..Some much to know about Property Investing
So many questions about Property Investments. Here are some answers. If it’s not here, send us a note, and we get one of our experts to answer it and add it to the list.
What is Property Investing?
Your content goes here. Edit or remove this text inline or in the module Content settings. You can also style every aspect of this content in the module Design settings and even apply custom CSS to this text in the module Advanced settings.
What is a Trustee?
The Trustees control the SMSF and makes all the investment decisions for the SMSF. When you establish a SMSF you have a choice of whether to appoint Individual Trustees or a Company Trustee to act for your SMSF. Each option is detailed below. It is important to understand that the SMSF Trustees do not own the SMSF Assets but are simply responsible for administering the SMSF which includes:
– Maintaining all records of the SMSF
– Establishing the SMSF Investment Strategy
– Complying with all Super Laws
– Lodging Tax and Regulatory Returns
You can appoint either Individuals as SMSF Trustees or a Company as a Trustee. Each is discussed in turn:
It is a legislative requirement that where an SMSF has individual Trustees, it must have a Minimum of 2 Individual Trustees and a Maximum of 4 Individual Trustees. The Individual Trustees will be responsible for running the SMSF. Anyone over 18 can be a Trustee of an SMSF including a spouse, adult, child or friends. It is FREE to appoint Individual Trustees for a SMSF.
Alternatively you may select a Company to act as a Trustee for your SMSF. In this case the Members of the SMSF will need to be Directors of the Company Trustee. The Directors of the Company Trustee will be responsible for running the SMSF.
Which type of Trustee should I use?
It is important to understand that there are no administration benefits, fee savings or taxation savings by choosing Individual Trustees or a Company Trustee. When buying property through your SMSF, a Corporate Trustee is the most popular way to establish an SMSF as higher loan to value ratios are generally offered by financiers.
Why use a Company as a Trustee?
Reason 1: You only have One Person
There are times where a client only wants to establish an SMSF for one person (themselves) and do not want a second Individual Trustee. In this instance the only option is to establish a Company to act as Trustee for the SMSF. You will in turn be the sole Director and Shareholder of the Company giving you total control of the SMSF.
Reason 2: You are worried about what happens when a Trustee leaves the SMSF or dies
If you have Individual Trustees and one Trustee leaves the SMSF or dies you cannot continue as the SMSF with only one Individual Trustee. To avoid this issue some clients setup a Company to act as their SMSF Trustee. However this is unnecessary because if you have two Individual Trustees and one person leaves or dies you can simply appoint a new Individual Trustee who is over 18 (eg child, friend, parent, spouse etc) at that time. Alternatively if you are left with one Individual Trustee and cannot find a second Individual Trustee, you can appoint a Company Trustee at that time and the SMSF can continue in the normal way.
Reason 3: Avoiding the need to update Accounts
When you add or remove Trustees in your SMSF, you must update all the accounts that the SMSF has. Accordingly if you have Individual Trustees and a Trustee is added or removed, all accounts the SMSF has must be updated with the details of the new Trustee. This is not necessary with a Company Trustee as the Company always remains as the Trustee even if the underlying Directors and Shareholders of the Company change.
Reason 4: You want a higher LVR
If you are considering purchasing Property with Borrowings in your SMSF, the Lender may lend more to your SMSF if you have a Company as the SMSF Trustee. For example, for Residential Property, St George Bank currently lends 80% of the Property Value if you have a Company Trustee whereas they will only lend 72% of the Property Value if you have Individual Trustees for your SMSF. Similarly for Commercial Property, Westpac currently lends 65% of the Property Value if you have a Company Trustee, whereas they will only lend 58.50% of the Property Value if you have Individual Trustees for your SMSF. (As of Oct 2012)
What is a Bare Trust?
How much money will the bank or lender give me in order to buy an Investment Property?
Why does the bank need a guarantee from the trustee?
What happens if you fail in your trustee duties?
As a trustee of a self managed super fund, if you fail to act in accordance with the super and tax laws, you risk:
• your SMSF becoming non-complying and losing its tax concessions
• disqualification, removal or suspension as a trustee of the SMSF
• civil or criminal prosecution, and/or
• Financial penalties.
Where is the best location to buy an Investment Property?
One of the biggest problems Investors face when looking at buying an investment property is “Where do I buy?”
We always suggest you look at historical data and consider the pattern of capital growth over the last 10-20 years to establish whether or not the locations you are looking at are worth consideration.
We must remember that the goal of investing in a property through super is to realise strong, long term capital growth, whilst keeping the investment property within your budgetary requirements. For this reason, it is vitally important that you select the right property from the outset. Failure to do so may lead to a less than adequate income in retirement.
We have found that the locations that hold steady long term growth are generally located within 1-12km from the CBD, have higher than average population growth statistics, and have substantial private or public infrastructure projects planned or underway.
