Borrowing to invest allows you to use someone else’s money with your’s to invest a bigger amount that will hopefully grow faster over time and provide you with a greater amount of wealth even after the borrowing has been repaid. This is often called a ‘leveraging’ strategy.
Leveraging or borrowing provides an opportunity to magnify gains but it also provides an opportunity to magnify losses – as many a margin-call investor would now realise.
Like with any investment, great caution needs to be taken in assessing the potential merits of an investment and even more so when borrowing is involved because of the magnifying effects.
A Self Managed Superannuation Fund (SMSF) can borrow to buy business real property under a Limited Recourse Borrowing Arrangement (LRBA).
Many business owners are now using this strategy with a SMSF to grow their assets faster and close ‘The Gap’ between what they have now and what they will need when they choose to retire.
Borrowing by their SMSF under a LRBA to acquire business property enables them to acquire property that they otherwise could not afford or have the cash to do so. There are special rules to be met for a SMSF to borrow under a LRBA which we will not go into in this article.
The commercial rent received by the SMSF from the business property over the ownership period is used to repay the principal and interest repayments of the debt so that at some stage in the future the property becomes debt-free.
The business property may never be sold for a capital gain until a time when the business owner has retired and is receiving a retirement pension from the SMSF. When the SMSF is in pension mode, any capital gain on the sale of the property is tax-free.
A combination of a low or zero tax environment and higher income being paid into the SMSF over the life of the fund allows a greater amount of wealth to have been accumulated to fund the retirement of the business owner.
Borrowing by a SMSF to acquire business property under a LRBA is becoming a very popular strategy to close the Gap between what you have now and what you will need when you choose to retire!