Think before you buy property in your SMSF

Property owners face the risk that tenants will damage the house or apartment.

Property investment and self-managed superannuation funds seem to go hand in hand.

However, when a particular strategy starts to get a feel of being the "flavour of the month" the risk increases that you jump on board to be part of the latest trend without having appropriately considered whether it's the right thing for you and your SMSF. So, what are some of the risks associated with property?

With any investment in your SMSF, it's critical to consider the risks and rewards, the costs versus the potential return. For managed fund and share investments in an SMSF, the physical costs are generally limited to the transaction costs in buying a particular investment, and then you are looking at the potential returns through capital growth and dividend and distribution payments. While there is no guarantee of a particular return in any investment, there is a wealth of information available that could help you in deciding which investments are potentially more sound and in line with your investment strategy and personal approach to risk.

With property, it's a little more difficult.

You can certainly do some research to see what the potential rental returns are for different properties in different locations, which might help you to decide which property to buy. But you still carry 'tenant risk'. Having the right property in the right location won't mean much if you have the wrong tenant.

Your investment objectives in your SMSF, and your future retirement intentions (and plans to get there), could be thrown into disarray if you end up with a tenant who won't pay their rent on time, a tenant who damages your property, or a tenant who is always complaining about something and who, simply, just becomes a headache.

Now, these risks are not unique to owning an investment property through your SMSF. They can arise if you own an investment property personally. But sometimes these risks are overlooked when held in an SMSF.

When it comes to property investing, another key consideration is how the investment is funded.

In many cases in an SMSF borrowing will be required. Again, you may need to borrow if you were to invest in your own name, but there are additional specific requirements under super law if you want to borrow inside your SMSF. These include the need to establish a holding trust that will own the asset until the loan is paid out, and you may require a higher deposit than if buying in your own name. Lenders are generally more cautious because of the risks involved and the interest cost may be higher than for an equivalent borrowing outside super.

Have you considered all relevant insurances? Clearly you would want to ensure that you have the property appropriately insured for damage, in the same way you would protect your assets if held personally.

What's important here is to realise that an investment in property can generate a number of additional costs that eat into the return you were otherwise expecting – costs that may not have arisen if you had bought other investments.

Of course, none of this should be taken to say that an investment in direct property is not appropriate for some SMSF investors. While there is always a risk of a property downturn, valuations for property have generally been less volatile than sharemarket valuations. And there is the added, sometimes intangible, comfort that some members derive from knowing that it is a physical asset, they can see the investment and have control over who the property is leased to.

It is about what is right for you. So how do you actually decide this? If you were investing in the sharemarket or managed funds, I would always recommend you speak with a professional adviser who can help you choose the right investments that match your willingness to take on risk and work towards your retirement goal. With property, the approach shouldn't be any different, but the advice you get may be slightly different.

A financial adviser won't be able to help you pick the actual property for purchase, but they can help you identify any cracks in the bricks and mortar up front, rather than spending your time later trying to cover up the cracks when it's too late.

Source: Financial Review