Using Your Super to Invest in Property in Australia – SMSF Guide

When it comes to investing in real estate, it can be difficult to obtain sufficient funds to make things work. This is especially true if this is your initial foray into the market for real estate investments. On the other hand, you could be wondering: can I utilise my retirement savings to buy an investment property?

It is possible to make investments in real estate using your superannuation, but doing so is not nearly as easy as it may appear. There are a lot of questions you need answers to before you can move on with investing, such as how to establish a self-managed super fund (SMSF) and whether or not your investment passes the "sole purpose test.

We will go through everything in detail so that you can make an informed decision about whether or not using your retirement savings to purchase an investment property is the best option for you.

Before making any choice, you should always discuss the specifics of your situation with an experienced financial advisor who is qualified in the field.

What is a self-managed super fund (SMSF)?

When one or more people make the decision to manage their own superannuation on their own, this is referred to as a self-managed super fund (SMSF). Each individual is a trustee of the pension fund, which means that in addition to having the ability to decide how the pension fund should be invested, they are also responsible for ensuring that the fund is operating efficiently.

How to set up an SMSF

In Australia, there are currently over 1.1 million people who have taken control of their retirement savings by establishing an SMSF. Here is how you can join them:

1. Choose your trustees.A SMSF may have anywhere from two to four individual trustees, or it may have a corporate trustee with anywhere from one to four directors. Check out the ATO's rundown of the advantages and disadvantages of each trustee option.
2. Draw up a trust deed and an investment strategy. These documents outline the goals of the SMSF, its members, its investment strategy, and the possible payment methods for rewards. Don't forget to clarify that it is acceptable to use your retirement savings to buy an investment property!
3. Set up your trust. A trust in which assets are held by trustees for the purpose of providing retirement benefits to members is known as a super fund. You will need some cash to get started, but there is no needed minimum amount of money to establish an SMSF..
4. Obtain an ABN.If you are eligible, obtaining an ABN is a straightforward process that only takes around ten minutes of your time. Visit the website of the Australian Business Register in order to acquire an ABN.
5. Register the fund. This ensures that the fund is eligible for tax reductions and the GST, and that members are able to claim tax deductions for their payments!
6. Open a bank account. Contributions can be made into this account, and it can also be used to pay for any expenses or responsibilities that may arise. You are also able to transfer the currently held super here.
7. Obtain an electronic service address. Members can now receive employer contributions thanks to this. The providers of electronic service addresses are listed below.

What’s involved in using SMSF to buy an investment property?

There are a few crucial factors to take into account before using super to purchase real estate:

1. Make sure your investment fulfils the 'sole purpose test.

Any investment made through a super fund must be made solely to increase retirement assets, not so that you can use the money right away. Therefore, you cannot:

• Rent the property out to relatives or other trustees.
• Renting the house out for less than market value
• Acquiring property from a relative
• Own the property and reside there.

In other words, it's crucial to ensure that the property is a long-term investment that complements the investing strategy of the SMSF.

2. Will you need a loan?

You will be able to obtain a loan known as a limited recourse borrowing agreement, or LRBA, if you require additional funding for your investment. It's critical to remember the following when it comes to LRBAs:

• A minimum of $200,000 must be in the SMSF's balance.
• Loan payments have to be made via the SMSF.
• The loan cannot be repaid by selling other assets held by the SMSF.

Before entering into an LRBA, it's a good idea to speak with a financial expert, especially since they are slightly more sophisticated than standard loans and demand careful adherence!

Should you use an SMSF to invest in property?

Now that you know what to think about, are SMSFs a wise idea? To assist you, we've listed the advantages and disadvantages below.

