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Should SMSFs trustees be investing in risky assets such as residential property?

High-risk investments, such as geared residential property are possible within an SMSF. But you need to understand the risks, and make sure the correct documentation is in place. Why SMSF trustees in 2015, invest in risky assets such as residential property is because they think they can do better than professional investors and outperform the share market and get a reasonable return on their investment. However the truth of a purchase in today’s climate could be far away from some of the investment strategies developed by young and inexperienced trustees.

Residential market is over heated in most capital cities in Australia and many TV channels are talking when the residential property bubble will burst. Vacancy rates are rising and rents are declining and many owners have to wait for more than three months for a tenant and that too after shaving off as much as 20% of the asking rent. For SMSF trustees, this is not good news as section 71 of SIS Act strictly prohibits occupation of these properties by related parties of the fund.

We are looking at empty homes being auctioned at 70% of their purchase price. Anyone who lived the Henry Kaye era will tell you all about it on how their investment homes disappeared when the bubble actually busted and swept away equity in their own home, a strategy which Mr Kaye promoted. But younger trustees who are buying now were only toddlers then and in today’s world of SMS texting, whatsup and instant maggi and results our brains are accustomed to only current news and memories fade quickly.

If anyone is reading this article – please visit www.realestate.com.au and search for residential property for lease in Blacktown NSW 2148, on my search, I got 287 properties. Value of any asset goes up because of demand – please note that tenants do not WANT to rent properties as the interest rates are low enough, they can buy them cheaper then renting them. And remember you and your relatives cannot live in a SMSF property unless you deliberately decide to breach the rules, period!

The reason why I have chosen Blacktown is because this suburb has shown the highest growth rate in NSW and coincidently has the highest vacancy rate. The average price is about $600,000 of which the fund needs about 30% plus stamp duty and legals or about $200,000 which is the about the same figure put by regulators as the recommended minimum amount required to set up a self managed super fund.

To learn how to set up a self managed super fund, click here.

What is a "Property Bubble"?

Many commentators are blaming overseas buyers, especially Chinese buyers due to some rule of property ownership in their country and losing up their economy and SMSF trustees, however, super fund trustees keep investing in high-risk assets no matter what they’re told.

My cousin architect tells me that he is sleeping only 6 hours a day and since January 2014 till today, he has done equal number of development applications which he has done in his 15 years of his practice, before that time. Basix, hydraulic, fire, traffic and all engineers have tripled their prices, its boom time for them and the net result is that it is costing more to build and it has to simply sell for more, which is not a problem as we are queuing right outside open homes and those who are selling off the plan.

Ask any real estate agent of his reading of the market “we have ready buyers, but there is just no stock”. One agent told me that he listed a property, got the owner to sign his agency agreement and went back to his car parked outside the vendors home, sent a mass email to his database of 200 buyers for an open house that same afternoon and had an offer of about $80,000 more than the vendors expectation and had the house sold within three hours. A cool $30,000 commission for only three hours of work!

Can a SMSF borrow?

One of the basic rules (SIS Regulation 13.14) about having an SMSF is the trustees may not give a charge over the fund assets. This includes a mortgage, lien or other encumbrance. The regulation prohibits trustees from activities such as: participating in margin lending products, and creating a mortgage over a property. One of the exceptions to this prohibition is a limited recourse loan borrowing arrangement, which has its own set of restrictive rules laid out in s67A and s67B of SIS act.

Investment decision for using borrowing including an analysis of the risks associated with using geared investments with variable interest loans, within the fund’s investment strategy could cause havoc when interest rates rise. To add to this insecurity, the restrictions and controls on using residential property by relatives and related parties such as Part 8 associates of the fund increases holding risk and offers lower returns.

Considering the compliance processes of borrowing to ensure the risks and controls are effective and the lack of use of financial planner by younger trustees will only result in counter blame game between bank regulators, financial planners, real estate agents and accountants for flogging the product ‘SMSF” in the blood bath which will follow after the bubble will burst.

Many SMSF advisers can help trustees prepare to purchase a property with borrowed money. Unfortunately, SMSF Auditors aren’t allowed to advice trustees or recommend a specific lender even if they were licensed to give financial advice. Any advice given by the SMSF auditor would be seen as a conflict of interest and provide grounds to independence and lead them to decline the audit engagement.

Click here to learn how a super fund can borrow.

Conclusion

In some cases, trustees have been unaware that they have given a charge over the assets of the fund or have let a Part 8 associate reside in the residential property. SMSF Auditors may have to become vigilant in this respect and make the trustees aware of penalties which they may cop for breaching these rules.

Can a self managed super fund sell a residential property to a related party? The answer is yes, but at market value decided by an independant valuer. Further, the transaction may be subject to capital gain tax for the fund and stamp duty may be payable by the related party.

If you are a professional investor, you will be counter cyclical. Sell, when others are fighting (in an auction) with each other to pay top dollar for your assets. Remember if your purchase has gone up in value, profit is yours only when you crystallize the sale, otherwise it wil just smoke away and disappear before you can catch it.

If you are a novice investor, in most cases you’ll be betting against a professional, and remember every contract you enter into has a winner and a loser. And those buying off the plan, just think, why are the builders selling, when it will be worth more when it is ready. Don't buy, wait for the burst, use your head! God's given you one.

This article is written by Manoj Abichandani our SMSF Technical Director who is also a licenced real estate agent in NSW and a property investor who purchased a property in his self managed super fund in August 2014 and sold it 366 days later in August 2015 for 40% more than the purchase price.

Contribution reserving – Admin Procedures

- By Mark Wilkinson

The ATO has now released a form, titled Request to adjust concessional contributions. This form notifies the tax office that a member of an SMSF has made concessional contributions in one financial year (year one) but their SMSF did not allocate them to the member until the next financial year (year two).

This measure will significantly simplify the process when they are using a contribution reserve to maximise their superannuation contributions.

The contribution reserving strategy allows contributions to be recognised for income tax deductibility in year one but not counted towards the concessional or non-concessional contributions cap until year two.

The problem for trustees is that the SMSF annual return does not make provision for contribution reserving. The trustee had to show both contributions as allocated to the member in the year of contribution. This resulted in the ATO issuing an excessive contribution assessment to the member, which the fund member was then required to object to.

The release of the “Request to adjust concessional contribution” will now allow the reserved contribution to be clearly identified. With the result that the trustee will no longer need to go through the objection process.

The new system will make it much easier to adopt this strategy without going through the expense of preparing and lodging and objection.