Can You Invest in Property with Your Super? SMSF Guide

This is a Momentum Media production. Nerd alert! Property nerds. The home for data-driven property investors, where we uncover Australia's hot and cold markets, latest headlines and trends. Welcome back to another episode of the Property Nerds podcast.

I'm your co-host Arjun. I'm joined by Jack. And if this is your first time tuning in, I'm the founder of InvestorKit Buyers Agency. We're Australia's Buyers Agency of the Year for 2024 and 2023. And I'm here joined by Jack from Fareka Financial.

So we've got an exciting episode here today. And if you are going to stay into the end, you're going to learn a lot about the world of SMSF in particular, not just the setups and the day-to-day stuff with it, but more like some trends that we've been noticing from some interesting research that we've done. And so please do stick around to the end when it comes to understanding SMSF, because we're seeing a huge activity level in this. And so it's important that if we're seeing so much of this, what are we seeing? Why are we seeing it?

And what can we talk about in today's episode that will help you with it if it's something you're considering? So Jack, I might throw over to you first. SMSF finance, it's ramping up like no tomorrow. From what I remember, I think it's something like one out of eight purchases for us, maybe some years back. And it's now almost one out of five purchases.

Like it's lifting substantially. What are you noticing in your space? And why do you think SMSF is becoming such a hot topic right now? Yeah, so I think a big driver of it is that people that are hitting their borrowing capacity limits outside of super are kind of looking to super as a bit of an add-on to their portfolio. That's one big reason.

But the more that I've delved into SMSF, the more I think that it actually can play a pivotal role in your strategy, in your long-term strategy, in your exit strategy, and how you accumulate assets and then deploying that into retirement. It's really powerful, man. There's some of the benefits that you have with super. It can really enable the exit strategy if you do it in unison with the purchases that you're doing in your personal name and in trust. Now, we obviously know the biggest thing that we've recognized is leverage seems to be that key factor for property investors because it's like, I don't get that in my own super.

Now, if you're listening to this, by the way, it's important to note that Jack and I aren't financial advisors and we aren't able to give advice on self-managed super funds or whether it's the right fit for you personally. This podcast is completely general in nature. We're talking about what we see in the SMSF world, what we're commonly seeing from lending policies, property buying, client decisions, and surveys that we've conducted. For anything SMSF for your personal journey, speak to an accountant, speak to a financial planner. Obviously, introductions that we can make because we deal with so many that can help so you have alignment between the team.

For that, we'll drop a note shortly. Jack, in terms of the borrowing capacity, yes, you talked about something where people are capping out, but when it comes to their SMSF, how much do they have left extra? I know you're saying that they get a new wave of borrowing capacity. Is that because they don't consider it like your personal debts as the same as your SMSF? It's like a separate line drawn?

That's right. That's right. Say you're buying any property in your personal name or in a trust outside of super, a lender is looking at your income, but they're not including the super in the serviceability. All the servicing they're doing is excluding super because super just goes directly to your super fund. Now, when you're looking at borrowing within an SMSF, they're not looking at the income.

Yeah, your taxable income, they're looking at it, but what they're really looking at the super contributions, you could be making a little bit extra, but that super contribution is not going to servicing debt in your personal name. That's going directly to your super. With those super contributions plus the rental income on the property, that's what they're looking at. If you are tapped out on your borrowing power, you've got 11. 5% of your super that is going directly to your super fund to service that debt.

It can really open things back up. Now, you get extra capacity in the SMSF. How much though? How does it work? I know it varies from people's income and contributions, but is it like you can use your fund to buy three or four properties or do you get usually tapped out at one or two?

What's the big difference makers here? Well, it depends on your income and it really depends on the actual funds that you have in the fund because a lot of times people would run out of cash within the fund before they run out of borrowing power in the fund. When you're borrowing outside of super, lenders have to look at your living expenses. They have to look at all of these other things, right? Dependents, right?

All that. When you're borrowing within super, they don't really necessarily look at that. It's pretty much a separate entity. There's no living expenses involved. It's just super contributions, rental income on the property, loan repayments, really, really straightforward.

But generally, you'll find that people run out of cash in the fund before they run out of borrowing capacity, but it really depends on the total household income. Obviously, the more total household income you have, the better your borrowing would be. Now, with business owners, they obviously can have incomes fluctuate over time. So sometimes they have a salary that they pay themselves. Sometimes that salary isn't there and they have profits.

How did they get that superannuation review when it comes to servicing? Because that would be a bit tough, right? In terms of different policies for them? Yeah. I mean, it does vary a lot when you're self-employed in regards to super contributions.

I really feel for the people that are self-employed that never really were pushed to put money into the super, although they should have. Some accountants are pretty strict with having their clients put money into super. Other accountants don't really care. And it really shows towards the end of the investment journey for those clients that haven't put any money into super, it kind of shows and it does limit their options in regards to exit strategy. So yeah, it is a little bit more complicated when you're self-employed, but if you've got some consistent contributions going in over 12 months, over 24 months, even if you don't and you're kind of just starting out, there's still going to be some level of...

