Using an SMSF to invest in property: A guide for novice and seasoned investors

SMSFs can allow investors to collaborate and combine funds with others for greater investment. While this could technically be done with anyone, it’s most commonly seen when couples (or family units) merge funds together to create one SMSF.

According to Lee, there are multiple opportunities across residential and commercial property for investors to use SMSF to get ahead and expand their property portfolio beyond their personal portfolio.

Property types and investment opportunities in SMSFs are usually similar to what will be purchased under a personal name. They should consider properties in solid locations with strong yields and future growth potential.

Is it for you?

Lee sees investing in an SMSF as a great option to further a property portfolio, especially if an investor is limited in their personal name due to cash flow.

With the current interest rate environment – and cash flow – a concern for many households, he says that an SMSF can provide leverage for investors by combining their super contributions with rental income to cover cash flow.

He sees SMSFs as “a solid option to get an additional property without forking out cash every month from the personal budget to cover the negative cash flow”.

What does it cost?

A combined SMSF balance of $175,000 to $200,000 is sufficient to allow investors to explore purchasing a residential property at a price point of around $500,000, says Lee.

He explains: “At this price point, investors can also have surplus funds in their SMSF to diversify their investments to other assets, have larger buffers, or even place larger deposits down on the purchased property.”

While income requirements to service the loan will vary, a back-of-hand calculation you can use is multiplying your rental income and contributions by the number nine.

This calculates roughly how much you will be able to borrow.

The tax break

Tax is “significantly lower” within the superannuation scheme, as Lee points out.

Income, such as a positive cash flow property, is taxed at just 15 per cent – typically much better than what investors are liable for in their personal name.

Capital gains are also taxed at 15 per cent, unless the asset has been held for more than 12 months, where the tax rate drops to 10 per cent.

While property transactions can be expensive, SMSFs can offer more incentives to ride market cycles in pursuit of gains and eventual redeployment of funds into another property investment, or multiple.

Other costs to consider

Setting up and maintaining an SMSF involves costs such as legal fees, accounting fees and audit fees, as Lee points out.

While it does vary depending on professionals used, it can cost anywhere between $3,000 and $7,000 to set up – plus $2,000 to $5,000 in ongoing costs year-on-year.

The ongoing cost is often similar to the fees charged on balances within a retail or industry fund, according to Lee.

The fine print

While not a cost per se, Lee highlights that there are some borrowing restrictions on properties held within SMSF, known as a limited recourse borrowing arrangement (LRBA) which aim to protect against other assets being claimed where a loan defaults.

“The main restriction for investors to be aware of is that the borrowed funds can’t be used for significant improvements or development. Any improvements must be funded from the SMSF’s own resources, not borrowed funds,” Lee explains.

This puts even stronger importance on picking the right asset in the right location.

All in all, with an SMSF, you have direct control over the fund’s assets and investment decisions. You are responsible for managing the fund in accordance with superannuation laws and regulations.

So, you’ve got the basics of SMSF investing down pat.

But are you really making the most of an SMSF?

The SMSF investor’s checklist

The tax break

The best investors are making the most of the advantageous tax benefits that come with investing in an SMSF, Lee believes.

This will look different depending on whether the assets are residential or commercial.

• Commercial

Typically coming with positive cash flow, investors harness strong growth alongside strong cash flow.

This allows the investor to have strong positive cash flow which gets taxed at a very low rate, explains Lee.

How it works: When the investor hits their pension phase (typically after 60 once the member has retired), they can then have a tax-free income stream. Commercial can also unlock a much higher purchase price for a client if their main restriction is the borrowing capacity; if a client has a large funds position as a high-income or mature investor couple, they should explore commercial property opportunities as it might allow them to purchase an asset worth significantly more and compound on that higher base.

• Residential

The best investors make sure they purchase the best growth assets possible in SMSF so they can ride growth cycles, and potentially sell the property once the growth cycle is over and use the profit to recycle into multiple residential properties, shares Lee.

How it works: This allows them to scale faster from one property to multiple, given there is no ability to pull equity from the current investment. While transaction costs remain high, because tax is lower in this vehicle, it becomes a lot more profitable with a more active buy and sell strategy for investors who can use data to monitor the markets they are investing in.