Why considering a land syndicate or REIT can be a simpler stress free way to gain exposure to property via your SMSF
A recent special report in the Australian Financial review warned of steep penalties for an SMSF getting it wrong when seeking exposure to the property sector via direct purchase.
Journalist Alexandra Cain wrote “Using a self-managed super fund to acquire a property has become a popular strategy with investors. But there's a right way and a wrong way to do this and it's important to know the difference between the two or risk substantial penalties.”
Referencing Kane Munroe, a director of online accountancy and bookkeeping firm Accountancy Online, says in terms of the considerations investors should be making if they are thinking about putting a property in their SMSF, the first one is whether this strategy will improve retirement outcomes.
"The point of any investment is to maximise your investment returns. This is even more important when it comes to superannuation. Ultimately your investment choices will dictate whether you can potentially lead a fairly comfortable retirement or have to rely on government support," says Monroe.
He notes an enabler of property in superannuation was the change of rules in 2007 to allow for borrowing inside superannuation, as this has put property within reach of many self-managed superannuation funds. "But just because you can doesn't always mean you should and it is important to see property as part of your portfolio and not your entire portfolio."
In terms of risks, Munroe stresses it's worth remembering superannuation and property is a tricky area. "If you don't know what you are doing there are some pretty heavy penalties if you get it wrong. So make sure you find a good accountant or professional adviser who knows what they are doing."
Another downside to direct property in a super fund is that having a large, illiquid asset in your fund like property can involve some cash flow management to ensure there is enough free cash on hand so the fund can pay its day-to-day expenses. If the fund is in pension phase, and the property is the fund's only asset, it may not be able to pay an adequate retirement income for members.
Greg Einfeld, director of SMSF experts Lime Super, agrees it's important to understand the rules.
"If the fund is unable to meet its repayments then the bank can repossess the property, but cannot touch other assets of the SMSF," says Einfeld. As a result banks often require a personal guarantee from the trustees of the SMSF.
He says once the property has been purchased using debt, any improvements must be paid for by cash in the fund, as opposed to paying for these expenses using further borrowings. The improvements also can't change the nature of the property.
"The most common mistakes SMSF members make when buying property arise from not getting the documentation correct. This includes having the wrong names on the property contract or loan contract, and buying the property before all the required entities have been established," Einfeld advises.
Another common mistake is having insufficient cash in the fund. "If the property is vacant for a period, or if the member isn't receiving contributions, then the SMSF won't be able to meet its obligations," he notes.
There are a number of reasons why an SMSF would choose to invest in an unlisted REIT or land syndicate which invests in commercial property, rather than directly into a residential or smaller commercial property. The most obvious is that unless the SMSF is very large, with significant assets, investment in a syndicated form, like an unlisted REIT or land syndicate, gives investors access to larger, higher quality buildings with larger tenants than most could afford themselves or exposure to a property development.
There is also the question of the interest cover ratio (ICR), which is a ratio used to determine how easily the trust or SMSF can pay interest on outstanding debts. An ICR of 1 means that income from the property is the same as interest repayments, 2 means it is twice as much, and so on.
For SMSFs investing directly in property with borrowed funds, the ICR will generally be lower. In fact this is one of the major risks associated with investing directly. The risk of a residential tenant defaulting, or a smaller property having its income affected by vacancy rates is much higher than for a large commercial property. Therefore, unless an SMSF is large enough to generate significant income from other investments or assets, the risk of running into trouble if a residential property stops generating income can be high.
The aforementioned land syndicates also offer an alternative for SMSF’s to gain exposure to the property sector with a lower capital outlay. Land syndication offers small and large investors the change to participate in the ownership and development of a parcel of land, earmarked for development. Investors can then watch their investment grow and take shape as it moves through the development process of planning, construction and sale.
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