As limited recourse loans enable SMSFs with only modest assets to invest in property, we can expect the number of SMSFs with a property holding to increase, although probably not at the rate sometimes hyped up in the media.
Holding property in SMSFs
There are still many more SMSFs with investments in commercial property than those invested in residential property, a feature I suspect of the nature of SMSFs set up by small business owners, where the property held is often their place of business that they then lease from their SMSF. The percentage of residential properties is increasing though, in line with an improvement in the residential property market over the past year.
As the ATO notes on its website:
Asset valuation is a key component in preparing meaningful SMSF financial reports. It has an impact on returns for members and, ultimately, SMSF sector performance as a whole.
So as an accountant are there tools available to help with accounting for the property holdings of an SMSF? And what guidelines should be followed to value property holdings?
Specifically are there tools to:
1. Assess a true market value as at a point in time, for example the end of the financial year?
2. Assess a true rental value for both residential and commercial properties?
Knowing the market rent and market value of a property assists with assessing the property asset when preparing the financial reports for the SMSF, when acquiring and disposing of assets and understanding their arms-length valuation, when determining the market value of in-house assets particularly for inter-SMSF loans and lease arrangements, and in determining the value of assets that support a member’s super pension.
In general, the ATO will accept a determination of an asset's value that is based on objective and supportable data, however it does note that an SMSF should consider using an independent valuer if the value of the asset is a significant proportion of the fund’s total value or the nature of the asset indicates that the valuation is likely to be complex or difficult.
As part of their residential lending operations, banks use both property valuation tools and valuation workflow engines extensively. Australia therefore has a mature industry-wide process for the ordering of valuations that SMSF providers can use to their cost and time advantage.
At the simplest and cheapest end, an Automatic Valuation Model (AVM) uses sales data, listings data and property characteristics to establish an estimated market value for a property using a computer model. The valuation takes into account known characteristics of all comparable properties, such as size of land, number of bedrooms and bathrooms and repeated sales of similar properties. These are factored in to a tested model that produces a valuation, and importantly also produces a measure of the degree of accuracy of that valuation. The AVM is often sufficient for end of year purposes for SMSFs where the asset is a residential property that was more comprehensively valued on purchase, and is able to be produced for any date in the past.
A more accurate and slightly more expensive valuation is a desktop valuation, which can also provide a rental market appraisal and is suitable for residential and some commercial properties. A desktop involves a qualified valuer evaluating the property and comparable properties at his or her desk. Tools such as RP Data’s Electronic Valuer Review platform that returns all the listings, sales, aerial photography and mapping are used for this purpose. The valuer then combines this data with market knowledge and their professional training to produce a professional desktop valuation.
For the highest accuracy, a full valuation could be one of a ‘drive by’ or a full physical inspection in which the valuer either fills in a standard short form or a long form report. In these cases, some form of physical inspection of the property occurs. A full valuation therefore helps the valuer validate their assumptions on the condition of the property and how it compares to other sales in the area. Given the valuer is a professional and has often seen quite a few of the other sales personally, they are then able to accurately judge relative quality between properties valued. Complex commercial and residential valuations especially on asset acquisition, disposal and other major SMSF events should use a full valuation.
The ordering of valuations is now a lot simpler through the exposure of the valuation industries workflow engines, Valex and VMS, into simple web interfaces that most SMSF software providers now link to. These allow for the same processes used by banks to be exposed to accountants for the ordering of professional valuations, using the top valuation firms and providing national coverage.
Obtaining a valuation, either in the form of an AVM, a desktop or a full valuation, should provide savings in time and consistency in approach and allow accountants to remain confident in the independence of these valuations based on objective and supportable data.
It should be noted though that the ATO may review a valuation as part of its compliance processes. As part of this review you may be asked to provide evidence of the valuation method that has been used to allow the ATO to decide whether to accept the valuation or not. This evidence would include documentation of the valuation method used. Accordingly, care needs to be taken, and expert assistance sought, where questions arise in order to ensure the ATO’s expectations are met and the valuation is accurate and can be safely relied upon.