How are people buying investment properties with their super funds?
Australia’s fascination with investment properties really knows no bounds. Australians are obsessed with property, that’s right, obsessed! We have touched on this many times before and whilst investment properties can be a valuable contribution to your portfolio, they should rarely form the entirety of it.
This is known as diversification.
On the weekend, a good friend of mine explained that her brother had just bought an investment property with his super money. She wanted to know how he did this and whether it was a good idea.
She had explained that his accountant had set up a Self-Managed Super Fund (SMSF) and whilst he contributed a lot to the purchase of the property, he also borrowed for it.
The process of setting up a SMSF involves asking your accountant to set up your own Super Fund. As you would expect, there are quite substantial costs in doing so and usually it is said that you require a certain balance before the fees associated become comparable to a normal super fund. This is commonly quoted as $200k but can vary.
So how did he borrow money to buy a house? Within a Self-Managed Super Fund, you can use a ‘limited recourse loan arrangement’ to borrow money to acquire an asset. What this means is that the borrowing is guaranteed by the asset acquired with the borrowed funds and any guarantor security that has been provided. Interest rates vary on these types of loans but usually because they are considered higher risk, they attract a higher interest rate and require a larger deposit than a normal home purchase.
Borrowing to invest is an investment strategy and is usually considered high risk. Whether this is appropriate depends on the particular person but the reason it is high risk is because the investor is taking a risk that the investment property will go up in value in excess of the interest repayment and all associated fees. Without good financial advice and a good understanding of the level of risk you are taking on, this can be a very dangerous strategy.
You can also borrow to buy shares in your superannuation. Again this presents similar risks to buying property.
Now whether this is a good idea or not depends on a number of factors which are too complicated and specific to the particular person to list here. The major concern I would always flag in this situation is the lack of diversification.
You see, my friend’s brother has put all his eggs in one basket. He has put all of his super money (and some borrowed money) into one house. Now if the property market does not perform, which it can and does from time to time, then he could end up either not making the returns he was hoping for or even worse, a loss. Now if he had received good financial advice, knew these risks, took them on willingly and put in the work to monitor this investment I wouldn’t be as worried, but this is rarely the case.
My friend’s brother likely set up a SMSF because his accountant suggested it. It is unclear whether he recommended it or whether he considered other options. In all likeliness if something was to go wrong the accountant could argue he never provided financial advice (and was unlicensed to do so) and that any problems are the fault of my friend’s brother.
My biggest fear is that my friend’s brother has taken on this high risk investment strategy and has no idea he has done so.
Having an investment strategy for your retirement funds is a great idea and is why we offer advice in this area. Usually our advice is about using sensible, diversified investments to achieve realistic gains over your required savings period. What we would not recommend is gambling with one of your biggest assets without getting the right advice.
So if you’re wondering how best to utilise your superannuation funds for your particular circumstances, why not give us a call? Because getting the right advice upfront could save you a whole lot of hurt in the future.
As always, please feel free to come to us with any questions, comments or opinions. We love hearing from you.
This post is from Ben Brett. Check out our details in the About Us page.