Updated 4 March 2016
By Penny Pryor with James Dunn
Limited recourse borrowing arrangements (LRBA) have come under the spotlight ever since David Murray mentioned them in his Financial System Inquiry report late in 2014.
It’s important to remember that borrowing to invest in residential property isn’t the only way to invest in property in your self-managed superannuation fund.
Here are five other ways to get exposure to this asset class.
1. Managed funds
Most SMSFs shy away from managed funds due to what might be perceived as high management costs but for some asset classes, like property, they are a good way for an SMSF to gain exposure.
Funds can be open-ended, or closed-ended but their sheer size will enable them to invest in commercial properties in the office, wholesale or retail sectors. These are areas that are very difficult for standard size SMSFs to invest in on their own.
2. Real estate investment trusts (REITs)
Another alternative for SMSFs are real estate investment trusts (REITs), which can invest in a range of different kinds of property, including offices, retail shopping centres and industrial centres.
As well as the type of property, the location of the properties will have an impact on prospective yields. REITs are effectively managed funds that invest in property, listed on the Australian Stock Exchange.
Real estate investment trusts are a cheap and easy way for an SMSF to get exposure to commercial property via the share market.
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3. Property syndicates
Property syndicates enable SMSFs to be involved in investments they could not make on their own. Most syndicates set up these days are SMSF compliant, reflecting the huge demand from SMSFs for property investment.
It is common to see syndicators offering a $20 million office building funded by SMSFs (and other investors) putting in anywhere from $50,000–$100,000 each, and enjoying 8 per cent plus yields for their trouble, with any capital gain on the building a bonus down the track.
Many property groups are now working with accounting firms and financial planning groups that advise SMSFs to tailor particular property offers. This isn’t always about multi-million dollar properties, but, for example, a syndicate of five investors could put in $200,000 for a $1 million property.
The risk is that syndicates are often involved at the lower end of the market in lower-quality assets. But this isn’t always the case, and if investors do their homework on the quality of the building – just like they would with any other property purchase – they can overcome some of this risk. Profiling tenants is also an important part of risk mitigation.
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4. Government-offered residential property packages
Defence Housing Australia (DHA) and the National Rental Affordability Scheme (NRAS) are federal government schemes that provide several benefits – and mitigate several prominent risks – and might be worth considering by an SMSF wanting to invest in residential property.
Defence Housing provides housing to members of the Defence Force and their families, and offers investors the opportunity to buy individual dwellings and lease them back to DHA. Investment can be a lease of nine to 12 years or three to six years. Investors have no tenanting or management responsibilities and their rental income is backed by the Federal Government.
DHA costs a lot more than standard property management, but vacancy risk is virtually nullified. Also, DHA pays for total refurbishment of the property on the exit of a tenant – a cost not normally paid by a tenant.
NRAS is a tax-effective property investment in which investors rent out approved houses at 20 per cent below current market rates to eligible tenants, in return for a financial incentive of a minimum of $10,661 tax-free per house annually.
The tax advantages of SMSFs are particularly well suited to NRAS. Cash flow is usually positive from the outset, out-of-pocket costs are minimal and there is a tax-free grant at the end of each year.
The drawback with both of these ownership structures is that you do not control your property.
5. Another alternative
An interesting alternative structure is DomaCom’s “fractional ownership”.
Residential and commercial properties are made available by owners and developers via the DomaCom Fund and the DomaCom platform.
SMSFs and other long-term investors are able to buy (and sell) fractional interests in these properties. The DomaCom Fund essentially simulates an investment in property but investors do not need to commit the entire amount.
Potential investors identify a property and pool their funds via a bookbuild on the platform, and DomaCom employs a buyer’s agent to negotiate the sale. If the fund, which operates much like a syndicate, doesn't get the property, the funds return to the investors.
Using a self-managed super fund and borrowed money to buy property can be risky business