Pros of using an SMSF to invest in property

• Access to increased capital: You could be able to purchase a fantastic investment property through a home purchase through your super!
• Lower tax rates: With an SMSF, you'll pay fewer taxes on your investment property. Compliant SMSFs can take advantage of the 15% tax rate on any rental income from your investment property. If you don’t sell your property until the fund is in the pension phase, there’s also 0% tax on any capital gains!
• Can increase ROI for your super fund:An effective investment can boost your retirement funds, benefiting both you and your trustees.

Cons of using an SMSF to invest in property

• Increasing risk exposure to your pension: When using super to purchase real estate, you'll be placing a lot of eggs in one basket, therefore it's crucial that your SMSF investing strategy makes an effort to diversify your portfolio of rental properties in order to lower risk.
• Compliance is essential: Managing your super might be difficult because annual audits by an accredited auditor are necessary to ensure that your fund is operating legally. The highest marginal tax rate will be applied to all of your SMSF's income if it is determined to be non-compliant.
• Restricted loan options:In contrast to personal property acquisitions, LRBAs have rigors guidelines that must always be followed, therefore it's crucial to make sure your SMSF can afford the monthly repayments.
• All transactions must be at arm's length:As a result, you are not permitted to conduct business with people who are 'associates' of fund trustees. Family members and business partners are considered associates.

So, is it worth it to buy a property with an SMSF?

Using your super to buy property can be a fantastic alternative for someone who knows the market inside-out and wants complete control over their investment. You could make a fortune if you can weigh the benefits of using your retirement funds to purchase a home against the risk of putting all your eggs in one basket.

To be able to benefit from lower tax rates, though, you'll need to be ready to assume the burden of creating and maintaining a fully compliant SMSF.

What Next? How to Build a Balanced Property Portfolio

Here's how you can tell whether you share our obsession with real estate investing:

You've purchased the property, secured a renter, and hired a property manager to look after the rental. What should my second real estate investment be is the only thought you have right now.

It's time to think bigger now and to begin expanding your real estate portfolio.

Three key components make up a successful real estate portfolio: diversifying your holdings, raising funds to buy more properties, and solidifying your foundation.

Let's examine these issues in greater detail, covering everything from the reasons why to the steps for building a property portfolio as well as some advice based on your individual goals.

What is an investment property portfolio?

Here are the fundamentals.

All the investment properties you possess are included in a "property portfolio" or "real estate portfolio," which is what we're talking about. Your property portfolio would be a list of all of your existing real estate investments.

Of course, the majority of people start off with just one investment property in their portfolio. Some investors, though, continue to grab more.

AFR estimates that 18,000 investors in rental homes have six or more properties, while 10% own three or more.

The reason for this will now be discussed.

Why is it essential to have a balanced property portfolio? 

Let's discuss the thinking that goes into creating a portfolio of properties.

What drives you to purchase many investment properties?

One rental is frequently insufficient. Most investors continue to purchase other properties in order to increase their returns. You can have two properties that both generate rent and appreciate in value, thereby doubling your earnings, as opposed to just one.

Building a property portfolio is an essential step to take if you're serious about achieving financial freedom, retiring early, or whatever your objective may be.

The property portfolio needs to be balanced, so why do we say that?

Building a balanced portfolio is a wise investment approach, whether you're investing in stocks, bonds, or real estate.

Finding ways to reduce your risk exposure and improve your chances of higher returns is the key.

The truth is, none of us are capable of foreseeing the future. The supply and demand for different types of homes and locations fluctuate constantly in the real estate market. But investing in different property kinds in a variety of postcodes is one proactive measure you can take to safeguard your money.

When it comes to real estate, the adage "don't put all your eggs in one basket" couldn't be more true.

You'll have stronger performers in your portfolio to offset any potential loss if demand for one of your properties declines.

It's also important to keep in mind that once you get things going, buying the next property is frequently considerably simpler.

In order to finance a second investment property and lower the upfront costs of your next mortgage by doing away with items like lenders' mortgage insurance, it is a typical strategy to use the equity in your first investment property as leverage.

