Investing in commercial property is a popular investment strategy for self-managed super funds (SMSFs).
One of the key advantages is that SMSFs can lease the commercial property to a related business they control, effectively paying rent into their own fund, provided the arrangement is conducted at market rates (we’ll talk more about that below).
While residential property has grown in popularity, SMSF commercial property remains a core investment strategy.
So, why would your SMSF invest in commercial property, and how do SMSF commercial property loans work?
What is an SMSF commercial property loan?
An SMSF commercial property loan is a type of finance that allows a self-managed super fund to borrow money to purchase business real property.
The Australian Taxation Office (ATO) requires all SMSF borrowing must be structured as a limited recourse borrowing arrangement or LRBA, which means:
- The loan is secured against a single asset
- The lender’s rights are limited to that asset if the loan defaults
- Other SMSF assets are protected
Why invest in commercial property through an SMSF?
Ever wanted to be Tony Stark and own your own high-rise? Using your self-managed super fund can be one of the most accessible ways of investing in commercial property.
Key reasons SMSFs invest in commercial property include:
- Ability to lease property to a related business
- Potential for higher rental yields
- Access to concessional super tax rates
- Long-term capital growth opportunities
See also: Buying a property through SMSF
How SMSF property loans work?
SMSF commercial loans are different from standard investment loans. Here are the key features:
Loan restrictions
Some lenders may have certain restrictions on the type of commercial property your SMSF can invest in, such as offices, warehouses, and retail shops. Development sites or vacant land may be excluded.
See also: Can an SMSF buy a land and build?
Borrowing extra funds to improve or significantly alter the property is generally not allowed under LRBA rules. Repairs and maintenance are allowed but improvements must usually be funded from the SMSF’s own cash, not borrowed funds.
Interest rates
Because SMSF loans are structured as a limited recourse borrowing arrangement, they carry more risk for lenders. As a result, interest rates for SMSF commercial property loans are typically higher than what you would be charged for a regular commercial property loan.
Fees
Oh, the fees. This is lender-specific, but don't be surprised to find fees attached to your loan such as:
- Application and establishment fees
- SMSF compliance or review fees
- Valuation and legal fees
- Settlement fees
- Ongoing fees
- Discharge fees and other charges
Depending on your lender, by the time you secure the investment, you could be several grand out of pocket.
- Take note: SMSFs incur legal and setup costs, which can add several thousand dollars to the overall investment.
See also: A complete guide to SMSF fees
Loan-to-value ratio (LVR)
Typical SMSF commercial property loan-to-value ratio (LVR) is 60%-70%. This means the borrower must have a minimum deposit of 30%.
While there are always exceptions according to individual lenders, SMSF commercial property loans can still be higher than residential property SMSF loans which typically require 80% LVR, or a 20% deposit.
ATO rules for SMSF commercial property
Before investing in commercial property through your SMSF, you need to make sure you comply with strict ATO rules. Here are the three things you need to satisfy:
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Business use test
The property must be a business real property, meaning it is used wholly and exclusively for business. No one can live there, although there are different rules surrounding residential dwellings on land used for primary production, i.e. farms with residential dwellings.
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Sole purpose test
All investments of the fund must meet the sole purpose test, meaning they exist solely to provide retirement benefits to members.
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Arm’s length test
All dealings must be conducted on commercial terms, which means the tenants you get are genuine and the property is offered at market rates. Failure to comply (for example, you rent the property at a steeply discounted rate or ‘off the books’ to a friend) can result in costly penalties or loss of SMSF tax concessions.
Do not purchase land with the intention of borrowing in the SMSF to build on. This is not allowed. Additionally, do not purchase an investment property that you will use from time to time.
Compliance is a significant part of running an SMSF. Working with an accountant who specialises in SMSF will help you avoid common pitfalls.
How to buy commercial property through your SMSF
Buying a commercial property through your SMSF can a bit complex. There are strict guidelines surrounding SMSF property purchases with harsh penalties if you fail to comply.
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Ensure it aligns with your SMSF investment strategy
Every SMSF is required to have a documented investment strategy and trust deed. It's wise to consult an SMSF advisor to be clear on whether a commercial property investment fits the fund's stated strategy.
The purchase will also require documentation to be updated as it will change asset diversification, liquidity, and other considerations.
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Confirm your budget and structure
Some SMSFs may be in a position to buy a commercial investment property outright, but it may be a better move to purchase using an SMSF loan depending on your fund's investment strategy, liquidity requirements, and other considerations.
- Take note: Your SMSF will need sufficient funds for deposit (typically 30% of purchase price), stamp duty and legal costs, and ongoing loan repayments.
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Find an SMSF loan that meets your needs
Not all SMSF loans are the same. You'll need to research the market to find financing that not only has a competitive interest rate but provides the terms and conditions that best suit the needs and investment strategy of your SMSF.
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Set up a bare trust
A bare trust must be established to borrow money under an LRBA. Essentially, although the bare trust will be owned by the SMSF, the commercial property purchased and the mortgage taken out are held by the bare trustee. This is to safeguard the SMSF's other assets in the event of a default on the loan.
The cost of setting up a bare trust is also another expense that needs to be factored into purchase calculations.
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Seek professional advice
It's advisable to consult a specialist SMSF advisor to ensure all is in place before you embark on a property search.
As with most investment decisions, there are also some pros and cons you should consider in determining whether commercial property is the best investment for your SMSF.
SMSF commercial property loan pros
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Leverage
One of the most important benefits (of any investment) is that you can borrow money you don't have on what's hopefully a high-performing asset, with the return on investment outweighing the interest you pay on your loan.
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Higher rental yield
Commercial property often offers higher rental yields compared to residential properties. Commercial leases can also be more stable, as lease terms are usually longer, and can provide higher income streams. Note that results depend on various factors.
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Tax advantages
Superannuation carries with it special tax treatment in Australia. Rental income received by the SMSF is typically taxed at the concessional super rate of 15% in accumulation phase, which can be significantly lower than many people's marginal tax rates.
Additionally, if you hold the property until the SMSF enters pension phase, rental income and capital gains may become tax-free.
See also: A guide to SMSF retirement phase
SMSF commercial property loan cons
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Restrictions on improvements
You can't borrow money or take out a loan to fund any significant improvements or alterations to a property purchased by your SMSF. These must be paid for through SMSF funds.
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Higher interest rates
SMSF commercial property loans typically attract much higher interest rates than regular home or investor loans due to the limited recourse structure.
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Complexity and compliance risk
SMSF loans involve a plethora of compliance and regulatory requirements, and failure to comply with them can result in severe penalties.
It's wise to seek specialist SMSF financial and tax advice before embarking on any SMSF investment to be aware of all the implications and ensure all requirements are met.
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Market volatility
Commercial property is typically a much more volatile asset class than residential property. Some events, such as a pandemic, can trigger high vacancy rates and plummeting asset prices.
Again, it's worth seeking specialist advice to ensure you invest in commercial real estate with good long-term prospects.
See also: How to buy a commercial property
Bea Garcia
