Borrowing to buy real property in SMSFs

Can a superfund borrow to buy real property? Well, on 7 July 2010, Section 67A and 67B of the Superannuation Industry Supervisory Act (SIS Act) was passed by Senate and this allowed superfunds to borrow provided that it is a limited recourse borrowing.

Hold on! Don't rush out making an offer on a property when you don't have an SMSF yet. It would only cause massive legal problems and expensive fees to fix. There is also the big problem of obtaining a signed Financial Advice Certificate (you need from a Certified Financial Planner) that all banks want before lending any money. The certificate tells the Bank that borrowing in your SMSF is an appropriate investment strategy for your financial circumstances.

What is a limited recourse borrowing? Limited recourse means that the lender has no recourse to other assets of the fund. In the event of a loan default, the lender can only sell the real property that is held by the bare trust.

Illustration of SMSF, Bare Trust, Lender and Vendor relationships and connection

Figure 1

This limited recourse borrowing arrangement is illustrated in Figure 1.

1)       VENDOR sells property to the Bare Trust

2)       Bare trust is the legal owner of the property

3)       SMSF is the beneficial owner of the property

4)       Lender has mortgage over the legal interest of the property

The SMSF has the right to claim legal ownership of the property once the loan is paid off. The SMSF can claim a deduction on the loan interest.

Most of the big 4 banks have loan products for SMSF. They loan up to 65% of the value of the commercial property(but up to 80% for residential property). The interest is higher than a plain vanilla home loan. Usually 2.00% more than standard home loan rate.  The fees to setup up this arrangement consists of :

  1. Setup of a Bare Trust and a Corporate Trustee for the bare trust. This can be from $700  to $2,000
  2. Loan application fees charged by the Lender. Up to $2,000
  3. Bank’s registered valuer fees from $1,000
  4. The Bank’s lawyer fees for checking the Bare Trust's trust deed. Up to $2,500
  5. Stamp duty payable.
  6. Some banks require a Risk Disclosure statement signed by a Financial Planner. The Financial Planner charges around $3,000 for this. This is a major stumbling block for settlement if a Financial Advice Certificate is not firstly obtained. Before making any offer, please ensure you have a Financial Adviser who has signed the certificate stating that borrowing in your SMSF is appropriate for your set of circumstances.

The cost excluding stamp duty can be quite high. More than  $8,000 for starters.

If it is a commercial property, the SMSF will need to register for GST before the banks allow things to go through.

This arrangement is for the acquisition of a single real property. 100% interest in it. No half shares, or other proportion is allowed.

Improvements to real property is not allowed

Trustees cannot renovate to improve the functional use of the property.  Trustees can repair and maintain the functional use of the property. However for arrangements entered into between 24 Sept 2007 and 30 June 2010, the trustees are allowed to do improvements on the property. Outside of these dates, trustees are not allowed to make improvements to the property.

You can not subdivide the land and build new buildings on it. Not while there is a borrowing still going on and the loan has not been paid off.

Overseas real estate

American and Greek house prices appear to be cheap bargains. But buyer beware as these properties may be difficult to rent out. The other major issue is that the big 4 banks do not lend monies for overseas property. There are sovereign risk and price risks for the banks and superfund. Some countries do not allow property to be held in a bare trust arrangement because "who is the legal owner of the property?".

Trustees also need to engage a foreign accountant to prepare the foreign tax return so the SMSF can include the rental profit or loss in its Annual Return.

Overseas properties are difficult to manage because of geographics. Do you trust your American rental property manager? Other risks are foreign currency risk, what if the US dollar plummets by 50%? Immediately, the real value of your US investment property has decreased 50%! Hmmmm....

Can I purchase a residential property from related party

No, an SMSF is not allowed to purchase residential property from a related party. The SIS Act defines :

related party, of a superannuation fund, means any of the following:

                     (a)  a member of the fund;
                     (b)  a standard employer‑sponsor of the fund;
                     (c)  a relative of the member of the fund, ie spouse, parent, grandparent, brother, sister,
                           uncle, aunt, nephew, niece, lineal  descendant or adopted child of the individual or
                           of his or her spouse;

The exception is that an SMSF can purchase BUSINESS/COMMERCIAL property from a related party. The common scenario is a business owner getting his SMSF to purchase his business premises.

Putting all your eggs into one basket! Big risk!
Most members approaching retirement age have super balances of around $150,000. That is enough for a deposit on the property but the SMSF would still have to borrow an additional $300,000 to get a decent/quality investment property. A $300,000 loan requires monthly repayments of  around $2,000. The SMSF has to find this cash to repay the loan.

The repayments are funded by rental income plus some cash super contributions. Super contributions are usually deposited every quarter (three months) by employers. Some employers do pay super each month but this is very rare. What happens if the tenant runs away? Can a new tenant be found quickly?

Double whammy! There is no tenant and the members lose their jobs. At that age (50 plus years old), SMSF members may be struggling to get a job. With $0 rental income and no contributions, the SMSF can't afford to repay the loan. What happens next is loan default and the bank sells the SMSF property for peanuts! Bearing in mind the bank is not obligated to sell the property at market value nor seek the best price on behalf of the mortgagor/SMSF.

Mortgage Protection Insurance does not protect you. It protects the banks! The bank sells the SMSF's property and recover its loan. Happy ending?! No. The insurance company goes after the SMSF trustees/members for the shortfall. For example, the loan was $300,000 but the property was sold at a mortgagee auction for $250,000 due to damage caused by bad tenants. The shortfall of $50,000 is covered by the insurance company. The bank is happy because its interest is covered. But then the insurance company chases the SMSF trustees/member for the $50,000 it paid to the bank. SMSF trustees/members will have to sell personal assets to satisfy the insurance company.

In this day and age, nobody can be 100% sure their job is secure. We see redundancies and businesses closing down left, right and centre and nobody is safe. If you are a senior employee, think carefully before putting your super nest egg into property. It may not be such a great idea.

Real estate agents spruiking properties in SMSFs
We have seen Real estate agent's advertising in local community newspapers about Borrowings in SMSF. They have this "fantastic block of apartments or units with guaranteed 10% rental return" that they want SMSFs to buy. Hot NRAS property for sale! Once again be wary. Is it a quality property? Is the location good? Is it overpriced? Will it be difficult to find tenants once the contract ends? Caveat Emptor (Let the buyer beware). Don't want to be conned by a snake-oil salesman. These property promoters are getting massive sales commission.

ASIC is targeting promoters of this property scheme because they are breaching Section 911A of the Corporations Act, providing financial product advice without holding an Australian Financial Services (AFS) license. A person convicted of carrying on an unlicensed financial services business may be subject to a fine of up to $34,000 or imprisonment for two years or both. If a company is convicted it may also be liable to penalties, including a fine of up to $170,000. Real estate agents should not recommend clients to purchase property using their superfund unless they hold an AFS license to provide that advice.

Common Scenario for Borrowing in SMSF
Borrowing in SMSFs is really for high-net worth individuals operating their business in an office/shop that they own or a related party owns. For example a young doctor and his  clinic wishes to transfer the clinic to his SMSF for asset protection purposes. His SMSF borrows because it does not have enough cash to cover the market value of the property. He pays his SMSF rent and is able to because his income is stable and high. He has zero risk of being redundant and is still young and able to do other work.

Still interested in borrowing to buy property for your SMSF? It's a long winded process and we need to look at the big picture and think carefully. Wisdom comes from asking the right questions and listening.


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Chartered Accountants

Jimmy CK Chong is a Chartered Accountant & registered tax agent. Contact him via:
Tel : 08 9440 0871
Mob : 0433 117 110
Email :

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