When is the best time to buy an Investment Property?
The most important principle to remember when investing in property is to think long term and have an educated written plan that you adhere to.
When to buy is nowhere near as important as actually buying a property, a trap some investors fall into is waiting for the market to fall so as to grab a bargain.
Inevitably what happens is the market increases and then they say:
“I should have bought last year when the prices were better; I think I will wait for a fall in the market.”
And when the market softens they will say: “I think I will wait for it to hit rock bottom” all the time missing opportunities to enter the market and grow their wealth, not to mention the tax savings they are missing when all this is happening.
While no one can pick the bottom of a market, the use of key economic indicators such as supply & demand, building approvals, auctions clearance rates, available credit, and rental yields does in fact provide a relatively good guide as to where the market sits within its cycle.
At Strategic Investor we make use of a property clock to make estimates where any one market sits within its cycle. We only select property within markets that show signs of an upswing, where supply is tightening and rental yields are at parity to the purchase price, i.e. $1 rent per $1,000 sale price. We then select property built by the most respected developers and builders in what we consider to be the best areas to accommodate capital growth, yields and to maximise depreciation benefits.
Self Managed Super Fund
What are the advantages and disadvantages of setting up an SMSF
There are many advantages and disadvantages in operating a Self Managed Super Fund (SMSF), some of which are listed below. It will depend upon your individual circumstances as to whether it is the right option for you.
The Trustee has complete control over the Fund’s investments. However, there is a requirement for the Trustee to formulate and document an Investment Strategy and follow it to achieve its stated objectives.
As the Trustees have complete control of the Fund, they are able to invest in a range of assets to which they may not have had access had they been in a retail or industry fund. These investments must however be allowed by the Fund’s trust deed and the relevant legislation.
Estate Planning Flexibility
Depending upon the details contained within the Trust Deed, the fund can provide benefits to members as well as to the family of members as nominated. This means that the Fund can continue after the death of a member, which can allow for many estate planning benefits.
Generally, the cost of managing a self-managed superannuation fund does not increase as the superannuation invested grows. Depending upon the types of investments held by the fund, it is generally cost-effective for large balances.
Depending upon your circumstances, there may be additional opportunities for tax management available by using an SMSF, in addition to being able to benefit from the generally available tax concessions associated with superannuation.
All decisions and responsibilities associated with managing the fund rest with the Fund’s Trustee. This will include making sure that the Fund meets any compliance and legislative requirements. There may be significant penalties for breaches of the legislation.
Depending upon what additional assistance the Trustee requires (investment advice, administration, financial advice, account-keeping etc), there may be considerable expense in maintaining the Fund. If the assets of the fund are quite low, this could be relatively expensive.
Diversification of Investments
An important part of investing is diversification. In some instances where a Fund does not have sufficient money, it may be unable to diversify across asset classes, and will therefore increase its risk profile.
Controlling all of the operations of a self-managed fund may be considerably more time consuming for a Trustee than other superannuation alternatives.
How is Property Purchased through an SMSF?
The SMSF chooses the property to be purchased, obtains a loan approval (where applicable), and finalises their purchase through their solicitor as they would with a purchase by a natural person. However, the purchase needs to be in the name of the property trustee as the property is held in trust for the SMSF by the trustee.
The deposit, remaining balance of the price of the property, stamp duty, and any other costs are then paid by the SMSF.
The property is by definition mortgaged by the trustee to the lender. The SMSF is then in charge of managing the property as any superannuation fund would any type of investment or asset. As such, it’s responsible for ongoing costs associated with loan fees and repayments, maintenance and repairs, property management, land tax and rates.
The SMSF has a right to acquire ownership of the asset by payment and receives all the income associated with the property, such as rental income. When the mortgage has been repaid, the title of the property can be transferred to the SMSF.
How is income and expenses of the SMSF and Investment Property managed?
All inflows and outflows of money go through your SMSF bank account.
Super contributions are paid in by your employer (or you can contribute privately)
Rent is paid in by the tenant, tax on rental income goes out to the ATO and loan repayments are paid back to the lender.
What happens if I lose my job and cannot contribute to my SMSF?
Can I include my own personal investment property or existing home into my SMSF?
NO – Your SMSF is not allowed to purchase a residential property from a trustee or member of the fund or a related party, and cannot lease the residential property to a trustee or member of the fund or a related party. So your fund cannot buy your own home or your existing investment property from you.
Can I use my SMSF to buy land and build a house?
Can I buy 'Off the Plan' property in my SMSF?
YES – Your SMSF can purchase ‘Off the Plan’ property such as an apartment as long as the deposit and costs such as the stamp duty to secure the purchase are not borrowed (existing funds are required) and once the apartment is completed and strata titled, finance can be used to complete the purchase in line with the bank’s lending requirements.
