SMSFs: Two things you must consider

The growing popularity of SMSFs has led some market commentators to call for increased regulation – regulation that if introduced, could significantly impact on the way that property investors can borrow in SMSFs. Nevertheless, for the time being, SMSFs remain a feasible investment vehicle for many Australians looking to break into the property market or expand their portfolio.

In last month’s blog, I outlined some key considerations relating to SMSF property investments including: the importance of establishing the correct SMSF structure before signing a sale contract; and the implications of understanding (or not understanding) the restrictions placed on SMSF property acquisitions.

In this particular blog, I will focus on two equally important, but perhaps less obvious, SMSF considerations – these are: the unique nature of SMSF borrowing; and the requirements around preparing an investment strategy.

1)    SMSFs lie in a unique borrowing world – forget what you’ve done in the past

The processes surrounding finance approval for SMSF loans are very different to those for mainstream mortgage products. If investors don’t recognise these differences from the outset, they risk incurring unnecessary expenses and losing properties altogether.

Most investors, particularly experiences ones, will have established relationships with mortgage brokers. Indeed, some investors may have used mortgage brokers for prior purchases and received strong Loan to Value (LRV) ratios before moving ahead with nice and easy settlements – straightforward processes with minimal fuss and complications.

The key difference in the SMSF borrowing process is that investors need to fulfill the strict limited recourse criteria – meaning that if the borrower defaults at any point, the lender’s recourse will be limited to the fund asset being financed and the income rights associated with that asset. Because of these criteria, it can take a lot longer for lenders to approve finance for SMSF property purchases.

The problem that commonly arises in practice is that investors don’t realise that the SMSF borrowing process is unique. Based on their previous property dealings, they’ll find a property, pay a deposit, and attempt to secure finance three or four weeks into the settlement process. If, for example, the associated settlement period is six weeks (as is commonly the case), the investor often won’t be able to prepare and submit the required documentation on time.

This is why it is so important to secure finance pre-approval well ahead of any intended SMSF property acquisition(s). By doing so, investors can place themselves in a position to act swiftly and decidedly should properties of interest arise – giving them not only a competitive advantage over buyers without pre-approval, but also a clear price guide and a level of certainty when searching the market.

2)    Prepare an investment strategy

All SMSF trustees are required under the Superannuation Industry (Supervision) Regulations 1994 (“the regulations”) to prepare, implement and regularly review a documented investment strategy for their fund.

The regulations stipulate a number of non-exhaustive factors that the investment strategy must take into account including:

•    The risk involved in making, holding and realising, and the likely return from, the fund’s investments, having regard to its objectives and its expected cash flow requirements;

•    The composition of the fund’s investments as a whole including the extent to which the investments are diverse or involve the fund in being exposed to risks from inadequate diversification;

•    The liquidity of the fund’s investments taking into account its expected cash flow requirements; and

•    The ability of the fund to discharge its existing and prospective liabilities.

There are no formal requirements associated with the document’s layout; your investment strategy could theoretically be anywhere from a hundred lines to a thousand pages. However, the more thorough you are, the more likely you’ll be to comply with the regulations and devise a strategy that works.

They key thing to remember when selecting a property (or properties) for your SMSF is that each investment must ultimately meet the objectives of the SMSF. This means that any prospective property investment must be aimed at benefiting members of your fund on retirement or fund members’ dependants (should a fund member pass away prior to retirement).

 About Naomi Mitchell

Naomi Mitchell has over 17 years’ tax and business advisory experience. She specialises in superannuation, overseeing over 120 self managed superannuation funds with assets over $40 million. Her clients cover a diverse range of industries including food manufacturing, construction and engineering, and hospitality.

For more information on SMSFs or the various services that Naomi and her team at Younis and Co offer, please visit http://www.younisco.com.au/.