What are the downsides to buying property through SMSF vs just shares in normal super fund?

I have been of the view for some time that given my overall investment portfolio is property heavy, that it is good to keep my $430k super just in international shares (through a super fund).

However was chatting to someone today who explained that one can borrow through SMSF and can turn that into $1.2M exposure. (I.e. buy two 500k properties $800k borrowing, and using $200k super deposit., and 200k left over).

Was a bit of lightbulb moment. Seems like a no brainer to use leverage in super fund, even if there is a slightly higher IR and some accounting fees.

So what are the downsides here? How come these are not more popular?

 

I'd imagine one of them is the 'SM' in 'SMSF'. How much time do you have for it, and how much do you love paperwork?

Disclaimer: I don't have one personally.

 

its a lumpy asset. Will the fund be able to pay the minimum pension draw down amounts if low cash flow? At some point it would need to be sold to meet this. What if a member dies and their death benefits have to be cashed in - could mean a sale needed.

 

I am the only member so would not care what happened if dead.
I have 20 years until retirement potentially so could sell the asset at retirement and convert it to high dividend shares if necessary?

 

It just seems to me and again I'm new to all of this but I have 430 grand compounding let's say they're long-term return on international shares is 11% according to q Super anyway and let's say that property is only seven and a half percent to be conservative well seven and a half percent on one point two million dollars exposure is a heck of a lot better than 10% on $430k exposure.

Would love to have this sense checked though.

 

I liked this episode. Going Against the Greats – Why You Shouldn’t Pay Yourself First!

 

How does this relate are you saying that borrowing within a self-managed super fund means that the opportunity cost is compounding on shares and compulsory repayments that are not going towards paying interest on an investment property loan? Because I guess that's the disadvantage of leverage you have to pay for it....

 

My first thought was if you just sat back and let it compound over 20 years you would be doing pretty well.

 

That makes sense if you have that period of time. Most don’t have a high enough balance and a long enough runway until retirement.
Risk would be picking the wrong property and there are also restrictions on what you can do with the property.
It also easier to borrow now and rates are a bit more competitive.
Traps would be using one of those companies that say they will do it all for you but you end up overpaying and not getting the growth as property more income focused.

 

One of the negatives of buying property in smsf is the higher interest rate. I have one in the 7.21% range and one at 8.45%! . Still think it’s worthwhile as you’ve pointed out, the leverage does turbo charge the investment. You have to keep good records for smsf compliance but not too different compared to regular personal investing. But yes more work involved that just having an industry fund that is set and forget.

 

Do you think that would do better than more than double that amount of money in property over 20 years?
Idk the answer?

 

Yours and our SMSF balance is almost identical.
If you'd like to chat about what we've been doing over the past 16 months, I'm happy to share by PM.

 

Please do

 

any chance of sharing too please

 

There are significant downsides. This requires licensed financial advice or specific personal tax advice.

Property yields tend to be low. And rates of interest to borrow are very high (7% ish). So a property loss occurs. This can consumer fund cashflow quickly without the risks of a tenant not paying etc which may also complicate things. That loss inst a good thing in super. Unlike personal onwership to reduce tax via neg gearinga fund cant do the same as its effective tax rate is just 15%. Losses can consumer contributions too. This means a fund that treads water endlessly. Other than the property asset value changing the fund strategy may be poor.

We even presented an arguemnet it wasnt profit making so the 50% CGT discount applied and no GST.

Its often wise to consider low or neutral gearing. The idea is to have positive geared income taxed at a low rate (15%)

Leverage via super isnt anything like personal ownrship and some people race in and make some aweful mistakes. I am not saying dont do it. There are also ways to structure it so the individuals can neg gear and a fund can positie gear and pay much of a deposit etc. And then over the future years gradually shift ownership so the funds owns more and more.

