By Naomi Rosenthal
It’s all the rage right now – setting up a self managed super fund and borrowing to buy a residential property as the major asset.
On paper it sounds like a great idea – you’ve got some money in your fund, borrowing costs are very low right now, rental returns are pretty good, it offers asset protection against bankruptcy and income and capital gains are concessionally taxed.
There are only a handful of occasions when we think it’s a good strategy and plenty of reasons why we have concerns about it.
Along with the standard costs of owning an investment property – maintenance costs, real estate management fees, land tax, council, water, electricity and gas rates, general insurance costs, etc. – a property-based SMSF costs more for accounting and auditing.
Obtaining and retaining tenants can sometimes be difficult. What will happen if the tenant leaves and you can’t install a new tenant for some time? You may find it difficult to meet mortgage repayments.
The maximum pre-tax contribution you can make to superannuation in any one year is currently $25,000*. For a husband and wife in a SMSF this can provide up to $50,000 in pre-tax money going into your fund to pay for outgoings not met by the rental income. You need to consider whether you can afford all the costs of the fund and your capacity to make the necessary contributions. (*For those 60 years and older for 2013/14, you can concessionally contribute up to $35,000. From 2014/15, those 50 years and older can contribute up to $35,000 concessionally).
While you can also add up to $150,000 after tax money to superannuation per member, this can become a tax ineffective strategy and end up costing you more.
Real property is relatively illiquid. You can’t chip off a brick and cash it in at the bank when you need a few thousand dollars. Difficulties may arise when one member of your SMSF dies and the fund is required to pay out their death benefits. If they owned 50 per cent of the property, unless there are other resources in place and the right asset protections in the fund, 100 per cent of the property will need to be sold. Further, when one member retires it can be difficult to pay their pension income stream if there are insufficient liquid assets or rental income available.
If the property needs to be sold while members are still in the accumulation phase, there will be capital gains tax on realisation. While this is a reduced rate in the superannuation environment, it may be unanticipated. Historically, capital growth on residential real estate has not exceeded the growth on Australian shares. You need to consider whether the capital gain on your property will show sufficient growth to cover the aforementioned costs.
As an investor you want to maximise your capital gain opportunity. Often buying a run-down residential property with a view to renovation for significant improvement and substantial alteration to the property can reap rewards and add value. Unfortunately, the rules for SMSF residential property ownership do not allow for improvements to the property (such as upgrading the kitchen or adding a granny flat) using borrowed funds. The fund needs to have enough money available to finance the upgrades without borrowing.
Every SMSF must have an investment strategy. The trustees determine their investment strategy and must abide by it when allocating investment assets. The decision to purchase a residential property as the key asset in the fund needs to be weighed against and compatible with the fund’s investment strategy.
The Australian Securities and Investment Commission (ASIC) is currently considering the introduction of new regulations to increase the level of detail and the amount of information that advice providers must provide to retail consumers intending to set up an SMSF. This is off the back of recent research conducted by ASIC that found, among other things, poor advice being given in a range of areas including:
A well-diversified portfolio can be far easier to manage, lower in risk and provide greater long term returns, as well as avoiding many of the problems discussed.
Naomi Rosenthal is a Managing Director at Tudor Investassure and a financial expert on Women In The Black. Professional Wealth Services Pty Limited (PWS) is a privately owned Australian Financial Services Licensee (No. 312047). Naomi Rosenthal (269088) is an Authorised Representative and Tudor Investassure Pty Ltd (245753) is a Corporate Authorised Representative of PWS.
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