Okay. So it'll help towards it. Now, what about if someone makes extra contributions? Because we've got, say, someone getting 15K to their super per annum, they chuck in an extra five in that year, and now you're reviewing their borrowing capacity. Does that help them with servicing or not really?

Yeah, definitely. Extra contributions? Yeah, definitely. So if we can show that there's been historic contributions consistently, a lender's definitely happy to take that, yeah. And do they want to review it for just one year or two years?

Because will the lump sum payment work there or not really? Because imagine I'm going, hey, this is the year I want to borrow. Can I put in an extra lump sum this year to increase capacity to show I'm able to do it, I'm capable of doing it? Yeah, well, it's got to pass the pub test. I think lump sum for self-employed makes sense because they usually just do it when they do their tax return, they just do a lump sum.

Over one year can do, over two years, even better. As a PAYG person, I know some people would get a bonus and then they'll put the super contribution in there. For lump sums with a PAYG over two years should be fine. But if you can just have it consistent, even over like six months to a year, we can make that argument. But even if there's no extra, like if there's no historic extra contributions, we can still, if we can still demonstrate that there's capacity to make proposed extra contributions, then we can even increase the lending there.

Okay, so that will help in good cases moving forward. So what we've come to notice is like, there's obviously property investing became a big factor over the last few years, especially after the boom. It's always been popular in Australia, but the last few years after this nationwide boom, it's almost like people are finding ways to go, I want to have more exposure to this. But then comes the game of diversity, right? Like people sometimes don't set up an SMSF because they go, well, I'm going to do property outside.

I'm going to leave my funds in shares and I'd like it to be different. But from what I know, you can still diversify in an SMSF as well. Is that right? And is that something that people also should be doing considering that like, it's not just property at the end of the day? Well, if they're specialized in that area, like if someone really knows shares and they think they can do better than their current fund, yeah, you can do an SMSF and have put it into shares.

It doesn't always have to be in property, but obviously I like property. Obviously, you can leverage into property. You can take 200,000 of cash in super and turn it into an 800K property. And then you're exposed to the growth based on the 800K, not the 200. So with shares, you're limited a little bit with the total exposure.

And yeah, especially with all the benefits and discounts on capital gains when selling a property in super, it can really enable an exit strategy. That's big and people don't talk about that often, right? But I guess the main thing here is that if you I think that sounds pretty straightforward. Hey, like just like just saving, you're a Kiwi, you're saving for your future. But with super, I guess the key thing I wanted to jump into is we've done some research on this.

And I wanted to share a few stats on this. And this is research that we've done, like on the superannuation world itself. And when we conducted this, this was survey based research. So we got a lot of insights, a lot of survey responses to understand where people are at. And what we found was pretty interesting.

So while SMSFs can be a powerful tool for building wealth, it's actually not as widely used by many Aussies. It's something that's picking up in popularity, but not as widely used. Our data from the survey said that 60% of Australian investors that answered the survey are actually eligible for an SMSF. And the eligibility was simply based on like balances. And having a balance of at least 200,000 plus or 150,000 plus depending on them.

But the key here was that we had 423 respondents and over 60% revealed that even though they had that position in super, they still hadn't set it up. That doesn't mean you have to set it up, but it just shows that there are a lot of people that may not be aware or haven't thought of it or haven't considered it, which was definitely the case there. Only 35% of those that were eligible for an SMSF that are aware of it have thought and actually considered it were the ones that are using it. So it gets lower when you go from not aware to not aware of eligibility to now, oh, I'm aware of it, but I just haven't gotten around to using it. And then 39% of the SMSF eligible respondents said that, look, I wasn't having an SMSF just because I don't have the knowledge about it.

So those that were eligible for SMSFs in terms of the ideal balances recommended by ATO or that consideration when it comes to financial planners, and they were like, oh, look, I'm aware of it, I'm eligible, but I don't know much about it. So it's clear that there's a big education piece. And when we were seeing what the biggest responses were, the top three responses was that I don't understand how to set up an SMSF or believe it would be too complex for my needs. The second biggest one was the superannuation balance. I'm not sure if my balance is large enough to use it effectively.

So that was interesting. And the number three was I just don't have the necessary expertise or confidence to actually self-manage my superannuation. So all really good reasons to consider a few things. Firstly, get the insights from a team around you. Now, if you're looking for introductions to certain accountants in this space, Jack, how can people reach out to you and your team?

Yeah, just head to foreca financial, the website. com. au. And yeah, they can just book in a meeting directly with me. Perfect.

