Home Real Estate Should you invest in property through super?

Should you invest in property through super?

Some investors see self-managed superannuation as a window for property investment. But is this an advisable approach?

Debbie Elkind

Your Money contributor

SMSFs now make up 30 per cent of superannuation assets (iStock.com/Jaruwan Jaiyangyuen)

In recent years, the numbers of Australians investing in self-managed super funds (SMSFs) has grown steadily.

SMSFs now make up 30 per cent of all superannuation assets in Australia – and the chance to take out a loan to invest in real estate is often one of the key motivators for people starting their own fund.

“More and more investors, and particularly Baby Boomers, are setting up a SMSF as a vehicle to invest in property,” says Michael Yardney, CEO of Metropole Property Strategists.

“Some see it as a way to take more control of their financial future, while others like the concept of leverage – borrowing to buy their investment in their SMSF and therefore having more money working for them.”

Yardney says that buying an investment property through a SMSF can be tax effective because any money you put in super is only taxed at 15 per cent up to the contribution cap. Because you often already have assets in your super this can also give you greater purchasing power.

The disadvantages of buying property through your super fund

However, there are downsides.

To begin with, Yardney cautions that there are some less than ethical property spruikers who who have moved into the real estate sales market, pushing second-rate or off the plan properties into the hands of new SMSF owners.

“The value of some of these properties has fallen considerably and some investors have lost out badly. Of course, those investors who bought investment grade properties in their SMSF are doing very well and helping secure their financial future,” he says. “As always – correct property selection is critical”.

To this end, he argues that you should particularly avoid off the plan properties and new house and land packages.

Buying an investment property usually comes at the expense of diversification. When you invest in a traditional super fund, you’re usually putting your money in a range of companies, sectors and even countries.

That isn’t the case if you buy an investment property.

“The first question SMSF investors need to ask themselves before investing in property within their superannuation is ‘am I adequately diversified?’”, says Marcus Evans, head of SMSF customers for the Commonwealth Bank of Australia (CBA).

“Many Australians, particularly those who have property in the capital cities or have investment properties outside of super, already have a high exposure to the Australian residential market,” he says.

“Having all your eggs in the one basket may not be the best strategy for long term wealth creation and for mitigating risk within a portfolio.”

Evans says that, for this reason, it may be worth looking for exposure to broader property portfolios that invest in commercial property – not just residential – both domestically and internationally.

If so, a property-focused managed fund or exchange-traded fund (ETF) may be a more sensible option.

He also says that if you’re looking to generate a retirement income, you may be better off allocating more of your super portfolio to dividend-paying shares or fixed income rather than a property.

Buying real estate inside super versus outside super

The other thing to consider if you’re determined to buy an investment property is whether you’re better off buying outside of your super rather than within it. And there are a number of compelling reasons this may be the case.

For starters, SMSFs can’t take out traditional home loans but are instead restricted to borrowing through a “limited recourse loan”.

These can only be used to buy a single asset, which means you can’t build equity in one property and then use it to purchase another to put together a portfolio. Limited recourse loans also usually come with higher interest rates and other costs than other loans.

Second, one of the main advantages of investing in property compared to other assets is the generous tax breaks available through negative gearing and the Capital Gains Tax (CGT) discount.

When you purchase outside of super, negative gearing lets you deduct interest repayments, depreciation and some other property expenses against your salary – effectively saving you money at your marginal rate of tax.

This could be as high as 47 per cent.

In an SMSF, you can only offset your losses against the income generated by your super fund. Given that SMSFs usually pay 15 per cent tax on any contributions, you usually won’t be saving anywhere near as much – especially if you’re a high income earner.

Third, investment properties purchased through an SMSF come with considerably more restrictions than those bought outside of super.

They must be bought with the “sole purpose” of providing a retirement benefit to you. You won’t be able to ever live in the property yourself or allow another family member to live there. You also won’t be able to alter or change the character of the property.

For these reasons, if you intend to negatively gear an investment property, develop or change it at any time, or use it for a purpose other than retirement income, you should consider buying it outside of super.

Other ways to invest in real estate through your super

If you do want to invest in real estate through your SMSF, there are options beyond beyond buying an actual property:

● Managed funds. This can give you exposure to a range of commercial property in other states, territories and countries, which you wouldn’t normally have access to. You also get the benefit of tapping into the expertise of a fund manager.

● Exchange-traded Funds. An ETF can be an affordable way to gain exposure to the property market with the ability to trade on the Australian Stock Exchange (ASX).

● Australian Real Estate Investment Trusts. A-REITs work in a similar way to managed funds. However, they’re listed on the stock exchange and often involve a property management function in addition to the ownership of physical property.

● Fractional property investment. Some new platforms such as BrickX allow you to buy a part share of properties, which also gives you a share in the rental income as well as part of the capital gain if the property is sold.

● A property-focused super fund. Superestate is a superannuation fund that invests in residential property. The fund claims that it is already proving an attractive proposition for many Australians, in particular millennials who find it hard to enter the property market.

Get the right advice

Finally, it’s worth remembering that everyone’s circumstances and goals are different. As with any major financial decision, it pays to do your own research and seek sound independent advice first.

Anyone who gives advice on an SMSF must hold an Australian Financial Services Licence.

Check ASIC’s professional registers to see if a specific company or adviser’s licensing, education and past conduct information.