INVESTING

What's a limited recourse borrowing arrangement?

By

So you decided to take the plunge and establish your own self-managed superannuation fund (SMSF) - that's an exciting step towards managing your own wealth. But perhaps an even more exciting step is realising that once you have an SMSF you may be able to use it to build a property portfolio.

Your SMSF can invest in real estate by borrowing money through what's called a limited recourse borrowing arrangement or LRBA. What's that I hear you say?

An LRBA involves your SMSF borrowing money for the purpose of purchasing a single asset (such as real estate) or a collection of the same asset with the same value (such as a parcel of one company's shares). Remember, the sole purpose of the fund (and its investments) needs to be to provide benefits to members during retirement. Let's take real estate - with a bank loan, you are able to purchase residential or commercial property - perhaps the key to the first investment property, or to a new business premises. Alternatively, if the loan is from a related party please keep in mind there are other things to consider.

SMSF and property

While the LRBA is in place the asset is held by a "holding trustee" in a separate trust.

Upon repayment of the loan the asset can be transferred into the name of the "fund trustee".

The safeguard offered by an LRBA is that if the fund defaults on the loan then the lender is only able to exercise a power of sale over the particular asset in that separate trust, as opposed to over all of the assets of the fund.

A lender may ask for a personal guarantee from you as fund trustee (this is more likely where the amount of the loan in terms of the value of the property is high).

If you are living at home with family or renting then this is unlikely to pose a problem.

But if you are thinking about purchasing a home to live in anytime in the near future, then perhaps consider that you may have a lower borrowing capacity whilst the LRBA (and guarantee) are in place.

It can be hard to work out if such a large, long term investment is in your fund's best interests, and indeed your own.

The absolute first thing you must ask is: Does this fit within the investment strategy of my fund? And the answer to this question has to be yes for an LRBA to be right for your fund.

It is worth taking time to then mull over things such as the following (and please note this is not an exhaustive list):

  • will your SMSF be able to make the loan repayments?
  • what are the other expenses of your fund to be accounted for?
  • are all of the members in it for the long term? What if someone wants to cash out their balance or start a pension
  • will the asset need to be sold?
  • who is the lender? Could they call in the loan early, or sell the loan which might vary the terms?
  • what are the associated fees and costs for the loan?
  • will the lender ask for a personal guarantee? If yes, are you thinking of buying a home in the near future? Will a guarantee lower your personal borrowing capacity?
  • if it is real estate, will it be leased? Will the fund manage in times without a tenant?

This is an important decision and one that should not be made until you really understand how the investment would work.

So make sure you do your homework and speak with qualified, appropriately-experienced people to help you get it right!

The key message is that there is something for everyone!

Investment is all about knowing what you can do, asking the right questions of the people with the expertise, and being realistic about what you want to achieve.

An LRBA, for example, is generally about generating a growth over a long term investment.

Assess the hand you've got carefully before you play your next card!

Lauren Absalom is a lawyer at Townsends Law

RELATED STORIES

TAGS
Post a comment
Link to something SwM6RjBC