By Vicky Richards
What are the risks?
Property is becoming a popular form of investment for SMSF’s as it is often easier to understand than many other types of investments.
If the property investment also involves SMSF borrowing there are additional issues and added risks you need to be aware of:
Diversification – if property investment is your major investment you may have little or no diversification. Spreading your money across a range of investments is one of the most effective ways to reduce risk and achieve more consistent investment returns over time.
Building a property portfolio in a SMSF can be quite difficult because you are not permitted to use any of the equity built up in other SMSF property or investments to leverage against subsequent property purchases.
Are all of your contributions being used to support the mortgage on one property? How are you going to diversify into other investments?
Cash flow – loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan repayments.
Is the property rental income sufficient to cover the mortgage payments and other expenses? Remember there may be periods of time where the property does not have a tenant and the SMSF will have to cover all the property costs. Are you relying on employer contributions to meet the shortfall? What happens if these cease? Do you have other money which you can contribute to the fund to cover these costs? Remember that all contributions to your fund will be preserved until your retirement and contribution caps impose limits on the contributions that can be made to super.
Careful planning is needed to ensure contributions and the fund's investment income is sufficient to meet the loan repayments and other liabilities as they fall due. Avoid becoming over-committed to a future large, heavily geared property purchase.
Death of a member – how will the fund afford to pay the death benefit? Will the trustee be forced to liquidate assets to pay out a death benefit as this could force the property to be sold in a fire sale situation resulting in a price well below its market value.
Where there are borrowings in a SMSF it is also important for the trustees to consider the need for life insurance should one or more contributing members of the fund die. Careful drafting of the fund's trust deed is also required to ensure the proceeds of a life insurance policy, in this scenario, can be used by the SMSF trustee to repay the loan.
Higher costs – SMSF property loans tend to be more costly than other property loans which must be factored into your investment decision. The documentation required is complex and can be quite costly.
If your SMSF property loan documentation and contract is not set up correctly, unwinding the arrangement may not be allowed and you may be required to sell the property, potentially causing substantial losses to the SMSF