In essence, you should create a well-balanced real estate portfolio for the following reasons:

• Increase your returns
• Lower your risk
• Investing in the second property is simpler than the first one.

How to build a property portfolio

The exact processes for creating a balanced property portfolio are listed below.

You should employ the following strategies:

1. Make a combination of properties with strong capital returns and high rental yields.
2. To access equity, refinance your current property.
3. Diversify your investing portfolio by region.

1. Make a combination of properties with strong capital returns and high rental yields.

Not all investment properties produce the same level of capital gains and rental income. In general, you'd anticipate more long-term rise in the value of houses, although better rental returns are anticipated for apartments.

You must take into account more than just the sort of property, though. Your rental income and long-term profits might be significantly impacted by location.

In the past, real estate in Australia's major cities produced stronger rental returns and capital growth. Regional properties, in contrast, have provided more reasonably priced housing, with some locations also delivering significant long-term growth.

In order to profit from the regional real estate boom in 2021, more investors are looking outside of Australia's main cities.

Mix the two and invest.

This makes sure you're producing a steady flow of passive income (to pay for repairs and maintenance) and positions you to make money when it's time to sell, which might help you pay for your next investment property.

2. Refinancing your property to access equity

You're accumulating equity because you already own a property (which is the value of your property, minus what you owe on your mortgage).

As you now have a potent new method of gaining access to property portfolio funding, this is tremendously helpful as you develop your real estate portfolio.

The process is as follows: you can refinance your current home and use the equity as a down payment on your next investment property.

Consider the following scenario: You own a property worth $1,000,000 with a $800,000 mortgage. After a year, the property's value rises to $1,300,000 (great!). If you refinanced that house, you might be able to obtain a new loan for $110,000. The equity you can access is the $300,000 difference. These $300,000 can then be used as a down payment on a new mortgage for a second property.

Additionally, your current property may serve as collateral for your new loan, which could result in a reduction in interest rates (since you have the assets to demonstrate that you are a low-risk borrower).

As you won't need to put together a cash deposit for your next mortgage, this can hasten the process of expanding your home portfolio.

Instead, you will be able to fund your second real estate investment with the equity in your home.

3. Diversifying your investments

In a similar spirit, having a well-balanced property portfolio can assist you lessen the effects of market ups and downs. Rental income and home prices will fluctuate as supply and demand shifts over time.

You may build a portfolio that will remain stable in the face of volatile market situations by investing in a variety of property kinds in diverse places.

Let's look at an illustration:

• Let's assume that there are too many apartments in the central city. You might have to cut your rent to get a tenant because there isn't as much demand for this kind of property. Additionally, this can reduce the passive income your investment property generates and make it challenging to cover bills (such as repairs and maintenance).
• However, adding a family home in the suburbs to your portfolio can protect your passive rental income stream and provide you with positive cash flow to pay costs as well. This home is still producing great returns.

A few tips for financing your property portfolio

There is no "magic bullet" for selecting the ideal investing approach, but there are a few factors to take into account when determining whether to use positive gearing or negative gearing for your property financing.

• You can create a steady stream of passive income by including a few positively geared properties in your portfolio. This will protect your funds, assist you in paying for upkeep and repairs, and may even result in a capital gain should you decide to sell.
• Additionally, it's worthwhile to employ a negative gearing approach for a select few of the properties in your portfolio as this increases your chances of seeing strong capital growth (which can provide you with the funds to finance your next investment property).
• However, because you'll be losing money while holding the investment, negative gearing can be a riskier plan (and there are no guarantees your property will make a capital gain when it comes time to sell).

In the end, it would be beneficial if you took your risk tolerance into account when creating your property portfolio.

Negative gearing can provide you with the funds to expand your portfolio, but there is a significant chance that you could lose money. Even though positive gearing carries a lesser risk, you might not be able to raise enough money without taking out a sizable mortgage to fund your next investment property.

Before making a decision, review our in-depth guides on negative gearing and positive gearing.

