Using Your Super to Invest in Property

Did you know that it is possible to purchase an investment property with your superannuation? By establishing a Self-Managed Super Fund (SMSF), you can invest in a direct property of almost any type including residential property.

Investing in property has always been a very popular strategy for Australian investors. And, borrowing money to finance a direct property investment is now a reality for SMSFs, which has added to the popularity.

Can I use my super to buy an investment property?

Yes, you can. As expert property investment advisors, we have helped many Australian investors use their superannuation to purchase property. The main benefit of purchasing property within superannuation is the effect of leveraging into property. For many Australians ordinary investment strategies that do not include any leverage at all, will not create enough wealth to comfortably retire.

And, further restrictions to superannuation have made it increasingly difficult for Australians to rely on this compulsory scheme to support them when they stop working.

Whilst the government provides incentives to contribute up $35,000 (depending on your age) to your super fund, many Australians are beginning to realise that superannuation, even with professional advice, is unlikely to provide enough asset base to make a decent living in retirement.

The average Australian salary including benefits and bonuses is $80,000, so the employer contribution would be around $7,500. Let’s assume that an investor (we’ll call her Sue) is in a position to contribute more to her super fund and invests $10,000 per year.

The average superannuation balance at this age is $100,000 (the average for women is actually around $55,000 at this age).

Scenario One: If the fund performs at 8% per year and Sue contributes $15,000 per year, she will have approximately $1.7 million by the age of 65, in 25 years.

Scenario Two: If it performs at 10% per year and Sue contributes $15,000 per year, she will have approximately $2.5 million by the age of 65, in 25 years. These figures sound impressive, but we have not factored in the effect of inflation and subsequent purchasing power of Sue, our retiree.

Scenario 1 would produce an average income of $90,000 per year. With inflation, the asset base would be the equivalent of about $1.3 million today and buy the same as $65,000 per annum.

Scenario 2 would produce an average income of $115,000 per year. This would be the equivalent of $1.7 million or $85,000 per annum due to inflation.

Many Australians would be happy with the power to purchase $85,000 worth of goods of services (in today’s terms) at retirement. But this relies on two factors: contributions of at least $15,000 per year and market performance of 10% per year. This is a stretch.

Most Australians are actually retiring on between $250,000 and $350,000 (or an income of $12,500 to $17,500 per annum). The average superannuation balance by age is between $15,600 and $74,100, peaking at $323,700 for people aged 55-64.

Benefits of buying property with an SMSF

The average balance for a SMSF is a lot higher than the average superannuation balance. According to the Australian Tax Office, the average balance per Self Managed Superannuation Fund (SMSF) member for 2018 was $679,000.

Alan Kohler noted:

“The average super balance on retirement is around $280,000, which would provide a lifetime annuity income of around $15,000, or $577 per fortnight. That would reduce the age pension by $212.50 for a single, under the income test rules, and $154.50 for a couple.

A single retiree would thus get $1,098 per fortnight instead of the pension of $733.70. A couple would get $1,528.70 instead of $1,106.20. Those amounts represent increases of 50 and 40 per cent on the usual pension income. Is that enough? Is it worth saving 9 per cent of your salary over your whole life?

And is it worthwhile for the Government to forgo a large amount of current tax revenue (Treasury’s bogus numbers put it at between $32 billion and $45 billion per annum) to achieve that small reduction in pensions later?”

We don’t believe it’s worth it, and Australians should be looking at alternative ways forward. One of those ways includes investment in direct residential property with an SMSF.

So what are the advantages of buying an investment property with SMSF?

Leverage

One way to boost any asset base is leverage. By purchasing property, you’ll get the opportunity to maximise capital growth, with rental income providing cash flow to flow further property investment. This is becoming more critical than ever before in sluggish and challenging super funds.

Here’s a basic explanation of how leverage works (forget super for a moment). Assume you have an asset base of $100,000. You have a range of choices for investment. For example:

1. Passive: Cash or fixed interest
2. Active: Stock market or manage funds
3. Alternative: Direct Residential Property

Assume you select one of these asset classes, you invest your $100,000 into it and leave it for the next 25 years. You do not contribute any other money towards it.

1. If cash performed on average the way it has from 1990 to 2016, it would produce a return of 4.81% pa

In 25 years, this choice would equal approximately $338,000.

2. If the Australian Stock market performed on average the way it has for last 30 years to 2016, it would produce a return of 9.5% pa.

In 25 years, this choice would equal approximately $966,000.

3. If the Australian residential property market performed on average the way it has for the last 20 years, it would perform at around 9% pa.

In 25 years, this choice would equal approximately $4,300,000 (minus the $400,000 owed to the bank).

Assume Australian residential property only performed at 6% for the next 25 years.

In 25 years, this choice would equal $2,100,000 (minus $400,000 owed to the bank).

Given the boost that you get when leveraging into property, it is clear that the strategy may have a place in an investor’s portfolio.

This is particularly where there are no incentives (rather, you’re penalised) for contributing to an asset base like superannuation. You are not taxed or penalised for growing assets within superannuation, only for contributing over the specified limits from your salary or income.

Concessional tax treatment

Rent

If you hold an investment property in your own name and without an SMSF, tax will generally be payable based on your personal rate of tax. This can exceed anywhere to around 46 per cent. There’s also a 30 per cent company tax if you own an investment property through a company.

However, if you receive rent from a property owned through an SMSF, you’ll be reaping the benefits of concessional tax that applies to super investment earnings. The maximum tax rate here is 15 per cent. The effective tax level will also end up even lower, since expenses such as land rates and renovations are tax-deductible.

Future capital gains

Further to rent, you’ll also be able to benefit from lower tax rates on any capital gains generated as a result of your property value increasing. So, depending on when you sell, any capital gain your SMSF generates could possibly be free of tax.

If you’ve held the property for longer than twelve months, the SMSF will receive a one third discount on any capital gain the property makes when it’s sold. This, in turn, lowers capital gains tax down to 10 per cent. Furthermore, if you purchased the investment property by taking out a loan, those interest payments will be tax-deductible.

Asset protection

Another benefit of owning property through an SMSF is that your assets are typically protected from creditors should you go bankrupt.

This is because SMSFs are a type of trust. “Trusts” are, put simply, a unique way of holding property that ensures your property is out of reach from certain people such as creditors. The assets of the trust, i.e. your property, are owned by “trustees” (which is the SMSF itself).

If you go bankrupt, and one of your creditors comes after you, they’ll generally be unable to touch one of your properties if its owned via the SMSF.

Creating an SMSF Strategy to Invest in Property

Prior to establishing an SMSF and investing in property, it is critical to develop an SMSF investment strategy.

Arnie Selvarajah, CEO of Bell Direct, commented that “time, or the lack of it, to dedicate to developing and implementing an investment strategy is one reason why the majority of SMSFs are exposed to portfolio
concentration risk”.

By taking the time to properly develop a strategy, you will take into account:

●  The risks of property investments (and other assets) as well as their likely returns;
●  The composition and diversity of the SMSF’s investments;
●  The liquidity of your SMSF’s investments; and
●  The SMSF’s ability to meet its legal requirements and liabilities.

You’ll need to take out the proper level of insurance to establish an SMSF, and you’ll also need to understand the relevance of the age of SMSF members.

If you’ve got any questions about investing in property with your superannuation, please feel free to contact one of our property investment advisors here at EDA property. We can help you understand the complexities around SMSFs and the benefits of developing a strategy to invest in residential property.