And the point of that is not to go, hey, jump on, set it up. This is advice. That's not the case at all. But the point of that is to go, what is your lending options available from a finance perspective? And then be able to go, hey, do you have contacts that understand SMSF well, can talk to me about the pros and cons, and we can make that introduction and they can make a discussion there for you to see it.

So that ticks number one, I don't understand how to set it up. It also ticks number two, to know if your balance is suitable enough based on what that advisor's seen, what they've set up, and even what Jack has supported clients with to know that, is that going to work or not? And usually we found sort of 200K plus in balance is the sweet spot. But we have seen some people on their own accord with their advice, gone and set it up with 150 to 175 because they feel there's a property out there that was affordable for us to go and purchase for them. Now that's been something for them to consider and again, get advice on.

And the last one is personal investment expertise. I don't have the necessary expertise or self-confidence in self-managing the assets or self superannuation. So these are big responses there for the top three. But the key with that third one is if you have a property buying team around you, a finance team around you for finance, an accountant and an advisor, you've now got firstly before setting it up your pros and cons consideration to see if you do it or not. And if it makes sense and you are doing it, you've got the property buying aspect, you've got the shares aspect from your financial advisor, you've got the admin aspect from your accountant, and you've got the finance from the finance team.

So you really can build a team to kill some of these things which are barriers to using an SMSF. So I thought it'd be helpful to share some of that research there. So that's SMSF research and obviously borrowing capacity. But another big one, Jack, that you wanted to touch in on was strategy. And I'm talking the property specifically because we can't advise on SMSF strategy in terms of how they go and invest it or where they should and shouldn't.

But assuming someone's now gone, Jack, I'm definitely going property, I've considered my advice. What are some things in the strategy fund that you think should be important from finance strategy for SMSF? Yeah, so it's heavily going to be dependent on your age and what your retirement goals actually are, what your portfolio looks like in your like outside of super and what like how long you have to invest. So it's very complex depending on each individual. But if you've got if you're really young or if you've got like 20, 30 years before before you actually retire, you would obviously start residential, you know, get some residential property because the price point to get a good residential property is a lot lower than the price point to get a good commercial property.

If you've got the capacity to go commercial straight away at a really high value commercial, but you're still 20 years out from retirement, you could probably still spend that first first half of that that 20 years building up a residential portfolio because it's actually really like generally selling a property is quite costly and you wouldn't want to do that. Right. But because of the heavily discounted capital gains tax and super to sell, you're actually keeping a lot of that capital. So a lot of people can go aggressive on the residential front with a buffer, hold that those properties for, you know, 10 years because then when they sell, they're going to be able to purchase a much larger commercial property at a better loan to value ratio. So the cash flow would be better, the asset class would be better.

And then because of that cash flow being better and, you know, you've still got some time before retirement, that big commercial property can just be set and forget. And then all the positive cash flow that's generated from your continuing to make contributions and also the positive cash flow on the rent, you can you can generate enough of like a deposit of 150, 200 grand to then fund another residential and then just use that to trade up and try to get to another another commercial maybe or if you can't quite get there, you can just wait until retirement and sell it off. Yeah, again, tax exempt, use it to pay off some debt in your personal name. So using super and the tax advantages there in the exit strategy, but also while you're growing, it can really change your thought process and how you approach your exit strategy in your personal name and in trust. So it really depends on how long you have until retirement.

And generally, you kind of got to just have a plan. Okay, some people are like 10 years out. Okay, so it's like, all right, well, maybe for the first five years, we'll go heavy on the residential, then start to consolidate out and generate a large deposit for a commercial at a low LVR. But yeah, like you can get a really quality residential property for 600, right? But for commercial, you'd want to be closer to two mil.

And you really need to use residential property as a springboard to get you there. So that takes time. Some people commercial might not be an option because they just simply don't have the balance all the time to get to that high value stuff. And then in that case, I probably wouldn't consider going that lower purchase price for the commercial just for the sake of it. You know, there's still...

And that's a big one, man. Like people forcing themselves into an asset because they think it's got that extra bit of income. Don't do that. Get the right one. Obviously, if you have a real defined cutoff date and that needs the income asset there, sure.

But I mean, that upgrade from residential to commercial, like people, I think what happens I've found is that people think that, oh, I can't do commercial if I keep getting residential. But the thing shouldn't be that I can't do that and always wanting both. It's okay to get rid of stuff. Do you know what I mean? It's okay because you're in consolidation phase.

Like if you're getting rid of your residential to transition to commercial, like use that as a celebration of the residential and what it's done for you rather than, oh, I invested all this money in residential and now we're going to commercial and now I have to start again. Like no, use that as a celebration. Like you could not have saved that money that you're about to now have. You could not have saved that tax from just your after tax savings on top tax rates personally where you're having much lower tax rate in the SMSF when you're exiting. And so I think the key there is like to firstly go, we don't want to flip residential properties really quickly to get to commercial.