Investors are increasingly buying commercial property with their pension funds, both in the UK and overseas, to take advantage of the tax breaks on offer.
Interest in commercial property investment has picked up in recent months following a bottoming out of prices at bargain levels. Investors have flooded back into retail funds, while institutions have also been snapping up prime properties.
Some investors are now opting to gain direct access to commercial property by putting it into their pension plans. Individuals can invest in commercial property – such as retail shops, business premises or industrial units – through a self-invested personal pension (or Sipp) – although residential property, including holiday homes, is not allowed.
Investing in property through a pension offers a number of benefits. Tax relief on pension contributions can help subsidise the purchase of a property in place of a mortgage or other lending arrangement. Sipp rules also allow people to borrow up to 50 per cent of the value of the fund to make an investment.
Once a property is held within a pension fund, there is full tax relief on gains within the fund, while rent is paid to the pension free of tax. If the property is sold within the pension scheme, it is not liable to capital gains tax.
Buying commercial property in a pension is also becoming a popular move among high earners, who now face restrictions on their pension contributions, advisers say.
John Lawson at Standard Life says that because rent from a property is paid back into the pension fund, this creates extra pension income that is treated as an investment return and so not counted as a pension contribution.
Most investors who choose to invest in commercial property through their Sipps are entrepreneurs or small business owners who want to put their own business premises into their pension for tax reasons.
During the recession, this has been a particularly popular move as a way of freeing up capital at a time when loans are scarce, Lawson says. The pension fund can borrow money to buy the property, and the cash is then distributed to the business owner for use elsewhere in the company.
High earners who now face limited contributions can phase in the purchase through a joint ownership structure, allowing them to transfer parts of the property at a time and avoid going over their limit. John Moret of Suffolk Life, a Sipp provider, expects this to become more common with business owners.
Fees for investing in property through a Sipp vary widely (see table). Some charge an upfront flat fee along with annual management charges to cover expenses such as valuations. Others charge on a time-cost basis, while some also have a property purchase fee in case the Sipp provider needs to organise a mortgage for the investor.
Matthew Ward at independent analysts Defaqto says investors should check first with their Sipp provider what the rules are regarding financing the purchase from the fund.
Investors who want to use their own solicitor or mortgage provider will also have to check with their pension provider, as some insist on using their own partners.
Different providers will have different rules on borrowing, what mortgage options are available and also what types of property they allow investors to buy.
Many lenders, for example, do not allow property outside the UK to be held in a Sipp because of the extra paperwork involved. Hornbuckle Mitchell, the specialist Sipp provider, is one of the few to allow investment in overseas commercial property.
But French commercial property is set to become a more accessible option for pension investors in the UK, with a change made in French law in March to recognise trust-based schemes.
Most Sipps are written on trust and can invest only in countries where this structure is recognised. Spain, for example, does not recognise trusts in law, making it difficult for investors to buy property in their pension there. Rowanmoor Pensions, a Sipp provider, believes the French ruling could open the floodgates for UK investors to put assets such as hotel complexes in Cannes into their pension fund.
Rowanmoor says its clients have so far bought hotel complexes in Cape Verdi and the Caribbean, and are showing growing interest in other areas such as Egypt.
Investing overseas tends to be more expensive as there will be two sets of legal fees. Currency fluctuations are also a factor to consider.
However, while the fees for commercial property investment can look steep in some examples, Lawson of Standard Life points out that £1,000 a year on a property worth £400,000 is “tiny” in comparison with annual fund management charges paid out to fund managers.