In a world of ever falling interest rates, more and more SMSF trustees are being pushed out of their comfort zone, having to move out of their cash investments and looking for more rewarding options. As of the time of writing this piece, CBA is offering a 3% p.a. return on its 12 months term deposit and 1.25% p.a. on its Netbank Saver account. The first is barely above inflation while the second is actually lower.
While looking for higher yields, many trustees who have had their superannuation invested in cash or bonds for a very long time turn to property, an asset which they understand better and potentially perceive as less risky or volatile than shares. They then discover that following a sustained period of capital growth which has not always been matched by growth in rental returns, many residential properties offer pretty disappointing rental yields.
Some younger trustees may find these returns acceptable, banking on future capital growth while having little need for liquidity. Unfortunately for retired trustees or close to retiring trustees, relying on the ongoing income from their SMSF assets to sustain themselves, that is not an option.
The next step for them is to explore some more exotic property options which have the potential to deliver that income.
Purchasing a serviced apartment is akin giving up on capital growth altogether but it provides a predictable, reliable net return which is generally in the vicinity of 6% p.a.
The reason these properties don’t experience much (any) capital growth is mostly because banks do not lend against these securities or only do so at low loan to value ratio. These lending limitations in terms translate into a much smaller pool of potential buyers and without demand, values don’t rise.
It is worth noting for trustees entertaining this type of property that it is virtually impossible to secure an SMSF loan from a bank for these purchases. Related party SMSF loans are essentially the only option available to them.
Student accommodations have very similar characteristics than serviced apartments in that:
- they are most disliked by the banks in general and particularly by SMSF lenders. There is currently no first or second tier SMSF loans available for these properties
- they tend not to grow in value
- they are very difficult to resell
- they have close to no vacancy issues, some of them offering guaranteed returns
- they generally return 6% to 8% p.a. rental yields
The main difference between the two is that they are relying on different tenants. While serviced apartments rely on short term visitors to an area (be it business or tourism), student accommodations’ fortunes are entirely linked to the education industry.
Purchased wisely and with a little luck, a good commercial property can turn into the ultimate asset for an SMSF. The banks do like these securities and there are plenty of SMSF loans available to trustees to purchase these properties. They can and do go up in value overtime and it is entirely reasonable to expect capital growth over sustained periods of time.
They can yield anywhere between 5% to 10% per annum depending on the particular type of commercial property being purchased. Shops and offices tend to be on the lower end of the yield spectrum while industrial properties such as factories and workshops tend to be on the higher end.
The main downside of these properties is the risk of extended vacancies. While commercial tenants usually have longer lease periods and options, it can sometime prove very long to replace a tenant, leaving the SMSF without any rental income for a substantial period of time.
Trustees should set aside some of the income from their commercial property to prepare for these periods. Trustees who are entirely or mostly reliant on their property income for their cost of living need to consider this scenario very carefully.
Short Term Lease Properties
Whether it is a property in a strategic location around a capital city or regional centre’s CBD or one around an attraction that will likely attract short term visitors (tourism or business), many properties are suitable to capitalise on the digital disruption of the short term accommodation market from AirBnB and the likes.
These properties combine the best of each of the above while avoiding their potential downfalls:
- Easy to finance for SMSFs with plenty of SMSF loan options available to trustees
- Easy to finance for potential purchasers in future, making the property easy to sell if needed
- Residential properties in high demand locations so no compromise on potential future capital growth
- Net rental return up to 100% higher than through traditional property management. I.e. I have personally seen the figures for a $400,000ish one bedroom apartment in St-Kilda returning just in excess of $53,000 in a year.
Which type of property will suit which trustee will depend on many factors, from their time frame to retirement, their need for an SMSF loan or not, the yield they seek, the opportunities available at the time and their appetite for risk. Whatever they decide, it is important that trustees complete thorough due diligence and understand the pros and cons of each option available to them.
If you are an SMSF trustee looking at investing in property using an SMSF loan, please contact us before committing to a specific property on 1300 781 680 or visit our website http://www.smsfloanexperts.com.au
* The information contained in this blog is general information only. No part of this blog is to be construed as a solicitation to buy or sell any security or financial product. The author, in preparing this blog, did not take into account the investment objectives, financial situation and particular needs of any particular person. Before acting on any information or advice in this document, you should consider the appropriateness of it (and any relevant product) having regard to your circumstances. You should also seek independent financial advice prior to acquiring a financial product.