Self-managed superannuation funds (SMSFs) can provide trustees with exciting opportunities to invest in commercial property developments through pooling resources in syndicates.
For those considering commercial developments, SMSFs can be an effective way to use superfund balances to access larger projects, enabling borrowing and long-term investment, but careful planning and professional advice is essential.
Pooling SMSFs for commercial property development
Pooling assets through property syndicates allows multiple SMSFs and other entities to collectively invest in commercial developments which might be outside the reach of an individual SMSF alone. This can take the form of joint ventures or unit trusts where each SMSF holds a proportionate interest.
One common structure is a geared unit trust, where the trust borrows funds to purchase the commercial property, and SMSFs hold units in the trust. This allows SMSFs to indirectly fund property developments with borrowing capacity, as SMSFs are restricted in borrowing directly except under strict limited recourse borrowing arrangements (LRBAs).
How can SMSFs borrow for commercial developments?
SMSFs may use their combined balances as security via an unrelated geared unit trust or through another syndication vehicle. The trust borrows to fund the development or purchase, and the SMSFs are unit holders, sharing income, capital gains, and risks according to their ownership balance.
Alternatively, SMSFs can hold commercial property outright or as tenants in common with other investors. However, borrowing is limited to a single asset via an LRBA, and development costs usually need to be paid from cash reserves rather than borrowings.
Important considerations and pitfalls
There are several factors SMSF trustees and advisers must bear in mind:
- Related party rules: The SIS Act restricts certain transactions with related parties. Development work often cannot be performed by related parties to the SMSF, or borrowing from related parties may breach rules.
- Market valuations: Properties must be valued at market rates, particularly for lease agreements or when purchasing related party interests, to satisfy compliance.
- Lease agreements: If a commercial property is leased to a related business, the lease must be at commercial market rates to comply with superannuation rules.
- Development risk: SMSFs undertaking developments directly bear all associated risks, including cost overruns, vacancies, or delays.
- Long-term tenants: Successful commercial developments can secure long-term tenants, generating stable rental income for the SMSF and growing fund assets via a geared structure.
- Liquidity: Commercial properties are typically illiquid; trustees should plan cash flow carefully, especially with borrowing involved.
- Complex structure management: Syndicates and geared unit trusts require careful structuring and ongoing management. Professional advice from accountants and financial planners experienced in SMSFs is vital to avoid compliance pitfalls.
Professional support is key
Using an SMSF for commercial property syndicates and developments offers flexibility and potential for substantial growth but involves complex regulatory and tax considerations. Trustees should work closely with trusted advisors to establish appropriate ownership structures, validate valuations, comply with the SIS rules, and manage leases and borrowing arrangements effectively.
Ensuring compliance in this area is vital – especially when it comes to trustees failing to properly document and prove that all transactions, lease agreements, and valuations comply with SIS requirements and market conditions are consistent with arm’s length dealings.
Please contact Audit your Superfund if you have any questions.