6 good reasons why NOT to buy property within an SMSF
With an ever-rising tide of Self Managed Super Fund hysteria, we think it’s time to lend some balance and perspective to the very popular investment debate of the day – the acquisition of real estate within your own fund structure.
It seems you can barely step foot into any social setting these days (particularly as one who works within the financial services sector), without being swooped by some self proclaimed SMSF aficionado who wants to chew your ear off about their latest plan to buy a bricks and mortar asset for their “personal” nest egg.
Then they invariably start to bang on about the “numerous tax benefits” and other such little bites of cheese whatever adviser they consulted on the matter held in front of their noses.
By now you might be thinking I’m completely anti-SMSF property investment. However, that is not necessarily the case. What I am against is hyped up products being pedaled as thinly veiled investment advice, irrespective of whether it actually aligns with a) the client’s risk profile and, b) the client’s long term financial goals and strategy.
Self-Serving Super Funds
You only have to look at the rabbit-like multiplication of financial advisers specializing in SMSF products recently, to recognise that this is essentially the latest offering in a long history of self-serving product promotion, which some advisors use to line their own pockets, with little thought for providing a genuine client service.
Before the GFC, when people got a little more edgy about equities, there were a number of successful finance industry spruikers selling hybrid equity products with the promise of lofty returns, largely based on the tax savings high income earners could enjoy.
Many were also promoted with ‘opinions’ sourced from high profile, globally recognised accounting and/or legal firms. So you have to understand that when I see SMSF products being sold in the same vain, predominantly with all talk of tax perks and very little substance around investment strategy, my instincts tell me to run the other way.
The problem with Australia’s financial services industry is that to attract a large volume of clients and make a lot of money from them, big corporations tend to dress up a product to make it look like advice.
But the truth is…no one has ever retired on tax savings. The sole focus of your investment endeavours should be about creating wealth, it’s that simple.
If an adviser can only tell you about a product’s virtues in terms of tax incentives and depreciation, rather than the quality of an asset, and whether or not it’s appropriate to your circumstances and will increase your net worth over time, you are being sold something for their benefit, not yours.
So here is my first warning against jumping into a SMSF property investment structure…
1. You might be getting sucked into buying a product! You decide to invest in property within an SMSF off the back of a blog or opinion piece you read somewhere, talking about the many benefits of SMSFs. Perhaps you attended a seminar or sought advice after having a dinner party conversation with some friends.
But when an advisor enthusiastically extols the virtues of property acquired within an SMSF, without first taking the time to carefully assess your financial position and goals, please don’t fool yourself into thinking you are getting “advice”. That person is making a sale, which may not be in your best interests.
Rather than watching your “nest egg” grow, you will be lining their pockets with an upfront establishment fee, followed by thousands of dollars in annual fund management and administration costs.
Ask yourself, is an SMSF property ownership structure suited to my long-term goals and strategies? If not, why would you bother?
2. Your money could be working better for you. The second point is about how reliant your fund will be on extra contributions, should you choose to borrow for the purchase of a property asset within the structure.
Irrespective of where your super is invested – whether it’s an industry fund, SMSF or retail product – the first step is deciding how much to contribute. We are all legally required to contribute 9.5% to our fund, there’s no getting around that fact.
But if you’re looking to borrow and buy property within an SMSF and doing so means you are required to make extra contributions, I would implore you to think very carefully about whether that’s appropriate for your age and stage of life.
If someone asked me, ‘Should I contribute more into super?’ I would be asking, ‘Do you still have a significant home loan debt?’ or, ‘Are you planning on upgrading and increasing the size of your mortgage any time soon?’
If the answer to either question is ‘Yes’, and they are still some way from retirement (say 20 to 30 years), I’d suggest that person would be better off putting any extra cashflow into their home loan, rather than being forced to make extra super fund contributions.
3. Literally putting all of your eggs in the one basket is never a good idea. What other investments do you have? Again, if you’re say twenty or thirty years away from retirement, I would typically recommend that people at least begin establishing an asset base outside of their superfund, before turning their attention to an SMSF structure.
Think about it, you’re already contributing 9.5% every year, which is a great start to accumulating a healthy fund by the time you retire. Arguably, you should look to at least match that same contribution amount to your own investment portfolio outside of Super, to ensure your future financial plans are not too super-centric. Because the next thing you need to think about is…
4. How flexible are your retirement options? In Australia, you cannot legally access your superannuation until you reach ‘preservation age’, which is currently 60 years (for those born after July 1964). Under certain circumstances, you may be able to access your funds sooner, but there are plenty of bureaucratic hoops to jump through if that is your intention.
Recently, there have been discussions in political circles about extending the preservation age to 67 or 70 years, and who knows where these conversations will lead in the future?
Essentially, to be too super-centric means handing your future to vote-grabbing politicians, allowing their legislative whims to determine how and when you retire and with what type of income.
The bottom line is this, when you rely solely on your super fund to draw a pension in your ‘golden years’, you will have less say on the matter of possible early retirement.
5. The risks might outweigh the rewards. If you’re nearing retirement, gearing to invest in property may not be an appropriate strategy for you to build your post-working income. Firstly, gearing obviously increases your risk, magnifying both positive and negative returns on investment.
As you approach retirement, arguably you should be looking at ways to reduce your risk, rather than increasing it. And whilst there is no guarantee the property you invest in will continue to grow in value and your returns are not certain, you are assured of having to pay interest on a mortgage every year.
In other words, you need to consider the pros and cons of an SMSF property investment with full awareness of what may or may not be appropriate to your life stage and circumstances.
6. You could be robbing Peter to pay Paul. Another consideration as you edge closer to retirement is access to cashflow and the liquidity of your chosen investment vehicle.
For instance, if you have a $200,000 balance in your super fund and decide you’ll purchase a $600,000 property asset, you will obviously use up a sizeable portion of that superannuation, particularly in meeting the associated costs of acquiring residential real estate, such as stamp duty.
This could essentially exhaust your fund’s cash allocation, leaving you with a balance of maybe $20,000. That’s not such a bad thing if you’re only forty and have another twenty to thirty years to rebuild those reserves, but what happens if you are only seven to ten years from retiring?
Will your fund have a sufficient balance to convert into pension phase and start drawing some type of income when you most need it, with the additional expense of an investment property?
Is an SMSF property investment ever a good idea?
Is there any time when you might consider investing in property within an SMSF? Of course there might be. But as with everything, it really depends on what stage of life you find yourself at and whether this type of strategy meets your own personal goals and objectives.
Are you being distracted by all the noise and hype because you neglected to set clear and attainable financial goals and implement a plan as to how you would reach them? Or is an SMSF aligned with your carefully considered investment strategy?
Warren Buffet says risk comes from not knowing what you’re doing. The biggest risk for people who fail to adopt a strategy is getting distracted and in turn, taking an approach that’s totally inappropriate to their personal circumstances.
I think gearing to invest in property within an SMSF is the current, quintessential example of how people who want to invest but don’t know where to start, get lured in by clever marketing and savvy sales people. Remember, investing is not a one size fits all prospect, you need to weigh up your own variables before diving in the deep end.
For more information on how you can profit from investing in Australia’s residential real estate sector by establishing clear investment goals and strategies, click here to contact us, or subscribe to receive regular post updates and industry insights.
Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: firstname.lastname@example.org
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