Among the common draws of establishing an SMSF is the ability to invest in a wide range of assets, including property here in the country and abroad. By comparison, investment options through standard super funds are limited and predefined, and investing directly in real estate is generally not allowed.
However, using your SMSF to pursue a property investment opportunity abroad entails several rules and caveats.
Here are the important things to consider before you proceed with this strategy to diversify your retirement portfolio.
Confirm asset classes allowed for the SMSF
Check whether the fund's investment strategy and trust deed allows the SMSF to invest in overseas property. The investment strategy specifies the asset classes in which the SMSF will invest, while the trust deed outlines the rules and conditions on how the fund will operate including the types of investments it can make.
Both are legally binding documents that the Australian Tax Office (ATO) requires trustees to follow. Under the Superannuation Industry (Supervision) Act 1993 (SIS Act), if either the investment strategy or the trust deed does not specifically permit overseas property investments, the fund could face legal challenges and penalties for non-compliance from the ATO. It could also lose its concessional tax treatment.
Assess the investment against the Sole Purpose Test
Any investment made by an SMSF, including overseas property, must satisfy the ATO's Sole Purpose Test, which requires that any investment must solely be for the purpose of providing retirement benefits to the fund's members.
If you're thinking of making this investment in hopes of using the property as a holiday home abroad, note that a real estate investment - whether residential or commercial - cannot be used for personal or related-party purposes, including personal holidays or rented by the fund member or their families.
See Also: Can I Live in my SMSF Property?
According to the ATO, it is considered a breach of super laws "if the trustees are not able to show evidence that their property is used solely for business purposes or is reported at market value in the financial statements".
Ensure adherence to local laws and regulations
Foreign investments bring additional complexities, as each country has its own property ownership rules, tax laws, and regulatory frameworks.
Before investing, conduct due diligence on the property and the local market. "This includes understanding local property laws, market conditions, and potential challenges in managing property from afar," property strategist and finance specialist Steven Tropoulos said.
This helps protect the fund's financial interests and avoid costly mistakes.
Vital rules and regulations to consider include:
Title and ownership
SMSFs must have legal title over the overseas property. However, some countries restrict foreign ownership or have specific rules about how foreign investors can purchase and manage property.
In this case, it would be best to seek professional legal and tax advice to explore alternative options and ensure the ownership structures comply with local laws and Australian superannuation regulations. For instance, some countries allow foreigners to control property through long-term leases or joint ventures with local entities.
Taxes
"Investing in foreign property can potentially lead to double taxation and additional compliance costs - navigating tax treaties, credits, and accounting requirements can be complex and costly," Terry Vogiatzis, director of Omura Wealth Advisers, told InfoChoice.
An SMSF might be subject to local taxes in the foreign country where the property is located and in Australia. For example, rental income may be taxed overseas, and capital gains tax may be payable when the property is eventually sold. These can effectively affect the value of your investment and its returns.
Also note that all income generated from overseas property must be reported to the ATO. Failure to report can lead to penalties.
Manage currency risks
Given that the property is bought and sold in foreign currency, fluctuations in exchange rates can affect the value of your investment and earnings. SMSF trustees can employ hedging strategies such as forward contracts, currency options, or natural hedging to mitigate this risk.
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Forward contracts allow trustees to lock in a specific exchange rate for a future date, so even if the foreign currency weakens against the AUD, the SMSF will convert it at the agreed-upon rate.
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Currency options give trustees the right to exchange currencies at a predetermined rate on or before a specific date.
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Natural hedging is when trustees match the currency of their liabilities (e.g. expenses) to the currency of the income generated by the asset. For example, if an SMSF-owned European property generates rental income in euros, paying for associated expenses in the same currency helps reduce exposure to currency fluctuations.
Find financing
If your SMSF intends to borrow money to pursue an overseas property investment, know that "SMSFs cannot secure loans for purchasing overseas property," according to Mr Vogiatzis. This is due to the additional complexity and risk involved in managing overseas assets.
The strict requirements under the Limited Recourse Borrowing Arrangements (LRBA) may also make it more complicated for trustees to find financing.
Under an LRBA, the lender can only claim the asset being borrowed for if the SMSF defaults. This prevents lenders from having recourse to other assets the fund owns if the loan cannot be paid.
If conventional loans are inaccessible, possible options would be to explore non-traditional or private lenders, which often impose higher interest rates, hefty fees, and stricter terms. So while it's possible to borrow money for overseas property investments, it can be a complex and costly process.
Consider valuation requirements
Like all SMSF assets, overseas property must be valued annually in compliance with ATO's superannuation laws. An accurate valuation is necessary when determining capital gains and when the SMSF moves into the pension phase.
See Also: Transitioning Your SMSF from Accumulation to Pension Phase
It is the trustees' responsibility to ensure that valuations are done accurately and by a qualified independent valuer, which could be harder - but not impossible - to accomplish in a foreign country where property market data may not be readily available and the valuation practices and standards may vary widely.
Have an exit strategy
Developing a clear exit strategy is crucial, especially if the fund is transitioning to the pension phase where liquidity is required to pay retirement income. Not only is the investment illiquid, but selling foreign property can be more complex due to market conditions, legal and regulatory complexities, and tax considerations in both countries.
An exit strategy is especially more important if your SMSF is highly invested in real estate.
"When you reach the pension phase of your superannuation, you're required to withdraw a percentage of your portfolio annually (5% at age 65 or 6% at age 74)," Mr Vogiatzis said.
"If your portfolio is amassed in property, you can't simply sell a bathroom to fund your pension payments."
That said, trustees should plan their exit strategy well before the SMSF moves into the pension phase. Allow enough time to sell the property at an optimal price to ensure the fund can provide for its members in retirement.
Is investing in overseas property a sound strategy for SMSF?
Investing in overseas property using SMSF funds can be a good strategy for diversification. Depending on market conditions, among other factors, such investment may offer higher returns that would ultimately benefit fund members.
However, the additional risks and complexities involved may turn an opportunity into a money pit.
"The primary advantage of property investment is leverage - the ability to borrow at attractive rates and amplify your returns," Mr Vogiatzis said.
"Without leverage - since SMSFs cannot secure loans for purchasing an overseas property - property often provides similar total returns to a diversified portfolio of traditional investments, such as shares and bonds.
Mr Vogiatzis, who specialises in superannuation strategies and asset allocation, believes, "Even if you choose a foreign property that delivers returns comparable to a retail super fund, the increased costs, effort, and reduced liquidity typically make it a less favourable option."
"In reality, you might end up with lower returns due to higher outgoing costs."
Ultimately, you and the rest of the fund members have to consider if the investment opportunity available through that overseas property is too good to pass up, and that you are not falling into what Mr Vogiatzis considers a behavioural bias where people think "putting in more effort into something or doing something more complicated will lead to better results".
Seek advice from professionals with expertise in both SMSF regulations and international property investment. This can help trustees navigate the complex legal and financial considerations of this endeavour, as well as evaluate whether the gains far outweigh all the work and costs involved.
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