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Self Managed Super Fund (SMSF) Article
Review of two SMSF property investment structures

By Tony Negline.

This article may be out of date.

14th November 2007

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About ten ago some fund managers suggested to the government that small super funds should disallowed.

Their arguments were primarily based around the poor compliance record these types of super funds have typically had.

Whatever the fund managers motivations for presenting these views to officialdom, it didn’t really escape anyone’s notice that they would be the main beneficiaries of this policy change as all the money then in small funds would have to be placed somewhere.

In June 1996, SMSFs had 12% of all super assets.  SMSFs are now collectively too big a juggernaut for anyone to stop or ignore and this looks set to continue.  By June ’07, this had doubled to 25% of all super assets.  Deloitte Touche Tohmatsu predicts that this growth rate will decrease and that by 2021 SMSFs will have 31% of all super assets the largest of any type of super fund.

Fund managers have belatedly realized that SMSFs are an egg which cannot be unscrambled and will remain massive and cannot be ignored.  The trick is that on the whole SMSF trustees don’t want the stodgy and unimaginative investments that retails super fund investors are happy with.

Two recent examples show how fund managers are reacting accordingly.

Recently Westpac Investment Management released a managed investment which provides direct access to residential property.  The trust invests in properties throughout Australia leased to defence force personnel.

The minimum investment is $10,000.  Normally when a SMSF wants to get access to residential property it needs to outlay a large proportion of its total assets.  This new product gets around this problem.

The fund will reach maturity in July 2014 and possibly earlier.  Only limited access to capital will be allowed before that time but penalties will apply if an investor wants to get hold of their capital.  Unlike normal property investments there will be no income distributions each year however this is offset by the potential for greater capital return at maturity.

As required by legislation when deciding on what assets to hold, buy or sell, SMSF trustees should therefore carefully consider the lack of ongoing liquidity and restriction on accessing capital.

Fees are always an important issue.  On going management fees will be 1% per annum of the underlying assets.  The manager can charge a performance fee if the investment performance exceeds an average of 9% per annum over the investment term.  There are also the normal costs of buying and selling assets that will be incurred such as valuation expenses.

On maturity the units will be converted into Westpac Residential Property Trust units.  The offer closes in late November.

Another organization, the Quantum Group, has created an instalment warrant over property.  Essentially the super fund and Quantum agree to buy a property, either residential or business premises.  Either Quantum or the super fund supply the property.  Quantum organizes the property finance of between 10% and 80% of the property’s value and manages and administers the whole arrangement including the property itself.  The super fund pays a deposit plus normal purchase costs as well as establishment and ongoing fees.  It also agrees to pay the borrowing costs on the outstanding borrowings annually in advance.

The super fund gets to keep the net of all expenses rental income during a lease period.  The super fund should not expect to see any net rental income arrive into its bank account until just before the annual interest cost becomes payable.

If business property is part of the arrangement then it could be leased to the super fund’s member’s business.  This might provide a handy way for the business to expand it premises by using the member’s retirement assets rather than the businesses capital and balance sheet.  An additional benefit of this strategy might be that the asset is held in a more tax effective vehicle given that when super assets are used to pay a pension they can be sold tax-free.  In the past this was a very potent argument for holding business property in a super fund however it has lost a lot of its currency due to the small business capital gains tax concessions introduced ten years ago.

The super fund’s members or their relatives could not lease a residential property purchased as part of this structure.

Whilst the property instalment warrant is in place, the property is held in a trust.  Because an instalement warrant is used, the super fund can walk away and doesn’t have to repay the borrowing but would loose their deposit.  If this occurs the property is sold.  The super fund would receive any surplus money remaining after all costs and the loan is fully repaid.

The term of the investment can be for whatever term the super fund would like but there are costs involved in the arrangement including adviser commissions which a super fund can negotiate down if they can strike a deal with the right financial planner.  Ideally the arrangement would exist for between 5 and 15 years.

Once the arrangement ceases the super has three options.  It can repay the loan in which case legal title to the property will be delivered.  Alternatively it would rollover the arrangement to another instalment warrant for an additional period of time.  Finally it could walk away without any penalty.

Quantum has received an ATO Product Ruling on this product which expires in June 2008.

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