Low interest rates, gilt yields and annuity rates, stock market uncertainty and an ageing population are putting increasing pressure on pension schemes. Defined benefit (DB) scheme deficits prevail, with some reports suggesting there is only a 50:50 chance of a DB scheme delivering its promise.
These things are a big concern to many. A DWP consultation, Security and Sustainability in Defined Benefit Pension Schemes, is in progress and might potentially allow schemes in difficulty to alter their benefits promises.
Higher transfer values are also adding inflows into already huge money purchase schemes and, with retirement flexibility and attractive death benefits, more people are taking responsibility for their own retirement income. Investing in commercial property could be a partial answer to the problem.
Before retirement, people are increasingly caught by the £40,000 annual allowance cap, £10,000 tapered annual allowance and money purchase annual allowance at just £4,000 a year. Rental income to pension funds is outside annual allowances. Is it a way to get excess contributions in?
In retirement, many do not want to risk the volatility of markets or like being locked into low annuity rates or low cash-based returns. However, they still want inflation-hedged growth and sustainable income after they have stopped working. In the words of Mark Twain: “Buy land, they’re not making it any more.” Property is benchmarked to the economy, interest rates and inflation, so provided you secure the right commercial property, it might be an income winner.
Tax breaks
There are plenty of tax reliefs available with this asset class, including the usual income tax and corporation tax relief on contributions, plus capital gains tax-free growth and no taxes on rental income to the pension fund. My pension fund owns offices, with my limited company as the tenant.
My company pays rents to my fund without any annual allowance restrictions and with the bonus that those rents are offset to corporation tax. In addition, the tenancy agreement is a full tenant repair and replace, which means my company funds any repairs, and with upward-only rental reviews my fund has an assured income stream.
It makes perfect sense for advisers, let alone clients, to consider commercial property investment.
Financial advisers should be aware of the above and of the differences between small self-administered schemes (Ssas) and self-invested personal pension (Sipp). However, the table offers a reminder of the similarities and differences between them.
| Ssas | Sipp | |
| Occupational scheme rules | Personal pension scheme rules | |
| Usually directors/employee members of the sponsoring employer | Private, personal scheme, but can accept employer contributions | |
| Notional share of the pension scheme funds/assets | Scheme in your name, but multiple Sipps can buy assets together | |
| Loans allowed to sponsoring employer | No loans to connected parties (people or companies) | |
| 100% of fund value can be invested in unconnected company shares, 5% of fund value can be held in sponsoring employer shares with no more than 20% of total fund value (at time of share purchase) in a range of sponsoring employers | 100% of fund value can be invested in company shares, including connected companies, but cannot own 100% of a company if that company is member-controlled, nor usually have more than a 70% of the fund in any one company share subject to Sipp manager approval | |
| Commercial property, not residential | As per Ssas | |
| Can borrow up to 50% of the fund value as a pension mortgage | As per Ssas | |
| High/more complex administration involvement for member trustees | Lower administration burden, but Sipp manager must approve investments |
With commercial rental yields of about 8 per cent to 10 per cent a year, this makes it an inflation hedge as prices rise. And with commercial property prices quite low, now might be a good a time as any to consider property, not just for clients, but also our own portfolios.
That said, you cannot simply rush out and buy the first commercial unit you find. You need to take many factors into account when assessing a suitable purchase.
Location obviously has some impact, but take a walk down some high streets and see how many premises are empty. There are clearly reasons why these are not tenanted and that is not just the growth in online shopping or an economic downturn. Below are details of issues to consider.
Rates
Check the rateable values of property locations. Even in a main shopping area, there might be an unseen local authority boundary. For example, on my local high street, properties in the centre have much higher rates than those at the end of the road, opposite a car park with good footfall.
Covenants
Beware of covenants attached to the property. Check if there are any restrictions; for example, that you cannot run a public house or – one I saw – that you cannot run an insurance brokerage on the land. Find out if restrictive covenant indemnity Insurance will need to be arranged before any property purchase can proceed.
Planning permission
Is the property listed or will there be issues relating to any planning permission or change of use applications with the local authority?
Land
Local authorities and utility groups publish land for sale lists online. There could be pension-build opportunities, where lower construction costs might mean profit on a sale or tenancy. You could buy village shops or village pubs. Is there an opportunity for community Sipp projects?
VAT
It is important to check whether the vendor is VAT registered and whether the sale price includes VAT. Is there significant improvement or refurbishment costs that could lead you to consider opting to tax for VAT for the property, then reclaim it on refurbishment costs? If that is the case, rent and any future resale price must include VAT.
Pension mortgages
Borrowing up to 50 per cent of the existing fund value will increase the range of commercial properties that can be considered. This might be easier than expected, as most banking groups have business managers and commercial lending for pension funds.
Expect interest rates linked to base rates – for example, 4 per cent over base – as well as application fees and the usual affordability underwriting of the property for rental income potential. The tenant business viability/ability to continue to afford rents.
Surveys: Given that a commercial property may be used by tenants, employees and the general public, all the usual surveys will be required. However, pension scheme managers may require additional surveys such as asbestos, damp and mining surveys, mundic tests, gas and electricity test certification.
Legal: The pension fund must be run at ‘arms-length’ to the member. The pension fund will need to appoint its own team of solicitors, not just for the purchase but also for any tenancy agreement. It could be that you are paying two or even three sets of legal fees: one to represent your pension fund, one to represent you if your business is the tenant and another for the pension scheme plan manager.
Liquidity and potential resale: Property is illiquid, so some thought needs to be given to the need for resale or income stream. The points above will affect this, but my rule of thumb is to also have a ‘Plan B’.
Is there potential to secure planning permission for rooms to be converted from commercial to residential? While the pension fund cannot own residential property, would selling with planning permission improve resale potential? One of my properties has a nice address and location perfect for easy, overnight conversion potential to office space ‘hot desk’ pods, ideal for start-ups or one-person business operations and consultancies that may prefer a commercial set-up rather than home office. I already have my Plan B ‘business plans’, domains and business names should I need them.
Ashley Clark is director of financialadvice.net
