How to Prepare Your SMSF for Its First Property Purchase

Buying property through a Self-Managed Super Fund (SMSF) has become one of the most popular wealth-creation strategies in Australia. The idea of taking control of your retirement savings and putting them into a tangible asset like bricks and mortar is appealing. It feels safer than the volatility of the share market and offers a clear path to long-term growth.

However, purchasing property through a super fund is fundamentally different from buying a home to live in. The rules are stricter, the deposits are higher, and the penalties for getting it wrong can be severe.

If you are thinking about using your super to secure a property in 2024, you need to ensure your fund is compliant and financially prepared before you even look at a listing. Here is how to get your SMSF match-fit for its first purchase.

Review Your Investment Strategy First

Before you apply for a loan or attend an auction, you must look at your SMSF’s Investment Strategy. This is a legal document that sets out the objectives of your fund.

By law, your strategy must allow for property investment and borrowing. If your current deed only talks about shares or managed funds, you cannot just go out and buy a house. You need to update this document to explicitly include property and the ability to use a Limited Recourse Borrowing Arrangement (LRBA).

If you sign a contract of sale before your trust deed is updated, you could be in breach of compliance rules. This is a common administrative mistake that can cause major headaches down the track.

Understand the "Limited Recourse" Loan

Borrowing money in an SMSF is not the same as taking out a standard mortgage. By law, SMSF loans must be a Limited Recourse Borrowing Arrangement (LRBA).

This structure protects the other assets in your fund. If the property investment goes bad and the loan defaults, the bank can only seize the property itself. They cannot touch your other super savings, such as your cash or share portfolio.

Because the risk to the bank is higher, they protect themselves by demanding larger deposits. While you might buy a personal home with a 5% or 10% deposit, SMSF lenders typically require:

• 20% to 30% deposit for residential property

• 30% to 40% deposit for commercial property

You also need to factor in substantial setup costs. Between the bare trust setup, legal advice, stamp duty (which can be over $30,000 on a $600k purchase in VIC), and bank fees, you need a healthy cash balance before you start.

Pass the Sole Purpose Test

The "Sole Purpose Test" is the golden rule of SMSF investing. Every investment your fund makes must be for the sole purpose of providing retirement benefits to its members.

This means you cannot gain any current-day benefit from the property.

• You cannot live in the property.

• Your family or friends cannot live in the property.

• You cannot rent the property to yourself or your business (unless it is a commercial property).

The property must be purely an investment, rented out to an unrelated third party at fair market value. If you breach this test, the ATO can impose heavy penalties or strip your fund of its complying status.

Check Your Liquidity Buffer

Banks want to see that your fund can handle the ongoing costs of the property without stress. They will look at your "post-settlement liquidity."

This is the cash left over in the fund after you have paid the deposit and all purchase costs. Most lenders want to see that you have enough cash remaining to cover 6 to 12 months of loan repayments and expenses.

If emptying your super account to pay the deposit leaves you with $0 in the bank, you likely won't get approved.

You need a buffer to handle potential vacancies, repairs, or interest rate rises without needing to make frantic personal contributions.

Assemble Your Team

You cannot do this alone. An SMSF property purchase involves a specific sequence of steps that requires coordination between several professionals.

You will need a financial planner to advise on the suitability of the strategy, an accountant to handle the tax structure and trust deed, and a mortgage broker who specialises in SMSF lending.

Attempting to DIY this process often leads to costly errors. For example, buying the property in the wrong name (e.g., your personal name instead of the bare trust) can result in paying double stamp duty to fix the title.

Getting Started

Preparing your SMSF takes time. Setting up the Bare Trust and getting pre-approval for an LRBA can take weeks longer than a standard loan. But if you get the foundations right, property can be a powerful engine for your retirement wealth.

Keen to understand how this applies to your situation? We’ll help you break it down and plan the next step.

Disclaimer:

The information in this article is general in nature and does not take into account your personal financial, legal, or tax circumstances. Property structures, tax regulations, and superannuation rules may change over time. You should seek advice from a qualified professional and refer to the latest ATO and government guidelines before making any investment or structuring decisions.