With stock markets, once again, showing that values do go down as well as up – sometimes at an alarming rate and in a very short period of time – it might not be such a surprise that other asset classes have been gaining popularity with those willing to look further afield.
Gold for instance now trades upwards of $1,600 an ounce, more than 100% above its lows at the end of 2008. Another asset class that has shown a notable recovery and has become an increasingly regular favourite in the SIPPs market is directly held commercial property.
But what have been the drivers leading this resurgence in this primary asset class? Obviously the market took a terrible pounding in the second half of 2008 and hit lows in 2009. Although quite often touted as an uncorrelated asset to equities, in times of extreme cash illiquidity and credit crunch, property suffered every bit as badly as other asset classes.
However, there are now some signs of sustained increases in capital value, backed by the Investment Property Databank’s property index that showed a total annual return of 15.1% in 2010, of which the majority was capital appreciation. In addition, the hands on the windpipe of commercial lending have been removed with a number of lenders re-entering the market and creating a more competitive rate driven environment.
When considering direct property as an asset class, however, research shows that less than 33% of directly held property is acquired as a pure investment with the majority being utilised to further the client’s business in some way, usually through self occupation. This highlights that, clearly, some confidence must be returning to the economy and to the business expectations of such clients.
It is a shame, then, that successive legislative changes have not helped the acquisition of commercial property. The reduction in annual allowance brought about by the anti-forestalling rules in 2009 stunted substantial funding of pensions for the high net worth individuals that make up the majority of the bespoke SIPP and SSAS market.
The restriction in pension scheme borrowing to only 50% of the value of the vehicle’s assets has also resulted in the outright purchase of direct property being more problematic than before A Day. To some extent the new annual allowance of £50,000 introduced from April 2011 along with a carry forward facility has reversed some of these previous barriers.
For these reasons it is now far more common to see purchases structured on a joint basis. This might involve several SIPPs joining together or acquiring property jointly with the member or members’ company. The latter option also allows for another increasingly popular process – the staggered property deal.
Doing the maths
For example, take a property valued at £500,000 including costs. If two partners in a business have SIPPs each valued at £100,000, with borrowing this results in the SIPPs being able to contribute £300,000 or 60% to a property purchase. If then their company has £100,000 of available capital and can raise a further £100,000 through bank finance it can contribute the remaining 40%. The acquisition is then structured through a side trust that acts effectively as a nominee and in which the 60:40 split is recorded. The property is then let back to the business with the rental yields set at an evidenced commercial rate and being more than sufficient to cover mortgage payments.
In this example, the following year the business has made good profits but has not generated large amounts of cash liquidity, with available cash having been used to pay down the outstanding property finance to £50,000. The company can, however, contribute to the two SIPPs by making an in-specie payment of property value.
Although the correct paper trail must be followed, effectively the side trust has to be varied. While the value of the property remains at £500,000, contributions of £50,000 gross for each member can be made representing a total of 20% of the property value. In addition, the company will receive tax relief on the movement of value between it and the pension schemes as a corporate contribution, despite the fact that no cash has changed hands.
The side trust then records ownership as being proportionately held by the SIPPs and the company in the ratio of 80:20. Subsequent rents are then applied to each party in the new proportion and the following year, if the same situation arises, the property can move across to the SIPPs fully.
Some practicalities need to be covered, as valuations will need to be produced to demonstrate that the property passed between connected parties at a commercial rate and there are some inexpensive legalities to cover, but the process is not usually as complex as many would believe.
In fact the acquisition and ownership of commercial property can be far less painless depending on the cooperation, structure and requirements of the SIPP provider. It should be remembered that self invested pensions are more correctly known as member directed pension schemes and the more control, influence or input a member or their adviser can have in a transaction the smoother it can be.
The SIPP provider does of course have the duty of responsibility to ensure that the interest of the beneficiaries should be protected and thus that adequate due diligence and processes are completed on the acquisition. Some providers might insist on a nominated solicitor, panel valuers, panel lenders, compulsory property managers and block insurance policies as well.
While there are arguments for streamlining the process and in some instances economies of scale, many conditions can be seen as a means to move control from the client, which can lead to discomfort or resentment. There are equally good arguments for the use of the client’s own appointed solicitors, valuers or lenders who may already know the building in question and indeed the strength of the company’s covenant.
Similarly, where the property is leased to the member’s own business it is unlikely that it will require the services of an external property manager. The clients, with the SIPP provider overseeing, can often manage the property themselves and obtain appropriate insurance cover with large savings under a block insurance deal.
The majority of properties are acquired for the purpose of providing accommodation for the member’s business, including offices, shops and warehouses. However, advisers can think beyond the obvious to more esoteric investments, including pubs, garages, and leisure facilities such as swimming pools, sport centres and snooker halls. Other, less common, investments include boat moorings, which are commercially leased providing excellent yields and appreciating in value.
Get a room
Another sector that has seen growth, which has now plateaued, is the direct holding of hotel rooms. Provided that it can be shown that these rooms are not residential, which remains prohibited from SIPP ownership in all but a few circumstances, there should be no barrier to the ownership.
Extra due diligence may be necessary to ensure that the laws and tax implications in which the hotel room is domiciled are known and understood. A word of caution should always be made with such investments that are, of course, unregulated, especially as claims of occupancy, yield and future capital values have rarely matched those promised at outset.
However, there are downsides to single property ownership in a SIPP. Firstly, clients investing directly to aid their company by buying business premises must understand the double jeopardy of the business failing. Not only would they lose personal capital and their means of income, but also the tenant contributing towards the growth of their pension.
Rental markets are still not as robust as they have been, meaning that clients can suffer with the liabilities of continuing insurance and rates bills while a tenant is found.
Commercial property is also still susceptible to the economy and to interest rates both in respect of borrowing and the gearing of their tenants. In addition, it is an illiquid asset, although to some extent the complete or proportionate transfer as a benefit payment in specie can mitigate this.
Finally a factor true of any single asset class is a loss of diversification and so increased risk. Many argue that commercial property is best held in a well managed collective portfolio, avoiding the risk of a single property void. Equally such an approach will average the returns and take away potential gain achievable on individual deals that are often sought by the entrepreneur – exactly the type of individual to whom a bespoke SIPP should be the appropriate vehicle.
Martin Tilley is director of sales and marketing at Dentons
