Self-managed super Funds (SMSFs) can offer many benefits not available to retail or industry super funds. One of these benefits is the ability to own direct property, in particular commercial property.
I recently met with a new client, James and Sarah*. James is a builder who runs his own business. Sarah works part-time and helps James with his bookkeeping. James and Sarah have been renting business premises since starting their business; however, their preference would be to own their own building. James and Sarah had heard about owning property through super but weren’t sure how it works or whether this would be an option for him.
How can an SMSF own property?
I explained to James that an SMSF can own property; however, there are limitations. The most common scenario is where an SMSF purchases a commercial property that is 100% being used for commercial use. This purchase can be from themselves or a third party. (note: An SMSF can also buy a residential property if it is not buying it from a related party). In this case, James would buy a property from a non-related third party.
James had $330,000 in his superfund, and Sarah had $80,000. James estimated he needed about $400,000 to purchase a suitable commercial building. James and Sarah can establish an SMSF and buy the premises outright with their existing benefits. James would then have a lease between his business and the SMSF as landlord of the building. This arrangement allows James and Sarah to have ownership in their building through their super fund effectively, and it also enables their super to grow through the growth in the value of their building and the rent the business pays to the SMSF. James and Sarah can also make contributions to their SMSF. It also means that James and Sarah did not have to go into debt to fund the purchase of the building. Over time, the rent paid to the superfund and any contributions will also build up. This additional capital can be used to invest in other assets and increase the diversification of assets within their super.
James and Sarah were very happy with this outcome. It allowed them to acquire business premises and also meant that the rent they were paying would now benefit them rather than a property investor.
Can an SMSF borrow money to purchase a property?
However, let’s just say that instead of a purchase price of $400,000, the purchase price of the commercial property was $600,000. Can they still achieve their goal of purchasing a commercial property through their superannuation? The short answer is, yes, they can. However, they will need to borrow the funds.
SMSFs can borrow money, but there are restrictions. Lending to an SMSF is completed using a type of loan called a Limited Recourse Borrowing Arrangement (LRBA). This is a loan structure designed for SMSFs where a holding trust (called a Bare Trust) legally holds the asset on behalf of the SMSF trustee. The bare trust holds the asset on behalf of the SMSF trustee until the loan has been repaid. Once the loan has been repaid the asset is transferred to the SMSF trustee.
In the event of a loan default, the lender’s recourse is limited to rights relating to the asset. These rights may include taking possession or disposing of the asset. If this possession or disposal of the asset does not clear the liability, the lender can not take any further action against any other asset.
While there is certainly more risk with this strategy, with the proper planning, it can be an effective strategy. The SMSF must have sufficient cash flow to meet the loan repayments as well as the other expenses of the SMSF. There are also restrictions on what can and cannot be done with borrowed funds. However, this strategy opens up opportunities for growth and diversification of assets within the super, which can lead to a more secure and prosperous financial future. This potential for growth and diversification should inspire optimism and hope in James and Sarah, and in other potential property investors considering SMSFs.
Could this be an option for you and your business? Contact Greg Thornton to start the discussion. Greg can advise you of your options, and then our team can help set up your SMSF if you choose to proceed. Your path to commercial property investing just got a whole lot easier!
*not their real names
