In the past, Self-Managed Superannuation Funds (SMSFs) were generally not permitted to borrow against when seeking to acquire an asset such as a property. This rule was changed in September 20071 to allow, in certain circumstances, borrowing to acquire an asset.
Buying a property by borrowing against your self managed super fund (SMSF) can be done, for example, with an instalment warrant under strict conditions, such as:
• The borrowed funds must be used to acquire an asset that the SMSF is permitted to hold under the SIS Act; • The asset must be held on trust with a separate legal custodian maintaining ownership and the SMSF receiving only a beneficial interest until the loan is repaid;
• The SMSF must have the right but not the obligation to acquire legal ownership of the asset by making one or more payments;
“To be a worthwhile purchase, the asset should generate a combined level of income and capital growth that exceeds the after-tax cost of borrowing.”
• The rights of the lender to the SMSF under the loan must be limited to the SMSFs interest in the asset purchased with the borrowed funds (i.e. no rights in other assets).
Also, a SMSF may not put an existing asset of the fund into an instalment warrant arrangement.
Before entering into such a transaction, trustees should ensure that the SMSF trust deed permits this form of borrowing. Also, the documentation required for such a structure can be complex and should be completed by specialists in this area to avoid breaching SIS Act. Some of the rules in the SIS Act include that the interest rate payable is at arm’s length and that the SMSF is not borrowing to fund the acquisition costs, such as stamp duty.
It is advisable that clients speak to their accountant and solicitor to ensure all capital gains tax, GST and stamp duty issues are appropriately dealt with. The Australian Taxation Office has expressed concern over whether a personal guarantee compromises an arrangement, but a formal view on this issue has not been released. You should also seek appropriate legal and accounting advice on this issue.
Should I Allow my Super Fund to Borrow?
Before proceeding with any borrowing to purchase an investment asset, it is important to ask whether the asset is one that the trustee would want to own, and whether it makes financial sense. If the answer to both questions is yes, the trustee would then need to consider the structure for owning the asset and how to best fund the purchase.
To be a worthwhile purchase, the asset should generate a combined level of income and capital growth that exceeds the after-tax cost of borrowing. Shares and property are most commonly used in gearing strategies as they generally provide both income and capital growth over time. Also, shares and property have historically provided significantly higher long-term returns than cash or fixed interest investments.
However, gearing poses its own set of risks, including:
• Risk of capital loss: gearing magnifies the gains where the returns are positive but also magnifies the losses where returns are negative.
• Risk of short-term volatility gearing should be viewed as a long-term wealth creation strategy of at least ten years, and investors should be aware that short-term volatility of returns may be experienced in pursuit of higher longer-term returns.
• Risk of an increase in interest rates borrowers should ensure they can repay interest and principal if interest rates increase. Loans should also be flexible to enable borrowers to change between fixed and variable interest rates, or use a combination.
• Risk of increase in loan to value ratio: if the assets secured against the loan fall in value, the loan-to-value ratio increases, increasing the likelihood that additional capital will be required.
It is also possible to lose more than the initial equity investment if the value of the overall geared portfolio falls by more than the initial investment. For example, assume a AUD$100 investment is made up of AUD$30 in equity and AUD$70 by way of loan. It can be seen in Figure 1 that should a portfolio fall in value by 50 per cent, additional capital would be required to repay the loan amount.
Typically, lenders will not lend as much for a property purchased under a SMSF loan agreement because the security in such an agreement may be limited to the property only.
Andre Karney from Investec Experien has spent over 20 years working in banking and finance. Andre’s lengthy experience in the area of specialist lending in the healthcare sector ensures an in-depth knowledge of the market and a strong ability to fulfil client needs. Call 1300 131 141 Australia Wide to speak to one of Investec Experien’s specialised Finance Consultants.
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IF THE INVESTMENT MOVES BY: |
-10% | -30% | -50% | +10% | +30% | +50% |
| Total invested | $100 | $100 | $100 | $100 | $100 | $100 |
| Change in Value | -$10 | -$30 | -$50 | $10 | $30 | $50 |
| Total investment value | $90 | %70 | $50 | $110 | $130 | $150 |
| Loan repayment | -$70 | -$70 | -$70 | -$70 | -$70 | -$70 |
| Net Equity | $20 | $0 | -$20 | $40 | $60 | $80 |
| Return on equity invested | -33% | -100% | -167% | 33% | 100% | 167% |
