Join our investing community

Our First Smsf Purchase - A Step By Step Guide

Discussion in 'Real Estate' started by Billv, 28th Jul, 2009.

  1. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    There are many sites where people can read about SMSF's but I have not seen anywhere a simple to follow step by step guide so here it is.

    First of all I should say that I find SMSF’s fascinating and I believe that it’s a powerful concept we should all be exploring.
    To give you an idea of my background, I am not an accountant, a financial advisor or anything like that but I've done a lot of reading, I've gone to multiple SMSF seminars (and to some of them twice) and asked many questions so I have a good idea of what can be done in a SMSF and what structure to use.

    We created our SMSF early this year and myself and my wife are the 2 and only trustees. We could have created a company to be the trustee but a SMSF is cheaper to establish and operate with personal trustees.
    Having personal trustees limits our options from the lending point of view but we had decided that our lender was going to be ST George because they did not require personal guarantees and they are happy to lend to SMSF’s with personal trustees.

    The SMSF setup was done though my accountant who basically bought the deed docs online and got us started.
    We then opened up a bank account for the SMSF and rolled over most of our super into our SMSF. We left some money in our old super fund because we had insurance cover and income protection with them and it was cheaper that way.
    When we opened up the SMSF's bank account we looked at several banks and the interest rate they offered and 1 of our essential requirements we had was the availability of a cheque book facility. This makes it easy to pay SMSF bills, buy a property at auction etc

    We decided to buy an IP which would be cash flow neutral or slightly negative. First we had to decide on how much we could spend.
    So we approached StGeorge and asked for a preapproval.
    The approval came through for a loan up to $365K
    Next we had to decide where to buy.
    We looked up the coast, down the coast, east, west and finally decided on western Sydney because that's where we could see value and there wouldn't be shortage of tenants either.

    It took us a while to find the right property, we made a few offers but
    the type of property we were after was very popular. There was too much competition from first home buyers and/or developers.
    We didn't give up and finally managed to buy our first IP in Casula for $323K (a house on a 700+ sq m block).
    Why did we buy this particular property?
    Because it was affordable, it will rent with only a minor reno, it's in a good spot, it meets our requirement for walking distance to everything and it has potential for redevelopment.

    It wasn't a rushed decision but it was an easy decision.
    We also looked at our recent super performance (+5% in cash), we took our preferred retirement age into account did the calcs and decided that our super without gearing wasn't going anywhere in a hurry so we bit the bullet and signed the contract.
    However, recent super performance was not our only consideration.
    We also looked at our finances this year and we saw that we'll be paying a lot of tax because all of our IP's are either cash flow neutral or cash flow +ve so we've decided to do something about it.

    We’ve decided to sacrifice into super 25% of our salary.
    This will not only save us tax (pay 15% tax instead of 40%) but will also reduce the IP loan considerably.
    I anticipate that interest rates will stay low for quite sometime so I can see ourselves doing the same next year.
    But even if we did not salary sacrifice, by my calcs and using $91K deposit,
    the property will be cash flow neutral from day 1 and our 9% employer contributions will be a bonus
    I've also read somewhere that we can also claim depreciation so this could reduce the SMSF tax considerably.

    Coming back to the IP purchase, I should point out that our IP was purchased in a bare trust which is basically an arrangement where the security trustee (a company) is holding the property in a separate trust.
    This is done to satisfy the tax office that the asset is not at risk.
    The property is bought in the name of the company which will be formed at the time of creation of the bare trust.
    In our case the bare trust and the company were created 2 days after we bought the property. so we had signed a pre-incorporated contract.
    For us this was not a problem because under the corporations act
    a company can have a meeting and ratify a pre-incorporated contract but if you live outside NSW check with your solicitor to make sure the same rules apply in your state.

    The bare trust is created when you purchase the property and ideally on the same day so it's best to get your accountant to decide which bare trust docs he is going to buy, then get their application form ready and signed and wait for the IP purchase.
    Once you find the IP and sign the contract, tell your accountant the property details and ask him to fax the application form in and to do a last minute check on the availability of the company name you are going to use.


