SMSF Investing Education & Strategies

Property

Property investment is one of the mainstays of the Australian investment environment. It is one of those asset classes that Australians feel they can readily understand, and while not without its risks, there is a perception (which may or may not be true) that property can be a relatively safe long term investment.

A property investment can generally be defined as one where investors purchase property assets for both income and/or capital gain. There are a number of forms in which this can take, which fall under two broad categories:

Direct Property Investment:

These include direct investment into residential houses, apartments, townhouses, commercial offices, factories & industrial properties, and land. One of the key advantages investors see in direct property is that it is tangible (i.e. they can see it and touch it), and that they can use their own labour to make improvements to it. They key disadvantages are the transaction costs, it is not divisible (i.e. you cant just sell the bathroom), its relatively illiquid in that it can sometimes take a while to find a buyer if you want to sell it, and the ongoing costs of maintenance. And of course the big one for SMSFs is that properties tend to be big ticket items, where the price of a property will generally range from 6 to 7 figures, and borrowing is often required.

Indirect Property Investment:

These include investment into structures such as property syndicates, listed property trusts, unlisted property trusts, and managed funds that invest into any of the above. The key advantage of these are the fact that you are going into a pooled structure, such that you are getting exposure to the underlying properties, but are not having to pay for the property all yourself. This is very convenient for most investors who want a diversified portfolio of assets, plus they tend to be more divisible and liquid. The downside (although some see it as an upside) is that these tend to be managed schemes, where you don't have the kind of direct control over the underlying properties that a direct investor has, and there will be fees involved in paying for the structure and management of the properties.

Investing in property in a SMSF

Direct Property :

As at September 2008, according to the ATO stats on SMSFs, direct property only accounts for around 13% of all assets held in SMSFs. This can probably be attributed to the fact that (as mentioned above) direct property investments are big ticket items, with borrowing usually required. So since borrowing to invest in a SMSF has been prohibited for a long time, it is no surprise that direct property makes up a smaller proportion of investment in SMSFs than you might otherwise expect. But is this about to change ? If you go to our SMSF Technical Education & Strategies page, you'll see that a particular form of borrowing is now available to SMSF trustees, and there are lenders who have now structured lending products for SMSFs to use for direct property investments. It will be interesting to see if this gives a boost to the overall level of direct property investing in SMSFs.

One of the most common SMSF direct property strategies is where a small business owner buys "business real property" with their SMSF monies, runs their business out of that property, and pays rent to their SMSF (at market rates) instead of to a landlord. Usually, the leasing of an asset to a related party of a SMSF is prohibited (see investment restriction on the SMSF Technical Education & Strategies page), however business real property is an exception that is allowed. Of course, just because you can does not mean you should. It all still needs to fit within a sensible investment strategy, and as always, your trust deed needs to allow it.

On the flip side, direct property has also been one of the biggest problem area's for the SMSF regulators, due to the propensity for SMSF property investors to fall foul of the Super laws. We are talking here mainly about the Sole Purpose test, and the In-house assets test (see the SMSF Technical Education & Strategies page for more detail). In general, the overriding tenet here is that investments are made solely for retirement purposes (i.e. not to get a current benefit), everything is done on an arms length basis, and at market rates.

Holiday homes are a common problem and a good example. Say you bought a holiday home within your SMSF in Noosa, but you live in Brisbane. You rent it out during the year to people on holiday at market rates, using an agent to manage the process. Then at Christmas time, you decide to not rent it out but to go spend a week there yourself instead. Now your problems start. Firstly, you are breaching the sole purpose test, as you are now getting a current benefit from the asset. You also have a problem with the in-house assets test. If you are not paying any rent, you have breached the rule of paying "market rates", and if you are paying market rates, you have breached the rule of "leasing an asset of the fund to a member of the fund". So your stuffed either way. Some trustees think they can just get away with it and no-one will know. Well, think again. The lengths that the regulator will go to these days to catch people out are extraordinary, and the penalties can be extreme.

Don't be stupid. Be very careful with direct property investing in your SMSF, get good advice, and stay within the rules.

Indirect Property

This is somewhat simpler than direct property. Listed property trusts (LPTs) are listed on the ASX and are traded just like Shares, and with the advent of stapled securities, it could be argued are more like equity investments. LPT's tend to have internal leverage, and extra leverage can be gained via derivatives. Property Managed funds invest in these underlying LPT's to provide extra diversification (albeit with fees) and may also invest in other direct property. This is fairly straightforward, and apart from the usual investment strategy and trust deed considerations, there are no real issues here for SMSF trustees.

Property Research for investment decisions