Do SMSF's need to have an investment strategy?
YES, SMSF requires an investment strategy. An investment strategy is a set of rules or guidelines as to how a trustee intends to invest funds and contributions on behalf of members to achieve their objectives.
An investment strategy can be simple, but it must include actionable strategies to: maximise member investments; provide diversification across asset classes; include a strategy for paying benefits and maintaining liquidity; and take into account each member’s term to retirement, at minimum.
An investment strategy may also define a set of criteria or hurdles (for example yield, lease terms, asset size, etc) in order to draw a line between what is, and is not, acceptable as an investment by the SMSF. This may also extend to specific due-diligence requirements as part of the overall property investment strategy for a fund.
Trustees can set their own strategies, or where they need help they should seek help from a professional superannuation specialist, property specialist or financial adviser. Without a strategy, trustees will not be able to determine how direct or indirect property fits into their SMSF portfolio, or what exposure they need to maintain at particular stages in life with respect to when members retire.
Can an SMSF buy your business property?
The good news for business people is that an SMSF is allowed to invest in, or buy your business premises, provided it is used wholly and exclusively for the business.
A superfund cannot purchase or run a business. It is a direct breach of the Superannuation Industry Supervision (SIS) regulations, attracting heavy fines from the ATO. However, a SMSF can indeed purchase the property in which a business is being conducted.
When a superfund buys the business premises of its member, the business simply becomes the tenant and pays the SMSF a commercial rate of rent. If a mechanic owned a factory from which he run his business, his SMSF would be allowed to purchase that factory from him because it would qualify as business real property. This would free up additional working capital to the business owner to expand the business. It can also facilitate the transfer of an attractive long-term real property asset into the superannuation as an investment.
When deciding to transfer business real property into their SMSF, trustees must take into account:
1. their overall fund investment strategy
2. how this will affect all members
3. how it will affect liquidity; and
4. Whether such a transaction will dilute their diversification benefits through creating a concentrated exposure to one asset.
Can you develop a property within an SMSF?
Generally speaking, a superannuation fund cannot develop the property. However, should a potential development represent a small portion of the fund’s total value and is in line with the investment strategy, incorporating all the other assets in the fund, it may be successfully argued that it is appropriate.
Due to the complicated nature of the process, specialist advice is highly recommended in order to take into account individual circumstances of the members and their fund, as well as the specific profile of any proposed development activity.
Can an SMSF borrow to buy property?
In September 2007, S.67(4A) was inserted into the Superannuation Industry (Supervision) Act 1993 (SIS Act), under which SMSFs became eligible to borrow in order to acquire a property as long as they complied with a number of provisions.
Recent changes to superannuation legislation now allow SMSFs to borrow to acquire assets including residential and commercial property to support their investment strategies subject to meeting a number of requirements.
Under the new guidelines, an SMSF borrows funds to acquire an asset, for example, a residential and/or commercial property. A separate trust is established to hold legal ownership of the property on behalf of the SMSF. These trusts are generally referred to as security trusts or warrant trusts. A loan is then arranged to meet the balance of the purchase price (plus costs) that the SMSF is not providing. The SMSF becomes the beneficial owner and manages the property as it would any other real estate investment.
The loan is a limited recourse loan and the property asset is used as security. In the event of a loan default, the lender only has recourse to the residential and/or commercial property. They cannot claim any other SMSF assets.
Are Family and associates allowed to stay in an SMSF residential assets?
SIS law is very strict about residential property owned in SMSFs as an investment, including holiday property investments. They simply cannot be used by members or any related parties. Members including their family, associates and business partners are restricted in using the assets of the fund unless they are business real property, and then only if they are solely used for business purposes by a member or related party, and only where commercial rates of rent and lease terms are being provided to the SMSF which owns the asset.
Is an SMSF allowed to buy a retirement home?
In retirement, people need an income and a place to live. One of the most fundamental superannuation questions is whether a member can acquire a residential property asset in their SMSF that will eventually become their retirement home.
The answer to this question is it may be possible providing you have undertaken the necessary steps. We would recommend you speak with an SMSF Specialist Adviser before you consider buying property to retire in.
Does SMSF's benefit in the super tax environment?
As with all investments in a complying SMSF, because contributions and investments in the fund are preserved until retirement, they enjoy the beneficial superannuation tax regime.
Just like negative gearing in an individual’s name, the SMSF would benefit from the same tax benefits, that is, the tax deduction for the negative component of the interest, and depreciation; however, the biggest benefit is CGT. Should the fund hold the asset longer than one year and then decide to sell it then CGT drops from 15% of the gain down to 10%, and if sold in the pension phase (generally over 55 years of age) CGT is 0%.
