SMSF residential borrowing banned as property investors pivot to commercial real estate

Commercial properties can often yield a high cash flow.

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Recent rule changes mean residential property is now off the cards for many people trying to buy property through a Self Managed Super Fund (SMSF).

SMSFs are no longer allowed to enter new Limited Recourse Borrowing Arrangements (LRBAs) to buy residential properties as of August 10, with existing arrangements entered into before this date grandfathered and still able to be refinanced.

The new rules still allow for residential property to be purchased outright (without borrowing) through a SMSF. They also allow for borrowing within a SMSF in order to buy commercial properties.

So, with lending now restricted in the SMSF space, what are the benefits and drawbacks of investing in property through self-managed super – and is it still worth it?

Warehouses can be popular in certain locations.

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TAX BENEFITS

While investors can no longer leverage residential property through their SMSF, all the same tax advantages remain for those borrowing to invest in commercial property, says owner and director of Palise Property Steve Palise.

One major advantage is tax-free income at retirement, he says.

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Other advantages include a 15 per cent maximum tax rate on net rental income and capital gains tax (CGT) while the SMSF is in accumulation phase. Investors who have owned a property for at least 12 months pay just 10 per cent CGT upon selling during the accumulation phase and no CGT if selling during the pension phase.

Director of Palise Property Steve Palise.

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LENDING BENEFITS

Rethink Finance mortgage broker Andrew Tan says while lending has now become more restricted within the SMSF space, clear benefits continue to exist for those buying commercial properties.

From a lending perspective, SMSFs are treated as separate entities, which can be useful for investors who have “tapped out” on their borrowing capacity.

“It is evaluated on a stand-alone basis,” he says. “You get like a blank slate again in terms of lending.”

A person’s contributions – and in many cases, even their proposed contributions – are used when assessing serviceability, he adds.

Rethink Finance mortgage broker Andrew Tan.

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Another benefit to buying commercial property through a SMSF is that most lenders will accept a smaller deposit size compared to those outside the SMSF space, he says, explaining that SMSF lenders will lend up to 80 per cent rather than 65-70 per cent.

“The other really key benefit you get from a lending point of view is that you get what they call a ‘set and forget’ loan term,” he says. While most commercial property loans operate on a rolling facility, which generally has to be reviewed every 2-5 years, a commercial property loan written through a SMSF typically has a 30 year loan term.

Lending through a SMSF has different benefits and drawbacks to regular commercial lending. Picture: Derby Property Group

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GENERAL DRAWBACKS

One of the major drawbacks of buying through a SMSF is that it’s more complicated than a standard property purchase. Tan says it’s crucial that a SMSF is structured correctly for the purchasing of properties, otherwise there is a very real risk that you will get caught up in a papertrail of expensive mistakes that need rectifying.

The ATO’s website also states that noncomplying funds are taxed at the highest marginal rate of 45 per cent.

For that reason, it’s important to engage an expert. While good advice usually doesn’t come cheap, it’s well worth it if it prevents you spending even more on fixing up issues after they arise.

The other major downside to SMSF investing is cost, Tan says. Not only does it cost more money to set up, the lending itself is done through non-bank lenders, with interest rates up to 2 percentage points more when it comes to commercial lending.

Shopfronts on busy streets can often attract tenants. Picture: Ray White Commercial Western Sydney

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COMMERCIAL INVESTING

Palise says out of the 30 commercial properties his agency purchases on average for clients each month, about 40 per cent are through SMSFs.

The interest has come after a surge in demand within commercial property investing.

“People are looking at it, even outside of SMSF, just as a great asset class to actually build a significant passive income,” Palise says, himself having specialised in commercial property investing.

He says even before the changes to SMSF borrowing for residential properties came into place he was recommending commercial.

There has been a surge in interest in commercial investing.

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“You’re getting typically the same leverage, so the loan-to-value ratio of 80 per cent, but then you’re also getting three times the cash flow because the commercial property has three times the income compared with the residential,” he says. “The benefit of that is at retirement for the same spend, you’re going to have three times the passive income.”

He says commercial can be more complicated, however, and it’s crucial to be wary about what you are buying in order to avoid long-term vacancies.

Investing through a SMSF has long been a popular way to prepare for retirement.

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BUYING RESIDENTIAL

Tan says while investors can no longer borrow through their SMSF to buy residential property, they can still reap the tax benefits by buying a resi property outright with their super funds.

A major downside, however, is the fact that you can’t take advantage of “leverage”.

Another major drawback is that you need a sizeable super balance in order to purchase a property in full.

It is possible to buy a property with a trusted friend or family member by bringing multiple SMSFs together under a Unit Trust structure. While this could enable you to own shares in a property through your super fund, it may be expensive and complicated to set up.

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