Changes to superannuation legislation now allows an SMSF to borrow funds for property investment. If you have an SMSF, you might now be able to borrow money to buy a commercial or residential property through your SMSF.
Limited Recourse Borrowing Arrangement
If the SMSF has enough funds for a deposit, the remainder of the purchase price can be borrowed. The SMSF can either borrow from a financial institution e.g. a bank, a credit union or from the Members.
Lending is done with non-recourse borrowing arrangements. This means the lender does not have a recourse or right on other assets in the SMSF. For this reason, the lender (bank) will ask the Members for a guarantee. This arrangement is generally referred to as a limited recourse borrowing arrangement.
The lender provides the Fund for a partial payment of the property and also pays all the relevant fees. The SMSF will borrow to settle the balance.
Where a bigger deposit is paid by the SMSF on the investment property, the bank may not ask for security from the Trustees. The property will be the sole security for the loan under this limited recourse loan agreement. In the event of default, the lender only has a recourse on the property. The lender can never claim against other assets within the SMSF.
As a general rule-of-thumb, a bank will lend 80% on residential property and ask for a guarantee from the trustees, or won’t ask for a guarantee at 60% loan rates. The benchmarks on commercial property are 70% and 50%, respectively. Factors the bank assesses to decide if there is a need of a guarantee are property quality, credit history and rental income.
An LRBA arrangement may be perceived to be an in-house asset as it holds 100% interest in another related entity. However, a ruling was issued by the ATO confirming that it is not an in-house.
The investment property is owned by the bare trust with the SMSF having a beneficial entitlement to it. The bare trust is merely the holder of the title until the loan is paid off. The SMSF will receive lease payments from the lessee and will expense the interest paid on the SMSF loan.
After the loan is repaid, the SMSF has the right, but not the obligation, to acquire the legal ownership of the investment property.
When purchasing a residential property, the SMSF cannot have any dealings with a related party. This means you can not sell your house to the SMSF. The Fund also cannot rent the property to a Trustee or a family member such as mother-in-law. You can, however, purchase the property from the SMSF when entering the pension phase.
When lending to an SMSF, Trustees need to ensure that terms of lending are on an arm’s length basis and issued on commercial terms. The Tax Office has recently published a practical compliance guidance (PCG 2016/5) which sets out the recommended interest rate and loan terms for a related party loan to the SMSF. This is known as the Safe Harbour Provision.
Safe Harbour Provision
For SMSF Trustees with Limited Recourse Borrowing Arrangements (LRBA’s), the Commissioner may not accept the arrangement to be at arm’s length as there is no certainty provided. For more information, see the link below:
Please note a sample loan repayment schedule here.
Bank and Broker Information
You are free to use any banks or lenders when financing for your SMSF property purchase. To get the best deal possible, you’d be well advised to use a mortgage broker. You can use a big bank or one of the niche players like Macquarie who has a very informative free brochure with some great examples. You can also download a cash flow analysis brochure here which gives examples on the cash flow details of an property with a limited recourse borrowing arrangement in place.
Trustees can contact John Gregory from Money Quest Finance Specialist for more information. Their contact details are noted below:
John Gregory (Money Quest Finance Specialist)
p: 0400 830 138
ATO Guidance on Borrowing
The ATO issued a ruling on borrowing. This is set out in the link below:
To send us the property details to set up us Bare Trust, click here to see the info we need.