Pension investors eye up commercial property

Owners of business properties such as shops, offices and pubs, are showing renewed interest in buying their premises through their pension schemes as the collapse in values has thrown up attractive opportunities.

Commercial property prices have slumped by more than 40 per cent since their peak in 2007, according to the IPD UK Monthly Index, but the falls appear to be coming to an end. The latest figures show the shallowest fall in UK commercial property prices for two years. Capital values across the sector edged down by just 0.13 per cent last month, while the retail sector even saw a fractional improvement, with prices up 0.05 per cent in July.

At the same time, the derivatives market, through which investors can speculate on prices, has called the bottom of the commercial property market.

However, commercial rents are still falling, albeit more slowly, and analysts are warning that any recovery in rental income could be some way off.

Standard Life, which now has 1,000 commercial properties held by customers on its self-invested personal pension (Sipp) platform, says that while confidence seems to be returning, it expects further pressure on returns over the next year.

Nevertheless, pension companies are reporting an increase in the number of investors looking to enter the market while asset prices are depressed.

“We are not seeing a huge change in behaviour, in terms of people rushing in, but we are seeing more inquiries from people who are in a position to buy their business property,” notes Billy Mackay, marketing director at A J Bell, a Sipp provider.

He says pension investors have been tracking commercial property prices and are aware of the good deals to be had. “One client, for example, knew his business property was worth £1m and had fallen to £750,000. He is now looking to use his pension scheme to buy the property.”

Business owners who earlier this year were unable to buy their premises because the value of their pension fund had dropped so sharply following the stock market falls are also now looking again at whether the deal would be feasible, according to Mackay.

“People are generally in a stronger position now than they were 12 months ago,” he says. “Some are retesting to see whether the movement in property prices and the recovery in markets means their pension fund is now big enough to facilitate the property purchase.”

Most of the people who buy a commercial property through their Sipp are looking to hold the property in their business in a more tax-efficient way. This has become popular among professionals such as dentists, doctors, lawyers and accountants.

Holding property in a Sipp means the rental income is paid into the pension free of tax. Any growth from the rental income or value of the property also builds up tax free.

This tax benefit – rather than the potential investment return – is the main driver for business owners to purchase their commercial property through their pension.

Another incentive – and one that is becoming more attractive in the difficult economic climate – is that selling the property to the pension scheme can release much-needed cash for the business.

“We have seen an increase in interest from people whose business is in some difficulty,” says John Moret at pensions provider Suffolk Life. “If the pension fund has cash or other investments, buying the property can help businesses that are struggling for cash.”

Malcolm Cuthbert, partner at Killik, the advisory firm, believes there are also good opportunities in the market for non-business owners who are interested in buying commercial property purely for the investment returns.

“Prices have fallen so far and so fast and we are already seeing some compression of yields,” says Cuthbert.

The derivatives market now expects a 0.4 per cent increase in capital values between now and the end of this year, according to Knight Frank. In terms of total returns – which include income from rent and capital value growth – the market anticipates up to 11 per cent annual growth over the next five years.

Average rental yields across the commercial property sector contracted slightly to 7.87 per cent in July, according to the IPD index but are looking attractive for investors. Two years ago, just before commercial property prices started falling, average yields were below 5 per cent.