Commercial property and your SMSF: Risk vs reward
Keen to invest in commercial property through your self-managed super fund? Make sure you do it wisely and well.
An investment in commercial property is tempting if you have a self-managed super fund (SMSF) – particularly if you run your own business. That’s because, under current regulations, your fund can buy your business premises then lease these back to your business. Essentially, it’s an opportunity to become your own landlord, with the attendant tax and business benefits this offers.
It’s almost certainly why the hike in commercial property prices earlier in the year saw a simultaneous rise in SMSF investments – up 7.6 per cent year on year as of March 2021.
But buyers (or, more particularly, trustees) beware. While commercial property isn’t as tightly regulated as residential property, there’s a raft of rules that need to be followed if you want to avoid heavy penalties.
Moreover, this type of investment can be problematic over the long term. Buying up big in one commercial asset may not breach any immediate trustee requirements as such, but it could result in a headache further down the track when you’re in need of regular retirement income.
Staying true to your strategy
As trustee of your SMSF, you’re legally responsible for your investment strategy. It’s critical, therefore, that you give due thought to the assets in which you invest and whether they offer adequate diversification and liquidity – as well as sufficient returns to meet your long-term needs. Does your SMSF investment strategy even allow you to invest in commercial property?
As NAB Director, SMSF and Investor Behaviour, Gemma Dale says: “It’s possible to have multiple investment strategies – it doesn’t have to be one for the whole fund or even one per member. However any investment strategy has to be documented and outline what assets you will invest in, in order to achieve your retirement goals. That can be changed, but all trustees need to agree to it and this will have to be documented and kept up to .”
In addition to stipulating what type of assets you intend to invest in, you need to specify the proportion of each asset class you are targeting and the potential returns. “For example, you might say you’re prepared to invest 100 per cent of your assets in Australian and international equities and that you’re trying to generate a return of one per cent more than the ASX 200,” Dale explains.
If your projected return appears unreasonably [high] in the circumstances – – you may need to adjust your expectations, or your choice of investment.
On the other hand, if you’ve already stipulated that you’ll invest just five per cent of your total assets in commercial property, that may mean a multi-million-dollar factory is off the cards for now in any .
Keeping your investments at arm’s length
When it comes to including a new asset in your SMSF, you should always consider your reasons for doing so, Dale says. Under the government’s ‘sole purpose test’, your fund has to be maintained for the “sole purpose of providing retirement benefits to your members”. In other words, the only reason to invest in an asset is to meet the retirement needs of your members. Personal or business interests shouldn’t come into it.
“It’s quite useful as a guiding principle for your investments,” Dale says. “A lot of people decide they have this wonderful idea to invest in a commercial property. But if that’s not the kind of investment that is realistically going to provide you with a retirement income stream, it might not be appropriate for an SMSF.”
However, the good news is, commercial property isn’t as strictly regulated as residential property. If you decide to add a new residential property to your SMSF portfolio, you need to be extremely careful that it doesn’t breach the in-house asset and related party acquisition rules in which you, and your trustee members, are prohibited from buying a residential property from a related party (think: parents, children, business associates) or renting the property in your SMSF to a related party. It’s also critical that none of you occupy it.
That’s not the case with commercial property, Dale says. “Commercial property has a heap of exemptions that allows it to be treated much more like a normal asset.”
Nevertheless, you have to be careful. While your SMSF can purchase a commercial premises, and lease it to a fund member for their business, it must be leased at the market rate. It’s also essential that your rent is paid on time and in full on the due date.
Ultimately, you need to approach every investment as if you were a commercial trustee, says Dale. That means all transactions should be ‘at arm’s length’ – that is, free from personal gain or influence or even the appearance of personal gain or influence.
When is big too big?
At the same time, you need to consider how this asset is going to sit in your portfolio, and whether you can afford it at the end of the day. Let’s face it, commercial properties don’t come cheap.
“One of the biggest issues with commercial property is the size of the asset,” Dale says. “Most commercial properties are going to be several hundred thousand dollars, if not several million dollars, in value and most self-managed super funds won’t be able to pay for them outright.”
While you may be able to access a limited recourse borrowing arrangement (LRBA) in a super fund, there are issues here – one being that they’re not widely available anymore.
As Dale notes, it’s also getting harder to buy big, expensive assets when the contributions you’re allowed to make to super have fallen dramatically over the past 10 years.
However, there are ways around these issues. “One thing that people have done in the past, and can continue to do, is unitise an asset and then acquire the units over time as the fund increases its value,” Dale explains.
If it’s a particularly large property, you may want to bring other parties into the deal. “If you have something quite expensive, , and you’ve got five self-managed super funds or parties that are interested, you can sometimes unitise the property where each party buys one unit worth $4 million.”
Where’s the money?
Even if the property is of a modest size and price, you may face other hurdles. While you might be able to buy the property outright, this doesn’t account for your situation in retirement.
“Once you get into retirement, you generally need to generate a pension income stream, and that’s a massive issue when you have to start withdrawing more and more of the total value of the fund each year from an asset that isn’t .”
If you’re 25 it won’t be particularly concerning, Dale acknowledges, but those within 10 years of retirement need to give some thought to where that regular annual income is going to come from.
“Liquidity is the biggest issue that people run into with commercial property, assuming they’ve got no other assets in the fund,” Dale says.
It may be that you can sell the property come retirement. Another answer is to build up the other assets in your fund well before you stop working. A generous yield could also help. As Dale says, “If you have you’ll be right for a few years.”
Whatever you do, the important thing is to get advice first. “A lot of this is quite complex from a structuring perspective, so you need to talk to someone with a professional understanding of how the legislation works,” Dale says. “You also want to ensure that you’re getting the best financial advice that takes account of the whole picture. At NAB Private Wealth, we specialise in understanding your business and personal needs.”