    When you buy a property remember to get building insurance straight away (accidents do happen. You don't want to be stuck with a burned down property and a contract which you can't get out of)
    Also, remember to buy it in the name of the company you are going to create and make sure the name doesn't already exist (get your accountant to check and pick a name which won't be common).
    for example, if you had named your super fund
    LORRAINE AND STEVE BOLTON SUPERANNUATION FUND you could name your company LSSF PROPERTY HOLDINGS P/L and its VERY UNLIKELY that someone else will pick the same company name on the same day you buy your property.

    What name you choose doesn't really matter but be careful not to buy your IP in another company's name. Also, buy your deed docs from a firm which has experience with these issues such as CST Corporate Solutions
    and if you don't understand something ask questions and they'll give you advise.

    Anyway, I can't say that the exact same process and strategy will work for everyone but I've used a real life example here so it should give people an idea of how to buy an IP in their SMSF. and if anyone has questions I'd be happy to answer them.

    Best of Luck
     
  2. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Personal Or Corporare Trustee?

    Another thing,

    If you are going to setup a SMSF make sure you get the structure right.

    For example, you'll need to decide if you will have a corporate trustee or a personal trustee.
    The Corporate Trustee option is the more expensive one but it's easier to do changes to it down the track.

    For example, if you decide to go with the personal trustee structure and later on 1 of the trustees passes away you'll have to rewrite the SMSF docs and depending on your circumstances it could be difficult to unwind the SMSF without significant costs.

    Companies which sell deed docs promote the corporate trustee option but both options are there so do your own research get your accountant to look at both options and then decide.
     
  3. AsxBroker

    AsxBroker Well-Known Member

    Joined:
    8th Sep, 2007
    Posts:
    1,448
    Location:
    Sydney, NSW
    Hi BillV,

    I'm not a SMSF specialist either...

    Well done for realising superannuation is a tax structure, most people think it is an asset class...

    Congratulations with deciding on going with St George as your lender, they apparently are one of very very few lenders who don't ask for a personal guarantee for SMSF loans as personal guarantees are non-compliant for SMSF loans. I've also heard that they have reduced the rate as previously it was expensive being a non-recourse loan though now it is a cheaper interest rate.

    For the bare trust, as far as I'm aware this is for the borrowing, not the actual property. If you bought a property outright with no borrowings you wouldn't need a bare trust, same if you borrowed to buy shares in your smsf, it would be in a bare trust to avoid recourse against any other assets in the smsf if for whatever reason the loan may not work.

    For insurance, you can ask the insurer for take-over terms and see what they say.

    Cheers,

    Dan

    PS This is general information. Speak to your SMSF specialist before making a SMSF decision.
     
  4. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Thanks Dan, I've been to a few seminars and got some ideas on how to do it. I wish I had started earlier but with several IP's outside super and high interest rates it was not easy to salary sacrifice.

    Yes they did decrease their variable rate.
    I was going to take a 3 year fixed loan but now that they dropped their variable I'll take that one.
    STGeorge is 1 of my major lenders so they are making good money from me.
    I am about to take 1 more IP to them and they'll give me 0.85% discount.


    That's correct.
    But I wouldn't buy a property outright.
    Without gearing IMO there is no point in investing in property.
    What's the long term average return on property? 7%?
    I could leave my money in the balanced fund of any superannuation company and earn more than 7%. But if I gear in property I can tripple my returns and as long as the rent covers the repayments, time will do the rest :)
     
  5. GregR

    GregR Reid Consultants

    Joined:
    13th Jul, 2009
    Posts:
    273
    Location:
    Berwick Vic
    Bill,
    I have done some work with clients looking at the SMSF option and for the right client it is an attractive option to be able to gear into a residential property using a SMSF. A super fund is a tax vehicle. There are further benefits if you structure it well by being able to reduce the contributions tax of 15% as well if it is a negatively geared property.
    A couple of lenders have a servicing model (incl St G) but it is not sufficient for you to take full advantage of. It is for their benefit for servicing, not yours to maximise your benefit. As it is a non recourse lend (the reason for the property being owned in the bare trust), it is a full doc loan and has to be able to satisfy servicing within the SMSF. Most lenders will only go to a 70% LVR so you may need a minimum of about $250k in the SMSF to be able to purchase a $400k property and be able to show servicing through income earned of rent and dividend, interest etc. Some lenders allow super contributions, SGC and salary sacrifice, in their calculation, some don't.

