Property is a popular investment choice for SMSFs, but all too often professionals and clients opt for the road most travelled. What is on the market for those looking for yield and diversity?
There are a variety of options on the market for SMSF trustees and professionals to consider. To name a few, trustees can diversify their portfolio by considering business real property, vacant blocks of land and primary production property.
SMSF Association head of technical, Peter Hogan spoke to SMSF Adviser about the pros and cons of various different types of property investment for self-managed super funds.
While residential is often the first choice for many investors, Mr Hogan said the rules around purchasing and renting a residential property are strict.
“The first and important thing I think about residential property is that it’s very limited in who the fund can buy residential property from and who it can rent residential property to,” he said.
“For example, it is perfectly acceptable for a super fund to own 100 per cent of a residential property that they purchase from an unrelated third party and they can equally rent it out to unrelated third parties.
“However, for anyone who personally owns a residential property, they’re not allowed to transfer the title of that residential property to their SMSF either as a contribution or as a purchase. The law is quite clear that if you own a rental property, you cannot sell it or contribute it to your fund.”
Equally, Mr Hogan said you cannot rent a residential property to related parties either.
“Where people come unstuck with this is things like they will buy a residential property from an unrelated party and then they’ll rent it out to one of their children and a whole lot of their mates that are going to university together. That’s not an acceptable way to deal with the property,” he said.
“That’s something that’s easily overlooked, I think, by people when they deal with residential property.”
However, one positive aspect of residential property is, you can own a residential property as tenants in common with your super fund.
“You can own a percentage of the property and your super fund can own a percentage of the property. It just means that your fund gets that proportion of the rental income and you get a proportion of the rental income,” Mr Hogan said.
“Obviously, you have to pay the expenses of owning the property in the same proportions that you own it at which can be a little clunky but nevertheless that’s perfectly acceptable.”
Business real property
An alternative type of property investment is business real property. This is property that is used wholly and exclusively in one or more businesses.
Mr Hogan said business real property is an exception to the rules that apply to residential property, giving it a lot more flexibility in the way it is purchased and rented.
“Firstly, it is possible for a self-managed super fund to acquire business real property from a third party or a related party, provided that it is acquired for its market value,” he said.
“You have to be able to demonstrate that you are actually paying a genuine market price for the property so that generally means an independent valuation, particularly if you’re buying from related parties.”
Equally, it is possible for the SMSF to lease that business real property back to the trustees’ business, which is a strategy that is well-used, according to Mr Hogan.
“The benefit is that it means that basically your business is paying rent for the use of the property back to your superannuation fund and getting a tax deduction for that expense of paying rent,” he said.
“Then, you as a member are getting the benefit of this income accruing in the fund and obviously adding to your retirement benefit down the track.”
Like residential property, Mr Hogan said it is possible to own a business real property either 100 per cent inside the fund or as tenants in common.
A third property investment option is a vacant block of land.
“A vacant block of land, you have the same restrictions as you do for residential property in terms of acquiring it,” Mr Hogan said.
However, once acquired, there are a range of acceptable activities that can be done with it.
“It’s perfectly acceptable for an SMSF to buy a block of land, use other assets of the fund to pay for the cost of building a house or townhouses on that land and selling them for profit,” Mr Hogan said.
“Obviously, the profit needs to stay inside the fund and be added to the value of the common benefits of the members of fund. It’s also important to demonstrate that there’s been no benefit derived by any of the members or relatives of the members in that process of buying the land and building the property and selling it.”
Another option is to buy a vacant block of land, build a house on it and rent it out to a third-party and derive renal income from it.
Primary production land
Farmland can come with the benefits of business real property if it qualifies as primary production land.
“There has to be a predominant primary production use of a significant proportion of the land for it to come within the definition of business real property,” Mr Hogan said.
“While it’s accepted that there will be, on occasion, parts of a farm that will not be actively used in the primary production business, in the sense that they’re not growing a crop on it or grazing an animal on it, nevertheless it’s treated as being used in the business provided that there is a business of primary production being undertaken.”
Mr Hogan added that hobby farms do not fit the requirements.
“It is important that whoever leases the land off the super fund is treated as a primary producer for tax purposes by the tax office,” he said.
“Hobby farmers won’t cause that land to be treated as business real property just as their activities are not treated as business activities.”
DomaCom general manager sales and marketing Warren Gibson also said that agricultural property is a good way to diversify a SMSF portfolio.
“No one would suggest to anybody that you put all of your money in to farm land, nor would you in to any other specific investment or even asset class,” he said.
However, Mr Gibson pointed to the wider benefits that can come with investing in agricultural property.
“Sadly, Australia doesn’t see its own potential, as evidenced again by the fact that the larger superannuation funds invest around about 0.3 per cent in the agricultural sector, which isn’t much,” he said.
“One of the problems that beleaguer the farmers in this country is debt and we think superannuation is very well-positioned to invest a small amount, say 2 or 2.5 per cent in to agriculture which would inject somewhere in the vicinity of $100 billion in to the market.”
Keeping an eye on return
Mr Hogan said different property types return different rental yields and capital growth rates which can help determine the best type of property to invest in depending on what the super fund wants.
“To some extent, what you want to achieve out of it depends on the circumstances of the members and the individuals,” he said.
“What you’re actually doing is you’re looking for a combination of both. You’re looking for a combination of capital growth in the asset plus rental income.”
As an example, Mr Hogan said business real property will often provide a higher yield but may not necessarily provide the capital growth.
On the other hand, primary production land offers a good capital growth over the long term, according to Mr Gibson.
“If you look at the rural bank report on Australian farm land values, it shows broadly that Australian farm land increases in value on average 5.8 per cent per year and has done so over the last 20 years, so it’s not a bad investment from that perspective,” he said.
“Over the longer term, they do reasonably well in terms of capital growth. It’ll never hit the ball out of the park, but not a lot of investments do and it can just form part of a diversified portfolio.”
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