Reports of self-managed superannuation funds increasingly holding residential property investment are concerning, particularly when the fund members are close to, or have entered, retirement.
Diversification is a key factor in maintaining a successful investment strategy in an SMSF. There are a number of problems inherent in having a large portion of superannuation savings tied up in one asset, and direct property holdings are no exception.
Having one dominant asset, and not many other holdings, brings increased risk. When the dominant asset is an illiquid asset – such as direct property – the risks are enhanced, as liquidity should be a key consideration for retirees who generally require good cash flow.
For instance, if a retired SMSF member needed a significant amount of cash – perhaps for the fund to make pension payments – having to sell a property to realise this cash is not ideal. It can take months to sell property and the market that you are selling in also needs to be considered. Having to sell property in a fire sale style, or in a market downturn, can lead to a less than optimal outcome.
SMSF trustees also need to factor in repairs and maintenance bills for direct property, expenses that are not required for other types of asset holdings. Equally if the property spends time untenanted – and not generating income – this will impact on cash flow.
There are a number of other issues for trustees to consider with direct property holdings, not least of which is whether it is appropriate for the SMSF to be carrying debt.
Retirees ideally should be debt-free and carrying debt is a risk. Property investors who do their sums on today’s interest rates could find the situation is very different in three or four years’ time.
Yield is another important consideration. While investors in residential property can benefit from capital gains over time, this is not necessarily a sensible scenario for retirees. There are better yields elsewhere.
Holding an investment property also places demands on the owners. While the SMSF trustee can appoint an agent to manage the property, there will still be decisions to be made placing greater demands on the SMSF trustees.
The rise of in the number of property investments seminars for SMSF trustees is also a concern. Properties sold to investors in this way are rarely bargains and frequently carry additional costs – such as sales commissions – built into the purchase price.
These seminar-based ‘opportunities’ usually require the investor to take on a large level of debt to fund the property purchase, which again may not be a suitable strategy for those who are approaching, or already in, retirement.
There are also tax liabilities when holding property in an SMSF that should be considered. An SMSF must be wound up upon the death of the last member and the proceeds paid as a lump sum to beneficiaries or the estate. Even if the decision is made to keep a property – by transferring it out of the SMSF – it will still trigger ownership transfer stamp duty costs.
Business real property is an exception to the direct property holding rule, and holding property in an SMSF can be beneficial is for business owners, particularly for younger SMSF members.
This strategy allows funds to be moved out of the business in a tax effective way by paying rent to the super fund rather than some third-party landlord, and it is also one of the few ways to utilise superannuation investments in a business.
As with any asset holding in an SMSF, direct property investment has to make sense from investment, tax and income perspectives, and not simply because it is the hot asset class of the moment.
This is not to say that direct property is not a good investment option. Geared property investments can be an extremely tax effective strategy when held outside of the superannuation environment. Negative gearing is more effective the higher the tax rate payable. Superannuation, with its concessional tax rate of 15 per cent, usually provides less of a tax benefit.
Going through the extra hurdles and cost of satisfying the super fund borrowing restrictions may not be worthwhile compared to holding the property personally.
Andrew Yee, director of wealth management, HLB Mann Judd Sydney
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