    Different lenders have different criteria, some require a corporate trustee, some lend at business loan rates while others will lend at home loan interest rates. You don't necessarily need to get a loan from a bank, you can lend to the SMSF yourself as long as it is at commercial rates and you are not making a profit by charging excess interest. If you have sufficient equity in other properties, this may be a solution to servicing etc.

    The main drawback for investors is that you cannot use a revaluation and refinance strategy to extract equity, nor can you access the income until at least 55 and permanently retired. The major benefit is the tax advantages once retired and over 60, the net rental is tax free, capital gain if sold in this pension phase is tax free.

    You need to consider the sole purpose test, formulating an investment strategy, structuring the trusts and trustees correctly. It may best suit those investors in their 50's wanting to build their super assets for retirement or as a complementary strategy to their personal plans outside super.

    I built a model to help clients work out their optimum salary sacrifice amount, amount of SMSF assets required, etc. It is a generic model but provides a more closely aligned solution for some investors. I suggest you get a good accountant to work through the issues with and find a broker who has knowledge or do the work yourself with the lenders but be aware, many branches and managers have little idea of their own policies relating to their SMSF product.
     
  6. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Greg
    You probably meant to say "you need a minimum of $150K in the SMSF"
    because a $400K property at 70% LVR requires $120K deposit plus another $20 or so for purchasing expenses etc
     
  7. GregR

    GregR Reid Consultants

    Joined:
    13th Jul, 2009
    Posts:
    273
    Location:
    Berwick Vic
    Bill,
    I meant $250k. You are correct you will need around $140k or so to fund the 30% deposit and about another 5% for stamp duty, so for a $400k property in Vic, funds to settle of $140k. The reason for the other $110k is twofold, if you are borrowing from a bank, they want to see that you can service the debt so you will need additional income by way of interest or dividends, unless you have an very high rent yield (I am presuming 4.5%). That means having other assets in the SMSF itself earning money.
    The second reason is for diversification. The ATO at some stage will frown on SMSF's without a proper investment strategy and I am hesitant to suggest just having one residential IP in a SMSF is an adequate investment strategy.

    Whether it should be $250k or $180k will depend on your circumstances and assumptions needed. I helped a client with a StG SMSF recently. He first went to a branch, the manager said he had $150k in his SMSF, no problems borrowing 70% to complete. The deal went to StG credit team who knocked it back as it did not service. The SMSF needed additional earnings or income to service.
     
  8. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Greg

    I think you'll find that you can buy an IP worth $400K with around $140K of super because the bank will take into account your employer contributions plus any salary sacrifice component.

    If you apply for a preapproval and they don't give you the $280K you want,
    there is no problem, they'll tell you the max lend for your income and you'll have 2 options
    1 buy a cheaper property
    2 salary sacrifice more to increase the max lend figure
     
  9. GregR

    GregR Reid Consultants

    Joined:
    13th Jul, 2009
    Posts:
    273
    Location:
    Berwick Vic
    Bill,
    It depends on the lender. Not all lenders take into account SGC contribution and salary sacrifice as income for servicing. The other side is the investment strategy and diversification to satisfy the SIC rules to keep the tax status.
    Greg
     
  10. Nigel Ward

    Nigel Ward Team InvestEd

    Joined:
    10th Jun, 2005
    Posts:
    1,172
    Incorrect.
     
  11. Superman

    Superman Well-Known Member

    Joined:
    6th Nov, 2007
    Posts:
    343
    Location:
    Gold Coast, QLD
    Really good information (the majority of it) in this post.

    I am a SMSF Specialist and absolutely believe that SMSFs and property (as a long term investment) are a fantastic combination.

    Although the ATO has not answered all the questions put forward, they have answered some questions here: Instalment warrants and super funds - questions and answers

    The tax effectiveness of purchasing a property via a debt trust with an SMSF is amazing. Being able to salary sacrifice to cover extra loan repayments is fantastic.

    I would always recommend a corporate trustee for a SMSF. For further information please see an attachment from one of my previous posts here: http://www.invested.com.au/attachments/5/496d1194509120-changing-trustee-smsf-choosing-your-trustee-free-report.pdf

    I have actually seen the difference in practice and can compare between clients who had a corporate trustee, and everything came together when one member passed away, compared to the drama where individual trustees were used and a corporate one (ended up putting in a corporate trustee anyway). Oops - getting off topic.


