But for self-managed super funds (SMSFs) investing in real property, it's important to be aware of a number of rules governing how a property can be used.
Residential versus commercial property
A residential property owned by an SMSF, for example, cannot be leased to a ‘related party’ of the fund – where a related party includes members of an SMSF, any of their relatives, business partners, and so on.
“Residential property is limited,” explains Marcus Evans, head of SMSF customers at Commonwealth Bank.
“Commercial property, however, provided it’s solely and exclusively used for business purposes, you can lease to anyone. That can include yourself or your own business, and provided it’s done on an arm’s length basis that’s fine and can work well."
This is one strategy small business owners may employ, enabling ownership of the premises from which their business is run.
Borrowing to invest
Given the additional risk involved, there are also strict rules in place around how SMSFs may borrow to invest in property, which can only be done through a limited recourse borrowing arrangement (LRBA).
Evans says that like everything within an SMSF, a property should be looked at objectively in terms of whether or not it represents a good investment in the first place, with particular consideration given to timeframe.
“This is particularly so with some limited recourse borrowing arrangements, because you might buy a property and then in four or five years’ time, due to the way in which commerce is changing, you may want to renovate this property and turn a retail space into a factory, for example.
"So you need to think about whether the property you purchase will be suitable for its intended use in five or 10 years’ time, and whether it will need repairs within a reasonably short period, because there are some limitations under the legislation on improving those properties where you’ve got gearing related to the superannuation fund.”
For this reason, it’s recommended that specialist advice is sought before buying property within an SMSF.
Does property investment align with your strategy?
Two other considerations for SMSFs investing in property are:
- How the property aligns with the investment strategy of the fund and;
- Whether it enables the desired level of diversification within the fund, rather than concentrating risk in one single asset
“It’s important to look at expected return and how that matches up with what you need to fund retirement expectations,” says Craig Day, Colonial First State’s Executive Manager, Technical Services.
Day adds that another important consideration should be the ages of members, given the impact on cashflow that ongoing property costs can represent.
“Consider maintenance and property management fees and all those other things,” he says.
“Once you are in pension phase your fund has to pay out a minimum amount as a pension and as you get older that steps up."
For example, a 65 year old with an account based pension will need to receive a minimum pension of at least 5% of the account balance calculated at the beginning of each year. However, at age 75 that jumps to 6% and then again to 7% at 80.
“So you need to take into account the fact that a property may not be able to generate enough rent to cover all the costs as well as fund the required minimum pension payments at some point in the future. Even where the property does generate enough rent, a property could still cause cash flow problems where the property becomes untenanted for a period," says Day.
Evans warns of situations where people in their 50s and 60s use an LRBA, but if one of the members of the superannuation fund is injured, or they want to retire earlier than expected then initial plans can be interrupted in those circumstances.
There are also the general risks of investing in property that it’s important to be aware of – particularly when borrowing to invest. This includes risks such as interest rate volatility, potential decrease in market value of the property, and the possibility that it may be difficult to sell the property when you need to.
Other options to gain exposure to property
Beyond so-called ‘real’ property, which can have steep entry and exit costs attached, there are other methods for both SMSF and non-SMSF investors alike to access this asset class.
Real Estate Investment Trusts (REITs), which pool money from many investors and use this to buy and manage property assets, are one method to gain indirect exposure to the property market.
The portfolio of properties within a REIT might include retail space, office space, aged care complexes, residential units or a mixture of these.
Units in a listed Australian REIT (A-REIT) are publicly traded on the ASX and provide income to unitholders in the form of distributions.
If the properties within the REIT’s portfolio increase in value over time then this also has the potential to provide capital gains to investors.
As a CommSec customer, you can invest in A-REITs, which include names such as Westfield Corporation (ASX: WFD), Scentre Group (ASX: SCG), Goodman Group (ASX: GMG) and Stockland (ASX: SGP).
Another option for investors looking for easy access to a range of property investments are managed funds.
Providers, such as Colonial First State (CFS) offer a range of different funds that invest in property globally, actively managed by professionals who select and review investments with the aim of delivering on the fund’s stated risk and return objectives.
A list of managed funds is available on the CFS website.