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If you’re thinking about establishing your own self-managed superannuation fund so you can purchase a residential investment property, there are four guiding principles you should follow, according to a senior financial planner.
Andrew Zbik of Creation Wealth always advises his clients to carefully consider the following points when they’re deciding if it’s smart to use an SMSF to borrow money to get into the property market.
Consider your minimum super balance
Heard you could start an SMSF with a balance of $200,000 to buy an investment property as the sole asset of the fund? It might not be advisable.
The Australian Securities and Investment Commission (ASIC) believes you should have at least $500,000 to establish an SMSF. The Australian Taxation Office (ATO) also notes that SMSF trustees are obligated to consider asset diversification within the fund. With that in mind, and given that most lenders are now requiring a 10 per cent liquidity buffer of cash and/or shares outside of the value of the property, starting an SMSF with $200,000 to buy a property is not likely in your best interest due to a lack of diversification and a lack of liquidity.
Plan to continue working for at least another 10 years
Borrowing with your SMSF is not an ideal strategy for anyone planning on imminent retirement. A full property cycle in Australia is around 10 years, and you need to allow time for your property to grow in value. The intention should be to hold the property beyond 10 years, according to Mr Zbik. He believes the only time an SMSF should sell off a property is when the debt has been repaid and the sale will allow the net proceeds to be invested into another asset class that provides a higher income yield.
Be prepared to protect your cash flow
If the fund has two members earning an income, you should think seriously about whether the SMSF can continue to service the debt if one of the members loses their job. Mr Zbik recommends basing lending capacity on one income only, so that if you find yourself in the unfortunate situation where one member is out of work, your cash flow doesn’t become an issue.
He advises that an SMSF hold a cash buffer of at least six months of all property expenses, including loan repayments and rental costs such as landlord insurance, strata fees and council rates. This additional cash can be held in an offset account against the superannuation fund loan, helping to reduce your lending expenses via the rate of interest paid. This also helps to improve the cash flow of the fund, Mr Zbik noted.
“A good diversification strategy would also include other liquid assets such as Australian shares, international shares and fixed-income securities,” Mr Zbik said. That way there are other assets available to liquidate if you find yourselves in a situation where one of the contributors is without work.
Have a plan to pay off the loan
Ask yourself: will your concessional contributions be enough to pay out the loan, and will you need to make extra contributions to your SMSF to have the property loan paid down before retirement? You need answers to these questions to assess if it’s smart for your SMSF to borrow to purchase assets, according to Mr Zbik.
“I never rely on a debt reduction plan that involves selling the asset itself,” Mr Zbik said. “I like it when clients have the ability to make additional superannuation contributions to the fund or have other assets in the fund outside of the property, such as shares or ETFs, that produce income and capital growth.”
If set up with additional cash flow, capital growth and income, you’ll be in a good position to reduce your debt without relying on the sale of the property itself.
Property refers to either a tangible or intangible item that an individual or business has legal rights or ownership of, such as houses, cars, stocks or bond certificates.