Tips and traps of off the plan apartments for Self-Managed Super Funds

Buying a Property and establishing a Self-Managed Superannuation Fund (“SMSF”) requires a clear strategy to determine if a SMSF and property is right for you.

Off the plan apartments can be attractive to many investors, however there is more to consider than the glossy brochure. Deciding on the right criteria for an SMSF investment property will help to determine its success. To grow your wealth through investment apartments you need to look at a number of factors and then ensure you keep these in mind when deciding on your property purchases.

Why are apartments so popular for SMSF?

There is no shortage of advertising for apartments on sale. Developers spend significant dollars on marketing including flyers in your letterbox and marketing agents contacting you endlessly to sell the benefits of off the plan apartments.

Many Australians have been priced out of the property market, with a booming property market in most capital cities. Therefore, with the declining share market and the hype around borrowing within an SMSF, many Trustees have turned to investing in property with their super. In fact, according to the ATO, SMSF borrowings have now reached $18 billion – over 3% of the $576 billion of total SMSF assets. This has grown $1.4 billion in June 2011. With foreign investors, SMSFs are a huge target market for developers and marketing agents alike.

Many consider the benefits of an apartment vs. a town house. Here, we focus on off the plan apartments. It is important to have a documented investment strategy when you purchase an apartment that includes how your apartment fits into your overall investment portfolio, which will be diversified, with a cash buffer for a rainy day. After all, SMSFs are supposed to be fun, making a poor investment decision can be quite stressful. Careful planning can help make investing in property within a SMSF a success.

Advantage of off the plan apartments

• Developers sell at a discount to obtain their own construction loan approval
• Low stamp duty
• Settlement of 12-18 months helps to plan your cash flow and obtain capital gain in a rising property market

Disadvantages of off the plan apartments

• Risk of a sunset clause
• Delays in completion
• Construction quality may not be up to your standard
• Interest rates increase before you settle

Below we identify six key tips in investing in off the plan apartments:

Tip 1 Due Diligence

When buying off the plan, many make an emotional decision based on a focus on “stamp duty” savings, however, there are a number of factors to consider prior to proceeding with an investment. After all, super is your retirement nest egg.

Firstly, there are different measurement guidelines for apartments. A developer may advertise an apartment as 50 sqm internal and an independent valuer may measure is as 45 sqm. This 5 square meter difference can have a disastrous effect come settlement and obtaining finance. This is a common error due to different measurement standards used by developers and valuers. You should inquire on the measurement standard used to ensure it is in accordance with the Property Council of Australia – Residential Property Guidelines.

Furthermore, the marketing plan for your dream apartment may be a draft and may be subject to change in that the developer may not have a plan of subdivision. It is important to obtain a contract and engage a legal advisor to review the contract prior to signing. Remember, off the plan contracts will generally be unconditional and not subject to finance so you will immediately pay a 10% deposit.

If your apartment has a car park and storage cage, you will need to ensure they are on the same title as the apartment being purchased, in order to satisfy Superannuation Law.

Tip 2 Recipe for success

The recipe for success involves an understanding of the factors that impact a property price. We need to state clearly that an investment in a SMSF is an investment not a home to live in. Under the sole purpose test, you or a related party cannot reside in an SMSF apartment. It’s therefore not an emotional decision, it’s an investment decision.

Boutique v Tower

Boutique apartments are “Cute” – generally less than 50 apartments in a development, provide a great possibility to differentiate your apartment from other apartments. For example – most investors choose corner apartments, in a small building this may be at the front of the building facing the main road, or at the back of the building with less noise and more privacy. Furthermore, there will be generally less than five levels with a car park. Boutique apartments are generally built in suburbs, which provide more lifestyle with access to schools, public transport and nightlife.

In relation to Towers, these are generally large apartment buildings, which have been favoured by foreign investors. Recent years have provided warning signs for Towers which are generally built in the CBD of capital cities such as Melbourne, Sydney and Brisbane. With apartments being sold off the plan to foreign investors, large margins have been added for marketing agents and have not been valuing up at settlement providing a nasty surprise for the buyers. Even worse, many are left vacant once the promised ‘rental guarantee’ expires due to high vacancy rates. Towers have been built in areas where independent valuers are providing risks of “over-supply” of apartments, so it’s important to do your due diligence and steer clear of towers for investments for the long term.

Verdict: Boutique Wins!

It also pays to look at the apartment building as a whole not just the single apartment. The right area is surely one of the most important elements when buying your apartment. Its integral to capital growth and also affects the rental vacancy rate. The more desirable the location, the less chance of an empty investment property in the future. After all, a SMSF Investment Property is a long term investment.

To be a desirable location the following amenities need to be close by:

• Public transport (train/bus/tram)
• Schools
• Public facilities (post office/libraries/parks/medical centres etc.)
• Shops and markets
• Lifestyle activities (restaurants/cafe strips/beach etc.)

Properties close to the inner city are usually more popular with renters and buyers, tending to consistently outperform the general market in long term capital growth. The infrastructure of inner city suburbs is also quite well developed and provides a desirability factor.

Tip 3 Focus on Capital Growth & Rental Yield

It’s important to achieve BOTH capital growth and rental yield. There should not be a focus on one or the other but both together. If you are borrowing to invest, your rental income will need to exceed your interest repayments to ensure you are not relying on contributions.

For example, a $350,000 apartment may require the following analysis on an annual basis:

Rental Income $17,500 (based on yield of 5%)

Loan interest ($13,842) (based on a loan of 70% of purchase price @ 5.65%)

Property Management ($875) (based on property management of 5% of rent)

Body Corporate ($1,250) (body corporate varies on each development)

Insurance / other ($250)

Net return ($1,283)

Depreciation # ($3,700) (Based on diminishing value method)

(#) Depreciation is a tax deduction

Tip 4 Obtain a finance pre-approval

Looking for an SMSF investment property can be an exciting and challenging experience. However, it is important to understand your borrowing power before taking the big step in completing the purchase by exchanging contracts for your dream SMSF property. An SMSF loan pre-approval is generally free and provides trustees with an indicative offer from a lender. This will assist to understand your purchase price and loan amount. Furthermore, trustees will be able to assess if they have sufficient cash in their SMSF to cover the deposit and settlement of the property.

Tip 5 Your Bare Trust needs to be set up

When buying in an SMSF, many sign a contract and then set up an SMSF. This is a NO. It is important to engage a SMSF Specialist Advisor set up an SMSF prior to signing the contract. Furthermore, in most states it is required to execute a bare trust prior to signing a contract. Your legal advisor will assist you with the name of the contract of sale, this needs to be correct to ensure there is no double stamp duty in the future.

Tip 6 Depreciation

Most property investors have heard of depreciation, however, have not unlocked the hidden benefits of depreciation. Depreciation can put thousands of dollars in tax deductions in your pocket each year. It’s simply compensation for “wear and tear” of the apartment over the period of your investment. Depreciation on items in the building such as dishwashers, ovens, carpets and blinds etc. are claimable. Your SMSF Advisor will assist you to obtain a depreciation report upon completion of the apartment.

Buying an investment apartment is about increasing your wealth. It takes thought and consideration to ensure the right property is chosen. Keep all the above information in mind when looking at real estate and you will be on the road to building a successful investment portfolio.

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