SMSF property acquisition
How should commercial property fit within my superannuation strategy?
Commercial property can be an attractive asset for a self managed super fund.
It can provide income, exposure to a tangible asset and the potential to hold quality real estate over a long investment horizon.
But the fact that an SMSF can acquire commercial property does not mean that every fund should.
The property needs to make sense within the broader purpose of the fund, taking into account its members, investment strategy, liquidity, diversification, future obligations and capacity to hold the asset through changing market conditions.
The starting question should therefore not be:
What property can my SMSF afford?
It should be:
What role should commercial property play in helping the fund achieve its long term objectives?
Start with the fund, not the property
The investment should serve the strategy.
Commercial property is often a substantial investment.
For some SMSFs, one acquisition can represent a significant proportion of the fund ’s total assets.
That makes the decision bigger than simply choosing a property with an attractive yield.
Before entering the market, consider:
- The age and circumstances of fund members
- Retirement timeframes
- Desired income
- Risk tolerance
- Existing investments
- Contributions
- Cash reserves
- Future pension requirements
- The fund's ability to meet expenses
- How easily assets can be converted to cash
The property should fit the strategy.
The strategy should not be rewritten to fit the property.
UNDERSTAND CONCENTRATION
One good asset can still represent a significant part of an SMSF.
For many funds, that is simply the nature of commercial property. A quality commercial asset can require a substantial allocation of capital, and some SMSFs may only have the capacity to acquire one property.
That does not mean commercial property should be avoided.
It means the quality of the acquisition matters even more.
If the fund is likely to own one commercial property, the objective should be to buy the strongest asset the fund can reasonably support. That means looking carefully at the location, tenant, lease, building quality, future leasing demand, income sustainability and long term appeal of the property.
A fund with most of its capital invested in one building may still be exposed to:
One location
One property market
One tenant
One lease
One building
One income stream
One major capital expenditure event
But concentration is only one part of the decision.
A well selected commercial property can still play a meaningful role within an SMSF, particularly where the fund has sufficient liquidity and the asset has strong underlying fundamentals.
The question is not whether the fund can own several properties.
It is whether the property it does own is good enough to justify the capital committed to it.
For a fund that may only buy one commercial property, asset selection becomes even more important.
Think about liquidity before you need it
Commercial property can provide an SMSF with a long term income producing asset and, for many funds, that is precisely part of its appeal.
Because property is less liquid than cash or shares, it is important to make sure the fund retains enough flexibility around the investment.
That means considering how the fund will comfortably meet:
- Loan repayments
- Property expenses
- Tax liabilities
- Insurance
- Repairs and maintenance
- Major capital expenditure
- Periods of vacancy
- Pension or benefit payments
- Other fund expenses
This does not mean a fund needs to avoid commercial property simply because a large portion of its capital is invested in one asset.
It means the acquisition should be structured so the fund can continue to meet its obligations while allowing the property time to perform as a long term investment.
With appropriate liquidity retained around the asset, commercial property can provide both income and a substantial underlying investment within the fund.
The objective is not simply to be able to buy the property. It is to put the fund in a position to own it comfortably for the long term.
Don't build the strategy around today's rent
Income needs to survive more than one lease.
Commercial property can provide attractive income relative to many other asset classes.
But an SMSF may own the property for considerably longer than the remaining term of the current lease.
So we look beyond today’s rent.
We consider:
- Current rent
- Market rent
- Rental review structure
- Remaining lease term
- Options
- Tenant covenant
- Outgoings recovery
- Incentives
- Releasing demand
- Potential downtime between tenants
- Likely future leasing costs
The relevant question is not simply:
What yield does the property provide today?
It is:
How durable is this income over the period the fund may own the asset?
Ask what happens if the tenant leaves
The SMSF owns the property, not the lease.
A long lease and quality tenant can materially improve an investment.
But neither lasts forever.
At some point the fund may own a vacant building.
Before purchasing, we therefore want to understand:
Who is the next tenant?
Not by name. By type.
How many businesses could realistically occupy the property?
Would the building suit them?
Would the location?
Would the rent?
How long might releasing take?
What incentives or capital works could be required?
A property that remains desirable without the existing tenant can provide the fund with a very different risk profile from one whose value depends heavily on a single occupier.
Consider where you are in the superannuation journey
Time horizon matters.
An SMSF with members decades from retirement can have very different requirements from one whose members are approaching or already in retirement.
A longer investment horizon may provide greater capacity to hold an illiquid asset through leasing cycles and property market fluctuations.
As retirement approaches, other considerations can become increasingly important:
- Liquidity
- Income reliability
- Debt reduction
- Pension obligations
- Ability to sell
- Timing of a future disposal
- Concentration within the fund
There is no single point at which commercial property becomes appropriate or inappropriate.
But an acquisition should make sense not only for the SMSF today.
It should make sense for where the fund is heading.
Borrowing changes the equation
Leverage can increase purchasing capacity and create access to a broader range of commercial property opportunities.
An SMSF may, in permitted circumstances, use a limited recourse borrowing arrangement to acquire a qualifying asset.
For some funds, borrowing can make it possible to acquire a higher quality commercial property than would be achievable using available cash alone. It may also allow the fund to retain liquidity rather than committing all available capital to the acquisition.
The key is to ensure the level of borrowing is appropriate for both the property and the fund.
That means considering:
- Loan repayments
- Interest costs
- Rental income
- Available cash reserves
- Property expenses
- Future capital expenditure
- Potential periods of vacancy
- The fund's capacity to meet its other obligations
Rather than simply asking how much a lender is prepared to provide, a more useful question is:
What level of borrowing allows the fund to acquire a quality asset while maintaining appropriate financial flexibility?
Used appropriately, borrowing can be an effective way for an SMSF to access commercial property while preserving capital within the fund.
