Whilst all educational material we write is not financial advice and we recommend seeking the advice of a professional adviser, we certainly like to voice our opinions and investment ideas. There’s an age-old argument between those that believe in, and those that are against investing in residential property within a Self-Managed Super Fund (SMSF). In short, the Affluence investment team believes residential property is a relatively sub-par investment vehicle for a SMSF.
As most readers would know, we believe appropriate diversification is a key priority when investing. A retiree/investor in Australia usually already owns their family home, and we believe investing into residential property in your SMSF on top of this may be simply too much exposure to this asset class.
No-one can predict with confidence the future performance of this asset class, but what we do know is the average yield on residential property is approximately 4% pa. After costs such as council rates and water bills, combined with any capital required to upgrade or replace items, the final cash flow yield figure is likely to be substantially less than that. This makes it pretty hard to argue for over-weighting of residential property on a yield basis, which means you must have expectations of reasonable capital growth to make the investment.
There are now many experts turning much more cautious on residential property values over the next 1-2 years. Many factors such as declining interest rates, above average population growth and rental growth, easy debt financing and perceived shortfalls in supply have been supportive of increasing property valuations in the past. However many of these factors are now turning either neutral or negative, which at best might result in significantly lower price growth over the next few years.
Furthermore, investing into residential property can bring about significant maintenance efforts that will be required by the owner. As an example, the owner may need to manage, maintain and improve the property over the time period the property is owned, as well as account for tenant control and unknown income (no tenant, no income). Also, the owner can only visit the property a couple of times a year! (Legally).
In addition, the specific structure required for investing in residential property through your SMSF is complicated and may restrict flexibility. The sole purpose test also means that you are unable to live in the property yourself if you ever want or need to, which probably excludes you putting a holiday home in your super fund. It may also be very difficult to rent the property to a related party such as your children, as the rules around this are quite strict.
If your property requires a large capital injection in the future, for major repairs or an extension for example, this can be difficult to do through your SMSF. There are limitations on additional borrowing and caps on how much additional capital you can contribute in a tax effective manner.
In light of the above, our view on putting this asset class in any SMSF is bleak. We believe investing into residential property via a SMSF can lead to a lack of diversification, increased market risks and an increase in maintenance of investments. So the question begs, why would an Australian retiree want to invest their hard earned money into more residential property, at the risk of being heavily overweight this asset class at the top of the cycle? Aren’t retiree days made for playing golf, baby-sitting grandchildren and enjoying your spare time?
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