Example 4 – Investing in a property through a self-managed superannuation fund

This example is designed to help understand how to use PIA to analyse the scenario of buying an investment property in the name of a self-managed superannuation fund.

Property details:

Let us begin with the property described in Example 1. This was a new Queensland property (three bedroom brick residence on large block) purchased for $465,000 and rented for $470 per week. Apart from standard rental management and letting fees, rental expenses included rates ($1850), insurance ($750), maintenance ($900), pest control ($150) and travel costs for property inspections ($450). The original building construction cost was $230,000 and the purchase price included $26,000 worth of fixtures and fittings. The purchase costs included normal State Government stamp duty and $1250 solicitor’s fees to cover the conveyancing.

Loan details:

Principal and interest finance was arranged at 7.2% over 30 years to cover all costs, including purchase and loan costs. The total loan costs include a fixed establishment fee of $500, no mortgagee insurance, and the remainder of the loan costs are as per the program defaults.

Investor details:

The investor’s annual salary was $85,000 per year, his spouse’s was $35,000 and they wish to purchase the property in the name of their Self-Managed Super Fund (SMSF) into which they make an annual contribution of 9.5% ($11,400) of their combined salaries.

What if:

The annual growth rate for the property was 5% and the annual inflation rate 2%.  

1. Will there be sufficient cash in the fund to service any shortfall?
2. What options are there to eliminate any shortfall?
3. What initial cash deposit would be required to ensure the investment was cash neutral?
4. If they were both to retire in 10 years time at which time they were to sell the property, what would be the after-tax return?

What are the steps?

1. Open or create the spreadsheet from Example 1.
2. Choose the investment analysis spreadsheet (Menu: View/Investment Analysis).
3. First we need the change the investor to that of the SMSF.  Open the Personal Details dialog (Menu: Investor/Personal Details), choose Super Fund as the Investor Type.  This will have the effect of changing the tax scale used for calculating tax credits to that specified under Superannuation in the Tax Scales dialog (Settings menu). It will also set home loan repayments and living expenses to zero as well as removing those parameters relating to a partner.  You will need to change the original figure for Investors salary/wages (85,000) to that relating to the fund (i.e. the fund contributions of 11,400).
   
   If you have the PIAPro version, you can also type in “Self-managed Super Fund” in the Investor field.

   

4. If we now bring up the SMSF Settings dialog, we can see what other options we have available. Note that, for the Accumulation phase, it will already denote the fund income as 11,400 and the tax rate as that for Superannuation (15%). The plan was to possibly sell the property on reaching the Pension phase in 10 years (2024) so we must choose to Apply pension mode in 2024 at which time the Capital Gains Tax would be zero.
   

   

   Now as we are interested in whether or not there will be sufficient cash in the SMSF to meet any shortfall, click the check box to display the Annual Cash Surplus at the bottom of the Investment Analysis spreadsheet.
5. The Investment Analysis spreadsheet should now look like this…
   

   

Will there be sufficient cash in the SMSF to meet the short-fall?

The annual cash surplus is negative (-10,559 in the first year) so there would be insufficient cash in the fund to service the shortfall. Click on the figures in the Annual cash surplus row to see how they are derived.

What are the options to ensure the fund meets its cash commitments?

The first option might be to change the loan type from principal and interest to interest-only. However, while this reduces the deficit from 10,559 to 5,990, the fund would still be in deficit.

The most obvious option, if they can afford it, is simply to make extra contributions to the fund. Re-open the Personal Details dialog and add 11,159 as Other income.

For the SMSF to meet its cash flow shortfall, it would require annual contributions of at least $21,959.

An alternative to making greater cash contributions would be to provide a significant initial cash deposit.  This can be estimated most easily by trial and error. Firstly Undo the additional cash contributions and enter a figure between zero and 251,985 (the cash neutral investment required for a neutral cash flow), say 100k.  The Annual cash surplus is still negative (-2,414 in year 1).  Try something higher, say 150k.  This would be more than sufficient as there is a cash surplus of $1,659 in the first year and it increase with time.  With a couple more intermediate trials, a figure of 130k as a cash deposit would still result in the SMSF meeting its cash flows.

What if they sell the property on retirement?

Under current Australian tax rules, there would be no capital gains tax if the property were sold once the couple were in retirement mode.  Generate the Investment Analysis report (Menu: Report/Investment Analysis) which will reveal an equity after-sale of $427,764 at the end of 10 years, representing an after-sale return of 8.61%.