Funds must have a written investment strategy that outlines what the fund expects to invest in and the returns expected from that investment.
Where clients want to use their superannuation fund as a vehicle to buy property, they will need a self-managed superannuation fund (SMSF). This is a fund where there are four or less members and where all members are in the same family or share a business association. The profile of the client most suited to this type of ownership structure would be those who already have large amounts of superannuation and who hold the long-term view that is needed to enable the capital growth to be realised.
Superannuation funds are protected from bankruptcy proceedings or other litigation. This means that the superannuation fund member, who is also a trustee of the superannuation fund has the benefit of maintaining their asset should such events occur.
In the event of death, there are no restrictions as to where funds are directed, although there may be taxation implications. The benefit may be passed on in the event of death. This may be in the form of the property as opposed as having to sell the property to realise a cash sum.
Super funds may now borrow using an instrument known as a ‘warrant’ under the following rules:
- The borrowed monies are used to acquire a single asset or a collection of identical assets that have the same market value (that are together treated as a single asset), which the fund is not otherwise prohibited from acquiring (called the ‘acquirable asset’). Borrowed money applied to expenses incurred in connection with the borrowing or acquisition (such as loan establishment costs or stamp duty), or expenses incurred in maintaining or repairing the acquirable asset, is allowed
- The borrowed monies are not applied to improving an acquirable asset
- The acquirable asset is held in trust (the holding trust) so that the SMSF trustee receives a beneficial interest in the asset
- The SMSF trustee has the right to acquire legal ownership of the acquirable asset by making one or more payments after acquiring the beneficial interest
- Any recourse that the lender or any other person has under the arrangement against the SMSF trustee is limited to rights relating to the acquirable asset. This limitation applies to rights directly or indirectly relating to a default on the borrowing and related charges or directly or indirectly relating to the SMSF trustee’s rights in respect of the acquirable asset (for example, rights to income from the asset)
- The acquirable asset is not subject to a charge other than as provided in relation to the borrowing by the SMSF trustee
- The acquirable asset can be replaced by another acquirable asset that the SMSF is not otherwise prohibited from acquiring, but only in very limited circumstances as listed in the super law.
In other words the loan must be non-recourse (the lender cannot seize other super fund assets to repay the debt, meaning that low loan to valuation ratios are provided) and each property can only be borrowed against once.
Investors should understand that not only would the super fund need considerable funds to start such a strategy, due to the loan LVRs which are provided on such funds, the limit of borrowing only once against each property severely restricts leveraging ability.
In addition, being the trustee of a super fund carries with it strict rules for governance and compliance and the administration costs can be significant. Your client needs to be in possession of all of these material facts, the drawbacks of which can outweigh the benefits, before indiscriminately setting up a self-managed super fund for the purposes of buying property.