    A thanks to Billv for posting his experience. One of the reasons it will work well for him is that he is obviously an experienced property investor and knows what he is doing. He spent the time, put in the hard yards and it will make lots of money for him!

    Some footnotes (based on my company's experience of assisting many clients over the past 18 months):

    - Ensure your solicitor knows what they are doing - your average conveyancing solicitor may be fantastic but they may not be up to speed with the rules surrounding these types of purchasers. Please see attachment for more information.

    - Documentation must be correct. The 'Bare Trust' deed and accompanying documentation that converts the property purchase with a loan (SMSF can't borrow) into an instalment warrant arrangement (one of the exceptions that makes it OK) must be done correctly to ensure compliance with SIS Regulations.

    - Ensure your trust deed is up to date. A lot of deeds out there (even relatively new ones) don't specifically enable the Fund to borrow via an instalment arrangement.

    - Ensure the borrowings and the underlying investment are part of a well thought out investment strategy that suits the members of the fund.

    - Look at insurances. What happens if you can't work, become disabled or die? Ensure you have answers to these questions covered before buying! (good advice for all property investment I reckon).

    - Shop around with the lenders. Not much choice at the moment - Westpac, NAB, CBA (their structure is different through), St George.

    - It will cost you more to purchase this way - even if you have an SMSF already set up. The banks typically charge higher legal fees, plus there is also the cost of the trustee company that would hold the title of the property and the bare trust itself. Ensure you budget for these costs.

    - If your solicitor does a bad job, when the loan is paid off and the title reverts back to the SMSF (from the property trustee / debt trust trustee) there could be double-stamp duty.

    - Member financed borrowings are a lot cheaper and easy to organise as you avoid the banks entirely (at least directly anyway). However the correct documentation still has to be there otherwise the ATO could consider the 'loan' to be a contribution and in excess of the contribution caps.

    - Do you really need borrow to buy that property? Could you manage your contributions to get more money into your SMSF and buy the thing outright?


    These rules are very new and have had limited exposure in the general market place. Once mortgage brokers, smaller lenders and real estate agents get their heads (and lawyers) around it - it will take off even more. However the fundamentals of borrowing to buy property still apply.

    Any questions throw them out there.
     

    Attached Files:

  12. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    ok, but you don't have to go with a pain in the a$s lender
    If I can't get approval with 1 lender, I'll try another.

    The property purchase was part of my SMSF's investment strategy and I have considered the risk factors and diversification.

    At the end of the day the SMSF trustee has to decide which area the funds will be invested in and I'd rather put most of the SMSF funds in brick and mortar than have it sitting in cash.
     
  13. ChristopherB

    ChristopherB New Member

    Joined:
    7th Aug, 2009
    Posts:
    3
    Location:
    Melbourne
    Nigel is right. A guarantee as part of securing an SMSF borrowing is fine.

    The ATO's draft ruling about the contribution tax payable on any guarantee payment — scary thought! — proves that guarantees are allowed as part of SMSF borrowing. For more info on the ATO draft ruling, see SMSF borrowing: tax risk for any payments under a guarantee - draft income tax ruling | ClearLaw Legal Bulletin | Australia.

    It's interesting to analyse what has caused people to think that a guarantee as part of an SMSF borrowing through an instalment warrant arrangement is non-complying.

    Guarantees are an issue for SMSF borrowing because the law requires that the loan be a 'limited recourse loan' — that is, the lender's right to recover money owing under the loan must be limited. Specifically, the law limits the lender's right as follows:

    "the rights of the lender against the regulated superannuation fund trustee for default on the borrowing, or on the sum of the borrowing and charges related to the borrowing, are limited to rights relating to the original asset or the replacement."

    It's the bit in that quote in bold that matters. The lender's rights 'against' the SMSF trustee(s) must be limited to the asset purchased with the loan money. However, the lender can have other rights (for example, a guarantee) against someone other than the SMSF trustee(s).

    I reckon the people who argue that guarantees are non-complying in SMSF borrowing are missing that last point.