How to choose your next investment property

However, each person has unique demands and circumstances.

Let's examine a few case studies that illustrate how to expand your portfolio of investment properties in accordance with your objectives.

If you’re looking for capital growth

Understanding what kinds of property and locations are likely to increase in value is the key to achieving significant capital returns.

The most substantial potential for capital growth is typically found in standalone properties in capital city outskirts. This is due to the fact that there is a limited supply and increased demand for these properties (unlike high-rise apartments or townhouses).

Additionally, it's important to take into account well-placed homes in rural areas with top-notch schools, close-by conveniences, and a variety of employment prospects.

As more offices adopt remote working, the demand for these is rising along with the cost of living in regional Australia.

If you’re looking for higher rental yields

On the other hand, acquiring an investment property in a region with a strong demand results in a dependable source of passive income.

You'll be more likely to find reliable profits on your investment property by looking for homes with a high rental yield, which is often between 8 and 10 per cent.

It's important to look for houses with rising rents and low home prices. This is frequently observed in some of Australia's smaller major cities, including Adelaide, Darwin, Hobart, and Canberra (SA).

Look at market trends in each suburb when conducting your study because high vacancy rates typically signify an overstock of homes in the area.

Although buying an apartment in a big city could be less expensive up front, if there are too many of the same kind of apartments in one place, demand may decline and rental yields may also fall.

If you’re looking for a balance of both 

Even while it can be difficult to locate investments that offer both high capital growth and high rental returns, there are some that can.

Townhouses and duplexes may typically be bought for a little bit less money while still providing high rental returns and the possibility of capital gains when it comes time to sell.

The biggest disadvantage is that these properties are frequently expensive.

Again, the strongest prospects for long-term growth are found around the periphery of large cities and in strategically located properties in regional areas.

Additionally, because there are fewer townhomes and duplexes available, rent increases are also more likely to occur over time.

Wrap-up - the key to building a successful property portfolio

It is possible to make investments in real estate using your superannuation.

However, it is not as easy as it first appears. There are a number of questions you need answers to before you can move on with investing.

These include how to set up a self-managed super fund and whether or not your investment passes the "sole purpose test. A trust in which assets are held by trustees for the purpose of providing retirement benefits to members is known as a super fund.

It's crucial to ensure that the property is a long-term investment that complements the SMSF's investing strategy, and that it meets the 'sole purpose test.

If you're considering using an SMSF to invest in property, we've listed the advantages and disadvantages below.

SMSFs can take advantage of the 15% tax rate on any rental income from your investment property.

The highest marginal tax rate will be applied to all of your SMSF's income if it is deemed non-compliant. Using your super to buy property can be a fantastic alternative for someone who knows the market inside-out and wants complete control.

To benefit from lower tax rates, though, you'll need to be ready to assume the burden of creating and maintaining a fully compliant SMSF.

Building a well-balanced property portfolio will increase your returns and lower your risk. Not all investment properties produce the same level of capital gains and rental income.

To access equity, refinance your current property. Diversify your investing portfolio by region to offset potential losses if demand for one property declines.

If you own a property worth $1,000,000 with an $800,000 mortgage, you might be able to refinance that house for $110,000. The equity gained can then be used as a down payment on a new mortgage for a second property. There is no "magic bullet" for selecting the ideal investing approach, but there are a few factors to take into account.

It's worthwhile to employ a negative gearing approach for a select few properties in your portfolio as this increases your chances of seeing strong capital growth. The most substantial potential for capital growth is typically found in standalone properties in capital city outskirts.

This is due to a limited supply and increased demand for these properties. It's important to take into account well-placed homes in rural areas with top-notch schools and employment prospects. It can be difficult to find investments that offer both high capital growth and high rental returns.

Townhouses and duplexes may typically be bought for a little bit less money. The biggest disadvantage is that these properties are frequently expensive, and rent increases are more likely over time.