which is why it’s so important for borrowers to work with a good accountant, financial planner and broker. Feel free to reach out to me if you need recommendations.