Rate rises fuel LRBA usage

LRBA interest rate

The increase in the use of LRBAs to buy property in an SMSF has been aided by the recent number of official interest rate rises.

The constant increase in official interest rates by the Reserve Bank of Australia has helped trigger an increase in the number of limited recourse borrowing arrangements (LRBA) being used by SMSFs to acquire residential property, a boutique fund manager has said.

“The rise in interest rates has forced many first-time homebuyers out of the market, leaving less buying competition for investors, particularly in the apartment space,” Clearwater Capital director Kris Vogelsong noted.

However, Vogelsong pointed out this economic backdrop is not the only contributing factor to the phenomenon.

“[In addition], rising rents have made these same properties more attractive to investors, despite the increase in interest rates and maintenance costs,” he suggested.

ATO statistics indicate the use of gearing to buy property within an SMSF has risen by 22 per cent and totalled $66 million.

Investment Strategist founder Tony Zulli warned SMSF trustees looking to take advantage of these factors making the use of LRBAs for property purchases more attractive to be wary of the strict rules governing this type of gearing.

In particular, Zulli made reference to the fact the loan liability must be serviced by the SMSF, which could become problematic if income from the property and other investments in the fund are not sufficient to cover these costs.

“Any shortfall will need to be covered by contributions, income from other assets, cash balances or the sale of other investments within the fund,” he noted.

He added the use of contributions to pay the LRBA principal and interest could also create issues for trustees due to current legislation and regulations.

“If the fund exceeds $1.7 million in assets, non-concessional contributions can’t be used to fund any shortcoming, meaning asset sales might be required. If rents don’t keep up with increasing mortgage costs, this could be a very real scenario for many funds,” he said.

According to Zulli, challenges arising from SMSF investments in property have often led to a revision of a fund’s overall investment strategy.

“We’ve been asked by a number of service providers and trustees to conduct a broad review or assist in problem solving around a particular issue. The catalyst behind these reviews is often property related,” he said.

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