Is limited recourse borrowing right for your SMSF?
Over the coming newsletters we will be taking a look at some of the topical items concerning self managed superannuation funds (“SMSF’s”).
Given the rise in the property market in parts of Australia, there has been a growing trend of acquiring property (usually residential property) in SMSF’s, however the question has often been how to fund the acquisition. This is where limited recourse borrowing comes in, which is essentially a loan that is secured on a single asset, where the lender has no right of recovery against other assets should the borrower fail to make the repayments.
Given this, the lenders (usually one of the major banks) like to see a minimum fund amount in the SMSF of more than $250,000 prior to consider making a loan. When assessing the loans lenders will look at contribution levels for members of the fund, expected rental yield and interest cover amongst other matters.
It should be noted that there is additional complexity in setting up a loan with a SMSF due to the governing law. A SMSF itself cannot take out a loan and therefore, a property warrant or instalment warrant would need to be arranged. Essentially, a warrant in these circumstances is a name for having an additional company act as an intermediary between the lender and the SMSF to borrow and fund the property acquisition. There are further conditions to be met in relation to the asset or asset(s) being acquired and understanding how the cash and borrowings of the fund will be used to make the purchase (see below).
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?;
- 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?
The lenders often charge a higher interest rate than a standard mortgage due to the limited recourse nature, but will generally request a cash float to be available and seek to understand the economics of the investment – unlike an external negatively geared property, losses remain the superannuation fund and cannot be offset against your salary.
Looking forward to future newsletters, we will be examining the single acquirable asset rule, repairs and maintenance in relation to property acquired or where borrowings are used to finance the acquisition of shares.
Limited recourse borrowing arrangements are generally long-term investments and as such the trustees should ensure that the investment is appropriate for the SMSF across its investment strategy and also complies with the sole purpose test. Should you have any queries on this, please do not hesitate to contact your ESV Partner on 02 9283 1666.
ESV is a Sydney-based accounting and business adviser. The are the appointed Auditor to the Association of Australian Boutique Winemakers Inc. They are also a generous sponsor.