    For more info, see this link, where there is a fairly groovy interactive graphic on it all
    SMSFs & Instalment warrant arrangements | ClearLaw Legal Bulletin | Australia

    Cheers
    Chris

    PS I'm not an advisor BTW. You need to get your own advice.
     
  14. mxd

    mxd New Member

    Joined:
    31st Aug, 2009
    Posts:
    1
    Location:
    Melbourne, Victoria
    mmm, too many thing to be said here.


    7% capital and 5% rental return is more like 12%, the 7% capital in the right area is more like 10% and the 5% rental return (in the right area) can be more like 7%. So I would say your looking at somewhere between 12 and 17% return.
     
  15. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Yes except that I don't count the 5% rental return because it will be used to service the loan.

    In this particular case, I've only put down a 90K deposit (72% LVR) so if you secure a $320K asset appreciating at 7% average p/a it will increase in value by $22K p/a which is something like 25% return on my original investment.

    Ofcourse interest rates could increase but so will the rents, and there will be a time when the rents will be paying off the principle, so the situation can only get better.

    IMHO
     
  16. bernardp

    bernardp New Member

    Joined:
    1st Sep, 2009
    Posts:
    3
    Location:
    Sydney, NSW
    I have been lurking here for some time and decided to register.

    Bill, thank you for sharing your experience, you have written everything down very well and your knowledge of SMSF and instalment warrants is very current.

    Not to mention that if you start a SMSF account based pension, then sell this property, you would not be liabile for any capital gains tax.

    Great strategy imo.
     
  17. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    bernardp

    No worries, hopefully it will be of help

    cheers
     
  18. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Update on the purchase

    The property settled yesterday, so it's all fun and games from now on.

    First I intend to renovate the place because it will allow me to increase the rent
    but I have a few more options up my sleeve.
    With this particular property I can build on the back and create a dual occ
    or could even subdivide the block (keep the house in the front and sell the back).

    I've got to get a survey done but by doing the numbers if I sold the land behind the house the loan will be paid off. With this option I'll pay CGT and after considering the selling and other expenses it's not such a good option, but it could work.

    I've also looked at building a duplex there but by the time I demolish the existing house it's not worth it. So I think I'll be going down the path of building something in the back yard or I'll do a basic reno to the existing house and leave things as they are for now.
     
    Last edited by a moderator: 1st Sep, 2009
  19. Tangible

    Tangible Mr.

    Joined:
    2nd Feb, 2010
    Posts:
    2
    Location:
    Sydney
    Inaccurate Info

    Bill, there are a few points in your blog are inaccurate: 1. Smsf should be postively geared. If your purpose is negative gearing, there will not be much left in your smsf when you retire. 2. Capital growth. The property needs to be in an area that has long term sustainable growth potential as well as good rental returns. 3. Legal docs. It is noticed that on line legal docs cost a lot more than in real life as to enable smsf to borrow, it is required a few legal docs and most on line docs charge item by item and when you add up the whole lot, they cost a couple of thousand dollars more than from a professional smsf specialist. 4. Professional advice. It is very important to get advice from a licenced adviser in smsf and the best this adviser can write the loan as well. If your broker and the adviser are two different people, you may find the Certificate of Independent Advice (part of the final loan documents) can be signed by any licenced adviser if he does not do the loan. 5. Personal guarantee. This is irrelevant. The money is lent to you as fund trustee. This is self-evident in the loan contract (you can see the account name of the loan is you as trustee of the super fund). Also, whatever the bank has control over is limited to the property itself. 6. Lenders available. The best are NAB and St George. NAB has bad services, St George has higher rate and fees. Westpac charges commercial rate and CBA basically makes it impossible for normal smsf (smaller than $200k) to borrow.
    Most of all, smsf loan is very easy because it is all black or white according to the banks' lending guidelines. Yet as an investment/taxation strategy, it is a complicated process. The best is to seek professional advice from an independent party instead of following misleading advice. SMSF is to make money for yourself, not for those such as banks, financial advisers, or brokers.


     
  20. Billv

    Billv Getting there

    Joined:
    15th Jul, 2007
    Posts:
    1,796
    Location:
    Sydney, NSW
    Tangible

    That's a strong 1st post there and you also forgot to introduce yourself.
    Are you posting as some type of an expert?