- Commercial properties offer higher rental yields, longer tenancies, and the unique opportunity to rent the property to your own business.
- Risks include liquidity challenges, market volatility, high vacancy rates, and the complexities of regulatory compliance.
- Leveraging can amplify returns but also significantly increase financial risks if market conditions deteriorate.
This is much more than the near-$50 billion in residential. This isn’t counting limited recourse borrowing arrangements (LRBAs) used to fund commercial property purchases.
Investing in commercial property through a self-managed superannuation fund (SMSF) is evidently an increasingly popular strategy among savvy investors. This approach allows individuals to have greater control over their superannuation while potentially unlocking the income potential of commercial property assets.
However, like any investment, it comes with its own set of benefits and risks that must be carefully considered. This article will explore the advantages and potential pitfalls of SMSF commercial property investment to help you make informed decisions.
Benefits of SMSF Commercial Property Investment
Diversification of Investment Portfolio
Diversifying your investment portfolio is a fundamental strategy for managing risk. By including commercial property in your SMSF, you can spread your investments across different asset classes, reducing reliance on the stock market and other traditional assets.
Commercial property often provides a steady income stream through rental yields, which can enhance the overall stability of your investment portfolio. This income can also be reinvested to grow your SMSF’s assets over time.
Tax Advantages
SMSFs offer several tax benefits, particularly in the accumulation and pension phases. The rental income generated from a commercial property is generally taxed at the concessional rate of 15% in the accumulation phase and potentially tax-free in the pension phase.
Capital gains tax (CGT) on properties sold is also reduced for properties held for more than 12 months. This makes SMSF commercial property investment an attractive option for long-term wealth creation, especially when the property appreciates significantly in value.
Potential for Higher Returns
Commercial properties typically offer higher rental yields and longer leases compared to residential properties. Not only is it common to charge a flat rental rate, it’s also common to charge a rent premium for a business' revenue over a certain amount.
Coupled with the potential for significant capital growth, this can lead to higher overall returns for your SMSF. When managed well, the combination of rental income and capital growth can substantially increase the value of your SMSF, providing a robust foundation for your retirement.
Rent to Yourself
Unlike with residential property held within SMSFs, it is possible to rent the commercial property to yourself. If you have an SMSF and run a business, you (your business) can pay market rent into the fund.
This can be handy because it solves having to direct money to a landlord somewhere else, and you may be able to deduct rent against your taxable income as a business expense.
Of course, talk to a specialist SMSF accountant when it comes to setting it up the right way, and ensuring your SMSF remains compliant. Failure to do so could result in fines from the ATO.
Risks & Downsides of SMSF Commercial Property Investment
Liquidity Risks
Commercial properties are generally less liquid than other investment assets, such as shares. Because of their more expensive nature, they may also be harder to shift than residential property.
This can pose a significant challenge if your SMSF needs to quickly access cash, especially during market downturns or when property demand is low.
If the SMSF needs to pay out a member’s benefit or meet other financial obligations, selling a commercial property quickly may result in a lower-than-expected sale price, potentially impacting the overall value of the fund.
As a trustee, failure to act in good faith for members' retirement outcomes may result in penalties from the ATO.
Market Volatility
The commercial property market can be volatile and subject to economic cycles. Factors such as interest rates, economic downturns, or changes in industry demand can affect property values and rental income.
A downturn in the commercial property market can lead to reduced rental income or a decline in property value, negatively affecting the performance of your SMSF.
Coupled with that, vacancy rates on commercial properties are typically much higher than on residential property, meaning the tenant may have more choice, and your property may sit on the market for longer than anticipated.
This volatility can be particularly concerning for investors approaching retirement who may not have the time to recover from market fluctuations or lengthy vacancy periods.
Regulatory Compliance and Costs
Managing an SMSF requires strict adherence to regulatory requirements. Failure to comply with SMSF rules, such as ensuring the property is used for commercial purposes only, can lead to severe penalties.
The costs associated with maintaining regulatory compliance, including legal, accounting, and auditing fees, can add up. Additionally, ongoing property management costs, such as maintenance, insurance, and council rates, can impact the net returns of your investment.
Leverage Risks
Many SMSFs use borrowing (leverage) to purchase commercial property. As well as that, commercial properties can be worth a lot more than residential property, and lenders can lend you a lot more money too.
While this can amplify returns, it also increases risk. If the property value decreases or rental income falls, the SMSF may struggle to meet loan repayments.
High leverage can lead to significant financial strain on the SMSF, especially if the market turns against you. In the worst-case scenario, the SMSF may be forced to sell the property at a loss, which could substantially diminish the fund’s value.
Is commercial property investment through an SMSF worth it?
Investing in commercial property through your SMSF can offer significant benefits, including diversification, tax advantages, and the potential for higher returns. However, it is not without risks, particularly related to liquidity, market volatility, regulatory compliance, and leverage.
To maximise the benefits and minimise the risks, it’s essential to have a clear investment strategy, conduct thorough due diligence, and seek professional advice. By understanding both the advantages and potential pitfalls, you can make informed decisions that align with your retirement goals and financial objectives.
Photo by Guilherme Petri on Unsplash
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