Be wary that reliance on what others share is still financial advice. Its unlicensed and may ignore so many factors eg here is one few think of. Life insurance. If you open a smsf you could lose cover. Replacing it can still happen but could be refused or be exceptionally costly. Even a member in good health can expect premiums 2 - 3 times that of a industry fund for same cover. And poor health may be refused cover or have very high premium surcharges. etc

 

Thank you so much Paul for your response:

Insurance: keep 10k or whatever preferred amount in the industry super fund in aggressive option. Don't roll over all to smsf?
That sorts out insurance.

Tenant not paying: Unlikely and temporary (just gets high visibility even though rare as its confronting). Can get landlord insurance.

No growth problem:
I take your point about higher interest rates and no negative gearing but I still feel that over the long run the fact that you are geared significantly Ie potentially double or more than double the amount of exposure your super has is going to result in a much larger end point growth (and then sell for no cgt in retirement and then switch to very high yield assets). I mean isn't that really the basis for property investment outside of super anyway? For me personally I am paying SMSF rates outside of SMSF (3rd tier loans) (and my marginal tax rate only 30%) but i feel I am still making decent money on IPs when consider CGs-holding costs.

"Its often wise to consider low or neutral gearing" - what do you mean? Buy a +ve cashflow property like a beachfront holiday high rise on the GC (wont have hardly any CG)? Or do you mean buy high dividend shares (also less CGs?).What sort of investment item are you referring to? What options please Paul?

"There are also ways to structure it so the individuals can neg gear and a fund can positie gear and pay much of a deposit etc. And then over the future years gradually shift ownership so the funds owns more and more."
Can you pls provide more info about this? What does it involve and what are the costs?

 

What is the total return of your properties over the long term including rent and capital growth less expenses.

with 7-8% interest you would need 10%+ consistently at 80% LVR just to equal unleveraged shares as much higher risk.

 

that

thats based on raw return but is not accounting for leverage.
Ok so the raw (unleveraged) return is less on leveraged property in SMSF than it is on shares.
But $100k shares' total return is going to be less than a $500k property total return (using that $100k shares as deposit instead).

Lets say after one year shares do 11% (about right for diversified international). You have 111k. VS
Property does 7.5% (fairly conservative) you make 37.5k CG less holding loss ($480wk rent less property holding costs is 22k less 7.5% interest on $400k is -8k total loss). So you make 29k almost 3 times as much per annum due to leverage (then less a few thousand SMSF costs).

Are these calculations reasonable? Am I missing something?
@Propin this responds to your point also.

 

We purchased one in Brisbane in 2021 and have achieved about 76% growth in that time frame so regardless of interest rates, the growth has been significantly better than shares. Must admit, the second one we purchased hasn’t had the growth as expected as yet and we have large holding costs, so not sure if over the long term it would be better than shares or not. Given the higher interest rates, I’d be targeting properties with higher yield and or areas you think are booming or very Likley to boom soon. Don’t just buy randomly and wait for growth, especially if yield is not great.

 

11% is a bit optimistic. And property 7.5% ?? More typically yield is 3%. but with high interest and costs its a loss. So no net yield. Growth varies and tends to be pitchy and ups and down and over short term is a true loss and it takes 3-5 years to breakeven on growth due to initial costs like legals and duty etc

Shares yield is often higher. Think of CBA shares. Fully franked. The tax rate of divs is 15%. But franked to 30%. So a 15% refund benefits the fund. . So if yield is 5% then the 15% refund vastly inflates the true return.

eg $10,000 divs = $14258 assessable. tax is $2138 less franking $4258 = $2120 tax credit (refund). The $2120 equates to 21.2% of the $10K dividend. As a tax refund or it covers other tax. Its real money.
Property doesnt do this.

Domestic shares can outperform international on the tax basis alone. Depends on shares. A 5% yield on international shares may just be that and no tax benefits. And depends on what the prevailing currency movement is. If McDonalds shares rise 7% and the currency falls 11% you havent made anything. I often see people who tell me they made X% on international but they are comparing USD cost and value. Not AUD. All super is based on AUD values.

Shares also run exposure to rise and fall in the short term v property. Eg you can find market falls 4% in a day Maybe up 3% the next ? Or not...