There has been a growing trend of acquiring property (usually residential) in SMSF’s and limited recourse borrowing can in assist in the acquisition; this is a loan that is secured on a single asset (property), where the lender has no right of recovery against other assets should the borrower fail to make the repayments.
Given this limited security (recourse) the lenders (often banks) like to understand contribution levels from fund members, expected rental, interest cover and they will lend a lower % of the asset price and charge higher interest rates. The lower debt % and therefore interest costs in and SMSF is not a bad thing as unlike external negatively geared property, losses remain in the superannuation fund and cannot be offset against your salary. Importantly in an SMSF profits are taxed at concessional rates.
An SMSF itself cannot take out a loan and therefore a custodian needs to be arranged; an additional company act as an intermediary between the lender and the SMSF to borrow and fund the property acquisition.
The trustee of a SMSF must evaluate exactly what transaction is being contemplated and will need to consider amongst other things:
- who will be the lender?
- what will the loan amount be?
- how will the investment be impacted by movements in interest rates?
- can the loan be called in early?
- how will the principal amount be repaid?