The beneficial superannuation tax environment means that income and capital gains earned from a property held in an SMSF provide greater reinvestment value, being the difference between a member’s individual tax rate on income and capital gains, less the tax rate they pay within the superannuation environment.
How do I select the right property for my SMSF?
The 2 main aims we have when selecting investment property for our clients are Capital Growth and Property Affordability.
Some people will tell you to buy land or a house as this will have the best capital growth, in some cases this is true. We must, however, also consider affordability; you don’t receive an income from land such as house blocks and thus in most circumstances can’t claim any benefits or costs associated with holding it.
Established houses are generally fair investments however will probably give you more troubles regarding Property Management, and cost you more to hold as generally, the returns are nowhere near as good as a new or near new apartment.
For SMSFs we generally recommend OTP or new apartments, townhouses or houses as they have high initial returns (rental income/cost) compared to established houses and are also easier to maintain and easier to let as there is a larger pool of tenants looking for quality new or near new apartments, townhouses or houses in the inner suburbs.
We have found that in some instances investors on an average income can buy a new apartment in suburbs within 1-12 kilometres from CBD and have it cost them as little as $10 to $40 a week after their tax benefits without noticeably affecting their cash flow. This is especially important when buying in an SMSF.
Why should I buy an investment property in my SMSF rather than shares or cash?
The best way to answer this question is to provide you with an example of how buying a property using LEVERAGE works compared to buying shares using your existing super balance.
Let’s say you had $200,000 in your family self managed super fund. You use the money in your super as a deposit including all costs to buy a property, the bank then lends you the rest.
So let’s say you wanted to buy a property worth $500,000, you could put in $175,000 which equals 30% plus costs, and the bank lends you $350,000 to complete the purchase.
Now your super balance has increased from $200,000 to $525,000 because the bank has loaned you the money. So in this scenario, if your fund made a 7% capital growth before you purchased your property, i.e. if you had your money in shares or cash, the increase in capital value on your $200,000 fund would be $14,000. Whereas, if you take that same 7% return and invest it within your SMSF on a property, the increase on your capital value in your super would be about $36,750. That’s a $24,500 or 162.5% difference in return.
It is also important to note that your loan repayments will be repaid by the tenant in rent, plus your personal, employer or tax-deductible super contributions. This demonstrates that substantially increasing the value of your fund (using leverage), significantly increases the potential for return on your investment in retirement.
What are the main contraventions of SMSF's
The ATO has recently announced that it will be stepping up its compliance program for trustees of self-managed superannuation funds (SMSF’s).
Trustees that are found to be in breach may be fined or the fund could lose its favourable tax status and be taxed at the top marginal rate.
75% of all SMSF contraventions fall into six categories:
Loans to members or relatives (19%)
SMSF’s are prohibited from lending money or providing any financial assistance using the fund’s resources to a member or a member’s associate. For example, payment of personal expenses by the fund.
Breaches of in-house asset rules (16%)
An SMSF cannot acquire or hold in-house assets that are valued at more than 5% of the market value of total assets. In simple terms, an in-house asset is a loan, investment, or lease arrangement with a related party. If a fund has in-house assets, a review is required on a yearly basis to determine if the assets remain below the 5% level.
Assets not in the name of the trustee (14%)
The fund’s assets cannot be held in the name of the individual or corporate trustees in their own capacity but must be held in their capacity as the trustee of the fund. If the assets are not in the correct name, the fund’s assets are placed at risk as they are not identified as being owned on behalf of the fund.
Documents requested by auditor not provided (11%)
If the auditor requests a document in writing from the trustees, each trustee must ensure that the document is given to the auditor within 14 days of the request being made. This applies only to documents that are relevant to the preparation of the audit report.
Breaches of sole purpose test (8%)
An SMSF must be maintained solely for the purpose of:
- each member on or after their retirement; or
- a member’s legal personal representative or the member’s dependants after the death of the member.
The fund is not permitted to provide many benefits to a member or their associate (e.g. renting a residential property owned by the fund to a member, or hanging artwork owned by the fund on the member’s wall).
Unauthorised borrowings (7%)
An SMSF is generally prohibited from borrowing money or maintaining an existing borrowing of money. An exception is instalment warrants, and even with these, trustees must ensure they comply with the very strict rules.
How do you select properties?
Our research unit spends 1,000 hours per year on the road and phone talking to developers, real estate agents and councils. The majority of the properties we recommend are inside the 15km circle to a major city’s CBD – close to where people work, and very easy to rent and/or sell again.
We look for properties that are attractive to owner-occupiers because that’s where over 80% of the buying market is. This means that when our clients want to sell there is a large market to sell to.
What is your relationship to developers?
For those projects that we decide to take on, we have a marketing agreement with the developer that ensures we are paid for the work that we do.