Property in Sipps: Building returns

This is because investing in property via a Sipp is not as straightforward as investing in, say, listed stocks and shares, and certainly does not lend itself to the ‘straight-through processing’ models adopted by simple Sipps. Every property is unique and while the process of purchasing, holding and disposing of property investments in a Sipp is well established, there is a need for experienced and knowledgeable staff to undertake those tasks.

Tangible assets

Although property investment is more complex than other types of investment, there are advantages. From the client’s perspective there is a certain belief – perceived or otherwise – that investing long-term in property is a good thing, mainly borne out of our cultural approach to house purchases. There is also the comfort factor of the investment being something as tangible as bricks and mortar rather than an investment product evidenced only by certificates and terms and conditions. This attitude is signalled by investors shunning pensions and savings products in favour of buy-to-let, despite it not having the tax advantages of pensions.

Due to pension tax legislation, investing in essentially any form of residential property, including buy-to-let, is not viable through a Sipp due to the significant tax charges that would be imposed. There are a few exceptions regarding property of a residential nature; investment in hotels, prisons, care homes and public houses is permissible. Residential property could be included if there is an element of commerce, for example a condition of employment being for an employee to be resident on site, such as a caretaker.

However, there is a great opportunity to combine the tax reliefs of pensions with commercial property investment. Typical commercial properties include offices, factories, warehouses and shops but land which includes forestry, woodland, agricultural land and land for development is also permissible. While many Sipp operators will restrict investment to UK commercial property and land, some specialist Sipp operators will consider overseas property and land too.

Business interests

Although some Sipp members do invest in commercial property or land they have no connection with, and view the property purely for its investment prospects, it is more common to find a connection between the Sipp member and the property, such that they will derive additional business benefits. Typically there will be cases where a Sipp is used by, say, a sole trader to purchase the shop from which they retail, or solicitors in partnership to purchase the offices from which they practice, or directors of a limited company to purchase the factory where they manufacture their goods.

In these cases, although the primary benefit will be the expectation that the Sipp will increase in value through the property’s capital appreciation and the rental payments it will receive, the business could benefit as well. If the business currently owns the property outright, it will have capital tied up which may be better employed elsewhere. The Sipp purchasing the property releases capital into the business and, rather than having sold the property to a third party and paying rent to them, rent goes into the pension.

Similarly if the business currently owns the premises but it is mortgaged, consideration could be given to the Sipp purchasing the property and the business using the sale proceeds to pay off the mortgage, which would in turn transfer to the trustees. The business would then commence paying rent to its own pension scheme. If it is currently renting a property from an unconnected third party, it could be considered preferable to rent a property that is owned by the pension scheme of the business owner.

An upside of removing property from the business’ balance sheet by selling it to the Sipp is that any creditors will not have access to it, although conversely the business will no longer have a secure asset on which to obtain credit if needed.

It must also be recognised that even though a property may be held as an investment within the business owner’s pension, it is technically owned by the scheme trustees and all transactions must be conducted at arm’s length market rates. In other words, the business is merely a tenant of a property owned by the pension scheme.

This means the property cannot be bought or sold to connected parties on favourable terms, nor can below-market rent be paid. Some Sipp operators may insist on the appointment of a particular property manager, but it is possible for members to retain control of the property’s management themselves.

Structures of ownership

It is often preferable for the Sipp to purchase the property outright but this is not always possible depending on the value of the property and the Sipp. The Sipp funds could be boosted in a number of ways, such as transferring in other pension arrangements, making further contributions or utilising carry-forward, although the lower annual allowance has placed some limitations on rapidly boosting Sipp funds. Another option is for the Sipp to borrow up to 50 per cent of the net value of the pension, the rental income being used to make the borrowing repayments. If the Sipp cannot purchase the property outright it is possible to arrange partial ownership, with the proportion the Sipp owns increased each year using the in-specie contribution mechanism.

Frequently in the case of partnerships or limited companies, property is purchased via a number of individual Sipps, with each Sipp owning a proportion of the property. For such joint purchases, a family Sipp or small self-administered scheme (SSAS) could be a better alternative – particularly for succession planning where the property ownership can remain unchanged as an asset of the scheme despite business owners and scheme members changing.

Lack of liquidity is often raised as a concern and does need to be considered. Even if most of the Sipp fund is tied up in the property, cash still needs to be available to pay fees. Over a period of time, it can be anticipated that the rental income will build up a cash surplus that can be invested in more liquid assets if appropriate.

An exit strategy also needs to be thought out regarding the provision of retirement benefits. Sale of the property by the Sipp is commonly sought to provide cash to pay benefits. A sale may be back to the business, to other business associates’ pensions or even to a new business owner if the business is being sold. However, continuing to hold property is possible as part of an income drawdown strategy, again with rental income providing a source of cash for income payments. Even where the member’s business has ceased to trade, on their retirement the property can be let to a new business tenant.

Property investment will not be universally attractive and there are a number of other considerations, not least the fees associated. While complexities exist, facilitating it should be standard fare for the experienced Sipp operator. For the adviser, property investment should not be shied away from as it offers an opportunity to demonstrate added value to the advice service, especially when there is talk of greater disintermediation through more online direct-to-market investment propositions. An important aspect is selecting a Sipp operator that has the necessary experience to support the adviser and their clients through the process.

Robert Graves is head of pensions technical services at Rowanmoor Group