Pros and Cons of property in superannuation

Cindy wrote and asked about investing in property with the use of super funds.  She is concerned and asked for our thoughts on risk and reward.  Ken Raiss answers her questions.
BONUS:   See Ken’s ebook on buying property in your Super Fund and you will also get access to some video presentations on the same subject.
Kevin:  I want to address an e-mail that I received from Cindy. Cindy lives at Murrumba Downs, which I think is in the northern part of Brisbane. My apologies if that’s wrong, Cindy. More importantly, what did you say in your e-mail? Cindy writes, “Hi, Kevin. My Sister and her husband have just withdrawn all of their super money to invest in real estate.” We’ll qualify that in just a moment.
“They’ve used their money as deposits on three separate properties with all of them being cash-flow-positive by just a few dollars a week. This whole idea is new to me and I have a lot of reluctance to pull my money out of super, but it seems like a good way to make money now and also have multiple properties at retirement. Could you please talk about this on your show and discuss both the risks and the rewards?”
Thank you for your e-mail, Cindy. I’m going to refer this to Ken Raiss from Chan & Naylor.
Hi, Ken. Thanks for joining us on the show.
Ken:  Thank you, Kevin. A great question from Cindy.
Kevin:  It is a great question, but let’s firstly qualify. What concerns me is the comment that they have withdrawn all of their super to invest in real estate. Can you actually do that?
Ken:  I picked up on that. Look, the short answer is normally no. There is what they call a condition of release before you can take your money out of super, which for most people is at age 65, at retirement. There are a few other conditions that you can get it a bit early.
Kevin:  It could be the terminology from Cindy, too. Maybe it’s just they’re investing their super money in real estate.
Ken:  It could be that. You have to be very careful if you take money out when you’re not supposed to because the ATO can penalize you up to 50% of the capital value of your superfund if you do something wrong – plus penalties.
Kevin:  Warning noted. Let’s assume that it’s going to be invested in real estate because there are a number of questions I want to ask you, the first one being about positive cash flow. Does that make sense, or should it be negatively geared in a superfund?
Ken:  We should never use negative gearing as an investment strategy. Long term, you’ll lose money. But you have to look at the investment as an investment first, not “Do I buy it in super or outside?” It has to be a good investment to start off with. What we’ve been finding over the reasonable long term is capital growth is what gets you retirement. It gets you cash flow eventually. It’s what gets you in the money.
Good capital-growth properties tend to be a little bit negative at the beginning, but then because you get increased rent and if you ever sell it, you get a better capital value, I’d be looking at that sort of property, which is what I personally do. Then do I put it in super or outside?
Kevin:  I want to talk to you about how you put it in super, but firstly, negative gearing is just a name given to property… It’s more of an outcome; it’s not a strategy, is it?
Ken:  Correct. Negative gearing is “My expenses are more than my income,” and it applies to businesses, shares, everything. It just so happens to have been a label that they’ve put on property in current times.
Kevin:  Largely around the fact that they’re probably going to put a 20% deposit in, which means you’re borrowing 80%, which probably means it is going to be negatively geared. However, if you put 50% into the purchase price, it’s possibly going to be positively geared, but you’re putting in more capital.
Ken:  Correct. You’re positive on the rental income, but there’s an opportunity cost of using more of your own money. You have to weigh up both of those.
Kevin:  I think it was valuable to just talk about that and relate that back to the question. Can I take you in a different direction? How do you buy property in a super fund? Do you need to set up a trust?
BONUS:   See Ken’s ebook on buying property in your Super Fund and you will also get access to some video presentations on the same subject.
Ken:  Yes. You need to have your own self-managed super fund. You can’t go to one of the big super providers and tell them to buy you a property. You have to have your own self-managed super fund. You’re allowed to borrow, and you can buy the normal types of properties that everybody buys. You can do renovations on them. You can do extensions. There are just different rules on whether you use borrowed money or super money if you do an extension.
The big no-no is you can’t buy a property in super with debt, bulldoze it, and then build a duplex, for argument’s sake. The asset you buy has to be the asset that you end up with; the property you buy is the property you end up with.
You have to have a self-managed superfund. You have to set up a second trust to hold that property. That’s because the bank can only take the property as security. They can’t take all of your other super fund assets as security. That gives you, as the super fund member, a bit of safety. The banks may want a personal guarantee, but that’s okay.
We find a lot of banks are lending 80%. Interest rates are little bit higher than if you borrowed outside of super, but the advantage in super is once you retire and once you’re in pension stage, there’s zero tax on the rent and there’s zero tax on the capital gains.
Property in itself is a long-term asset. You should be buying it to take you through a couple of cycles, and super is a long-term investment vehicle. So, it’s almost a marriage made in heaven. The structure is long-term and the asset is long-term.
If it is a property that you’re buying that’s going to be negative, meaning that the rent isn’t enough to cover the interest, you fund that shortfall with your super guarantee, the 9.5% that you’re funding into super all of the time, any of the profits that the other money you might have in super is making, or thirdly, you can contribute more into super.
As long as you’re within your contribution caps – that, until the Budget, was $30,000 or $35,000 per year – if you bought that property outside of super and it was negatively geared, you can still effectively negative gear it in super against your wages by just salary sacrificing that amount of money into super. By that, I mean contribute more money into super to absorb that loss. While you’re working, you’re getting all of the normal tax benefits against your wages, but in retirement, it’s in a tax-free environment.
I have four steps you should look at if you’re going to contemplate buying in super. The first one is talk to a professional to make sure the type of property you’re wanting to buy is allowable. The second one is then go and get some pre-approved finance. Thirdly, set up the structures. Then fourthly, go out and buy. That will keep most people out of trouble.
Kevin:  Ken, I forget which point it was now, about setting up the structures, but getting back to Cindy’s original e-mail saying that her sister and her sister’s husband are buying three separate properties in their super fund, that means they’ll have to set up three separate trust accounts because you can’t have one trust account for more than one property. Is that correct?
Ken:  Correct. You have the one self-managed super fund, but that additional trust that will hold the property is only allowed to own or hold one asset at a time. But that’s fairly minimal costs – those trusts that hold the property – and you don’t have to do a tax return for that trust that holds the property. You only do the one tax return for the super fund as if it was all in the one super fund.
Kevin:  But it does actually make a slight problem when you’re purchasing the property: because you are buying it in a trust, that takes a little bit longer for that process.
Ken:  Correct. We’re finding it can take the banks an extra couple of weeks in their approval process. The big thing is they tend to charge you a slightly larger interest rate.
Thirdly, sometimes they may not give you the 80% LVR. It might come down a touch. But about 80% is the maximum, whereas outside of super, we’re seeing banks now lending anything up to 90% or 95% again. But in super, assume 80% cap on your loan in relation to the valuation and a slightly higher interest. But you’re paying a little bit more interest today to have it tax-free later, so if you do the numbers, you’re well ahead.
Kevin:  Ken, we’re out of time, unfortunately. I can talk to you for such a long time about this because it’s such a big issue. But thank you for your time. Ken Raiss from Chan & Naylor.
We’ll talk to you again real soon, Ken. Thank you.
Ken:  Thank you, everyone.
BONUS:  See Ken’s ebook on buying property in your Super Fund and you will also get access to some video presentations on the same subject.

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