Buying Property Inside Super

You can usually feel the question coming. There’s often a little tell just before a client pops the most frequently asked question about superannuation.

It’s like a southerly change. First you see the leaves move before the clouds appear.

And it usually goes something like this:

“What do you think about buying property inside super?”

It’s a fair question, because for most people, superannuation has felt like a dark cloud lurking since the GFC 6 years ago. They’re desperate for a silver lining and many believe buying a property inside super is the answer.

John and Jenny were no different.

Both are in their mid-50’s and have come to get my opinion.

To kick things off, I explain that buying property inside super it is quite different to buying in their personal names because of all the rules involved.

If you’re not careful, it can create what I call a ‘mud and dust’ outcome. You get bogged down in ATO compliance and can run dry of funds in retirement if you don’t get it right.

To keep things as simple as possible I outline the following points, which is in no way exhaustive.

The Mud
Tax rate – the tax rate inside super is only 15% and so the level of tax deductibility is very low. Therefore any property investment is relatively tax ineffective from a cash-flow point of view, especially when using borrowed funds.

Borrowing – you must use a Limited Recourse Borrowing Arrangement (LRBA) and house the property in a holding trust until it is fully paid off. This means there is ‘limited recourse’ for the banks to foreclose on the property if the loan defaults. But…

Deposit – the banks often require a larger deposit to reduce the risk of a loan defaulting, therefore a deposit of 25-30% is not uncommon.

After tax returns – after tax returns for property inside super usually decrease while for shares they increase. This is because most shares have tax rebates (franking credits) which increases their after tax yield. Properties tend to incur a lot more costs as well.

Modifications – if you borrow money to buy property inside super, you can only make repairs, not renovations. E.g let’s say three floor boards in a kitchen need to be replaced, you can’t replace the whole kitchen floor while you’re at it.

Diversification – putting all your money on the one horse can be very risky. Diversification is very important because there’s no guarantee the horse won’t turn into a dog. Just ask any publican how properties can plummet unexpectedly.

The Dust
When a superfund enters pension stage, superannuants must withdraw a minimum 4% of their total super balance each year. This percentage increases with age as well.

This means if you don’t have enough available cash to cover the withdrawals, you must begin selling down assets to cover your pension payments, even if the assets are trading below their original purchase price.

Not surprisingly, this is currently the biggest risk faced by superannuants buying property in a very heady market. Some of your super can easily turn to dust later on without the right asset allocation. Some SMSF’s are already in this position.

Summary
As a general rule of thumb, for every property you can buy inside super, you can usually buy two outside super because of the larger deposits required in super.

In my opinion, buying property in this market is a very life stage, specific decision. That is, the closer you are to retirement the less margin you have for error. It’s all a function of time.

And just because something has a roof on it doesn’t make it a safer option or a better performer than shares. And it’s certainly no more tax effective either.

Don’t get me wrong, I’m not against buying property inside super. I just don’t think it’s the panacea some would have you believe.

Finally, I have one last piece of advice for John and Jenny.

If you plan on retiring in the next five years and you think interest rates will never go up, property prices will never come down and you don’t want to miss out, go for it. Enjoy the party while it lasts.

Just make sure you’re dancing near the door when the music stops.

Have a great week!

P.s. thank you to all those who made contributions to www.buyabale.com.au last week plus the very kind words in response to the Moowsletter.. I don’t know who or what contributions were made but I’m told it was significant. So thank you!