Finance structure, borrowing arrangements and compliance should be established with appropriately qualified SMSF, financial, legal and lending advisers before entering into a transaction.
Don't let the tax environment become the investment case
Structure cannot rescue the wrong property.
Superannuation can provide a particular tax and ownership environment.
Those considerations may form part of the overall strategy.
But they should not turn an ordinary property into a good one.
The underlying investment still needs to withstand the same scrutiny as any other commercial property:
Is the price supported?
Is the rent sustainable?
Is the tenant appropriate?
Is the lease commercially sound?
Is the building functional?
Is there future tenant demand?
What capital expenditure is approaching?
What happens at vacancy?
Who will eventually buy it?
Tax treatment may influence the structure.
It should not replace the investment case.
Tax consequences depend on the circumstances of the fund and its members and should be considered with appropriately qualified tax and financial advisers.
WHEN YOUR BUSINESS BECOMES THE TENANT
For some business owners, an SMSF can provide an opportunity to own the commercial property their business operates from.
This can create a strong alignment between the needs of the business and the long term investment objectives of the fund, while allowing the property itself to become a substantial asset within the SMSF.
Where the arrangement involves business real property and related parties, the property should still be assessed on its own investment merits.
Ask:
Would this be a quality commercial asset even if another business occupied it?
That means considering:
- Market value
- Market rent
- Location
- Building functionality
- Alternative occupiers
- Future leasing demand
- Capital expenditure
- Exit market
A property that works well for the operating business and also has strong underlying commercial fundamentals can make a compelling long term asset for the fund.
Transactions and leases involving related parties need to comply with applicable superannuation rules and should be structured with specialist SMSF, legal and tax advice.
Keep the arrangement on commercial terms
Where an SMSF owns property connected to a related business, the relationship should still be treated as a genuine commercial arrangement.
That means the property, rent and lease terms should be supported by the market rather than simply agreed between the parties.
We would want to understand:
- What the property is worth
- What the market rent is
- What lease terms are appropriate for the property
- What comparable evidence supports those positions
Clear market evidence helps ensure the property is being treated as an investment in its own right, not simply as premises occupied by a related business. The relationship may be familiar. The terms should still be commercial.
Plan for vacancy
The fund still has obligations when the tenant stops paying rent.
A property may provide reliable income for years.
Then a tenant leaves.
During vacancy, the SMSF may need to meet:
- Loan repayments
- Council rates
- Insurance
- Land tax where applicable
- Repairs
- Maintenance
- Leasing commissions
- Incentives
- Fitout contributions
- Compliance works
All while rental income has stopped.
This is why we consider both the quality of the property and the financial resilience of the fund holding it.
A vacancy should be a scenario the strategy can absorb, not an event that forces an immediate sale.
Think about capital expenditure
Yield before future expenditure can be misleading.
A commercial property can produce strong income while carrying substantial future capital obligations. Considerations include:
Roofs.
Air conditioning.
Fire systems.
Lifts.
Car parks.
Electrical infrastructure.
Building facades.
Major compliance works.
The timing of those expenses can be particularly important inside an SMSF where liquidity may already be constrained.
A property should therefore be assessed not only by the income it produces but by the capital it may require over the likely ownership period.
Cash flow should be considered after ownership costs, not before them.
Think about the exit while you still have time
An SMSF may eventually need something different from the property.
Circumstances change.
Members retire.
Pensions commence.
Investment strategies change.
Debt may need to be reduced.
The fund may eventually need greater liquidity.
That means the future saleability of a property matters from the day it is acquired.
Consider:
- Likely future buyer pool
- Asset type
- Price bracket
- Property condition
- Land component
- Lease expiry profile
- Tenant appeal
- Alternative occupancy
- Building obsolescence
- Market depth
You may intend to hold the property for many years. However, it is important to develop your exit strategy.
That is precisely why the eventual exit deserves consideration now.
Then assess the property on its own merits
Superannuation is the ownership structure. The property still needs to perform.
Once the role of commercial property within the SMSF has been considered, the acquisition itself should face investment scrutiny.
The property
Location, land, improvements, functionality, condition and future tenant appeal.
The income
Passing rent, market rent, rental reviews, outgoings and sustainability.
The lease
Term, options, obligations, guarantees and other commercial provisions.
The tenant
Financial strength, business characteristics, industry exposure and reliance on the premises.
The market
Sales evidence, rental evidence, vacancy, leasing demand and future buyer depth.
The price
Whether the amount being paid adequately reflects all of the above.
An SMSF does not make a property a good investment.
A good property still has to earn its place in the SMSF.
The questions we would want answered
Six things we would want clarity on
Before acquiring commercial property within an SMSF, we would want clarity around six things:
01
What role is this property intended to play within the fund?
02
What level of concentration will the acquisition create?
03
Will the fund retain sufficient liquidity before and after the purchase?
04
Can the fund comfortably hold the property through vacancy, expenditure and changing market conditions?
05
Is the underlying property an asset worth owning independently of its superannuation structure?
06
Does the acquisition continue to make sense as the members move closer to retirement?
Those questions do not replace financial, tax, legal or SMSF advice.
They help answer the property question:
Is this an appropriate commercial asset for the fund to own?
The property should fit the super strategy. Not become the super strategy.
Commercial property can form a meaningful part of a self managed superannuation portfolio.
But the decision deserves more than finding a property, calculating a yield and arranging the finance.
The fund needs to be able to acquire it, hold it, absorb its risks and eventually exit it while continuing to serve the retirement objectives of its members.
Our role is to assess the commercial property acquisition.
We work alongside your appropriately qualified financial adviser, accountant, SMSF specialist, solicitor and finance adviser to ensure the property decision is considered within the broader strategy and structure.
