Wednesday, 21 January 2015

Trap #6 When Buying a Property in an SMSF: Relying Solely on Future Capital Gain

Trap #6: Relying Solely on Future Capital Gain

Whilst it’s nice to think a property in your SMSF will grow in value, there is no guarantee. I’ve seen many properties held by clients slowly go backwards each year because they were either convinced to buy an over-valued property or they purchased in the wrong location or at the wrong time. Using property in your SMSF can be a good growth strategy, but it can also be poorly executed.

Don’t rely on the future capital gain, if any, as the sole incentive to setup an SMSF to buy a property within it. Until that capital gain happens in the distant future, your fund needs to be growing from income generated from the investments in it. If the property is too highly geared or is not generating net cash-flow into your fund, then it is not providing for your future retirement, it is eating-up your future retirement funds instead. The property must stand on its own merits within your SMSF and must not be reliant on you heavily supplementing the short-fall with additional personal super contributions or additional salary-sacrifice contributions. It will end up draining your personal money if you need to constantly keep “topping up” your SMSF because the property expenses are draining your life savings.

The sole purpose of a superannuation fund is to provide benefits to you in your retirement. This is hardly happening if your SMSF is struggling with paying the property outgoings. I had one client who telephoned me and asked if he could pay the recent land tax bill for his property on his personal credit card and the bill was 2 weeks overdue. I asked him why his SMSF couldn’t afford to pay the bill and he said because there was no money left in the SMSF, the property had drained about $20,000 in what remaining cash he had in there in the last 12 months!

Until your actually sell the property, you have no capital gain, it’s just speculation. Until that day comes sometime in the future you must deal with the facts of the present and make sure the property within your SMSF contributes and does not detract from your retirement savings.

My advice is to get your accountant to do a detailed, 12-month cash-flow that incorporates worst case scenarios. What do I mean by worst-case scenarios? Worst-case scenarios includes the property being vacant and earning no income for 5-15% of the year or interest rates increasing on your loan by 4% into the future. What will your property returns look like under these, changed circumstances? Be realistic, no property is fully tenanted every year and interest rates will go up. Have you been convinced that the property you are about to purchase in your SMSF is a “good thing” based on favourable market conditions that exist today?  If you want to insulate your SMSF from collapsing, then build your cash-flow model on worst case scenarios during your due diligence stage (Trap #3). You want your SMSF to be insulated during the bad times as well as during the good times.

NEXT WEEK: The Final Trap of the series; TRAP #7 - If you don't want to miss out of this valuable weekly information then follow my blog via email. Use the link "Follow by Email" on the top right to register. You will automatically get delivered directly into your inbox each week each SMSF trap update.

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