More people may be interested in buying an investment property using a self-managed super fund (SMSF) now than ever before. This could be because it has become possible to borrow money from your SMSF in order to purchase a single asset or a collection of identical assets that hold the same market value.
Since buying an investment property can be a risk all in itself regardless of whether it is purchased using money borrowed from a SMSF, there could be a number of mistakes that can occur while doing this.
Here are some of the common ones to watch out for.
1. Not completing enough research
Doing your due diligence by completing extensive research of the different aspects of the process of buying an investment property through your SMSF prior to investing is crucial. Knowing the rules and risks that can come with this kind of investment and outlining your game plan accordingly could be the thing that allows investors to prevent many of the mistakes on this list.
Property investors could also be better off after researching their loan options for their SMSF. By choosing the right one, they could earn lower interest rates or increased borrowing capacity. In order to find the right loan, spending some time comparing their options via a comparison website.
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2. Not adhering to lending and buying requirements
There are various requirements that must be adhered to through the process including the strict limited recourse borrowing criteria and not borrowing from a related party. SMSF and superannuation legislations can change regularly, so it is important for investors to be aware of any alterations to the rules to avoid any potential breaches that could cost the fund thousands of dollars. Failure to comply with these requirements could slow down the borrowing process or prevent the investor from borrowing enough funds for the investment property that they have lined up.
Limited borrowing recourse arrangements are an initiative approved by the Australian government that refers to the ability to borrow money from SMSFs for their property. For residential properties, borrowers could borrow up to 75-80% of the property’s value under this arrangement. This drops to 70% of the value for commercial properties. Understanding this rule, as well as whether lenders need to provide a personal guarantee from SMSF members or if a particular SMSF allows property investments, is necessary to ensure that investors are able to stick to their investment plan. It should also be noted that borrowing requirements can differ significantly from standard mortgage products.
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Borrowing from a related party could be a breach of the arms-length arrangements that comes with buying an investment property. Although borrowing from a related party is not prohibited, this changes when it is done on more or less favourable terms. In addition to this, buying from a relative, which could include a child, parent, sibling, grandparent, niece or nephew, uncle, aunt or even an ex-spouse, is prohibited. Outside of your family, members of your fund, standard employer-sponsors and their associates are also included in this arrangement. Investors are also not allowed to buy a property from themselves and cannot use it for personal use.
3. Property Location
The location of the property you are buying is one of the main features investors should consider before taking the jump to purchase. Rush buying is one of the biggest mistakes investors can make so the property’s location in relation to amenities, as well as the growth in the area, should be carefully considered before this major decision is made.
Buying a property in a risky location could have drastic effects for investors, especially if they are relying on one industry. If that industry begins to suffer or collapse, any investments made become liable. This could be a dangerous position for investors to be in.
In addition to this, it is important to consider any factors of the location that could create a greater rental return. Purchasing a property in a high demand area that has limited supply could allow opportunities for regular rental increases and improvements in long term tenancies. Ignoring this factor could be a huge missed opportunity for investors.
4. Not Having A Power Of Attorney
Ensuring there is an appropriate power of attorney is important to ensure that the fund remains compliant if one member loses their mental capacity and cannot make decisions regarding the fund. Legally, every member of a SMSF must be either trustee or a director of the corporate trustee. If a power of attorney is not in place, the only solutions would be to pay out the balance of the account member or close the fund. This may result in loss on the property if it was a recent purchase.
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5. Incorrect Documentation
There are various legal issues that could occur if the correct structures are not in place in terms of setting up SMSF loan documentation and contracts. If this is not done properly, investors may not be able to undo the current arrangement and instead will be forced to sell the property prematurely. If the property has only been purchased recently, this premature sale could come with substantial losses for the investor. This is why it is crucial to seek proper legal assistance before settling on a property.
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6. Purchasing Multiple Assets
As mentioned previously, limited recourse borrowing arrangements must be adhered to. This can be seen as The Single Acquirable Asset Rule. This rule means that when a property has multiple title deeds that property purchase may not be completed, ruling out the purchase. This can even occur in cases where the multiple deeds are sold as a single entity.
For example, if the property is fully furnished that the contract for sale refers to the property and furniture as multiple assets, this can also prevent the purchase from taking place. Likewise, if the property includes a car parking space that is located on a separate lot, this may be viewed as a separate asset to the property and, therefore, the sale cannot go ahead.
7. Borrowing To Renovate Property
While investors can borrow funds to pay for maintenance or repair of the assets, they cannot do this if they wish to renovate. If the renovation is to be done to restore something back to a new condition can be classified as repairs, however, when changes are made such as removing a wall or extending a bench, this is when they may run into trouble. Installing granny flats also count as improvements and are therefore prohibited if the money to do it is borrowed. Payments for any improvements must instead be funded via the fund’s internal cash resources.
8. Paying Rent Into Personal Account
According to the Sole Purpose Test as outlined in section 62 of the Superannuation Industry (Supervision) Act 1993, investors are not allowed to benefit from the SMSF. The investor should not ask tenants to pay rent into their personal bank account as the SMSF legally owns the property. This means the SMSF keeps all income generated by the property and must pay all expenses associated with keeping the property, such as the rates, water bills and more.
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9. Poor Management
Once an investment property has been purchased and leased out, this does not mean that the investor can now sit back and watch the money roll in. They will need to manage the trust in compliance with SMSF regulations and ensure tax returns and financial statements of the fund are audited every year.
They will also need to keep checking on the performance of their property over time to make sure it is meeting their expectations. If they fail to do this every 12 months at a minimum, they could potentially get in trouble if the market turns unexpectedly due to poor local market conditions. It’s also a good idea to monitor the news that mentions the area the property is in to detect changes in the market early.
If you’re looking into buying your first investment property, check out our Guide To Property Investment to get your research started.
General Advice Warning:
The above information is a guide only, and not to be taken as financial advice. Please seek out a professional financial consultant to help you with your SMSF lending needs.
Words by Jessica Testa
- A Guide To Buying Property Through An SMSF
- Using your self managed super fund (SMSF) to buy a property
- The essential guide to LRBA loans for SMSF trustees
- What Is A Limited Recourse Loan?
- Compare self-managed super fund loans
- What is Sole Purpose Test
- Superannuation Industry (Supervision) Act 1993
- SMSFs: Investment property tax deduction mistakes to avoid
- The 9 Mistakes That Can Ruin Your SMSF Property Investment Efforts
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