Putting property into Sipps

Many people were disappointed when chancellor Gordon Brown performed a U-turn on his plan to allow buy-to-let investments to be held in Sipps. However, rules introduced in 2006 allow investors to get direct exposure to residential property through their pensions, either by investing through syndicates or by focusing on certain exempt sectors.

Residential property

The exempt sectors are: student halls of residence, nursing homes, hospices, prisons and hotels. Alternatively, you can invest in any residential property using a syndicate arrangement, subject to strict rules.

Syndicates must have a minimum of 11 members so that no one person owns 10 per cent or more of the property. A syndicate must also hold at least three properties or be worth a minimum of £1m. And, in order to be "a genuinely diverse commercial vehicle", no one property can account for more than 40 per cent of a syndicate's assets. Whether you are investing through a syndicate or directly, you must not make personal use of the properties.

So this leeway to invest in residential property through Sipps could be good news for investors who had hoped to hold buy-to-let investments inside their pensions.

Stuart Law, of property manager Assetz, points out that because student halls are among the exempt sectors, syndicates that focus on them will not have to stick to the rules explained at the start of this article. He says these types of syndicates will typically have between five to 20 members and will require a minimum investment of around £25,000 each.

Risks

But a restricted syndicate must be shown to be run by its members, not the promoter, or there could be harsh consequences. "If a syndicate were deemed to be an illegal fund, the person running the syndicate could be in a very sticky situation," says Mr Law.

To get around the problem, Assetz uses online voting to ensure democracy. The company has already established a secure legal structure for syndicates, developed for its commercial property syndicates. But for groups of private investors who band together to set up their own syndicates, it might be more risky. You would definitely need the help of a good lawyer.

Ronnie Ludwig, of accountant Saffery Champness, says another risk with syndicates is the timing of exits, as some people might wish to sell their stakes in order to start taking their pension benefits, while others might be keen to remain invested. He notes: "Their aims and ambitions could be radically different and that is a recipe for trouble."

Clear rules on exiting the syndicate should therefore be established at the outset. It might be simpler for a syndicate to have a fixed lifespan, as finding someone to buy your share of a property syndicate could be difficult. On the other hand, it is now possible to sell shares in property investments from Sipps to "connected parties". This should make life a little simpler than under the old pension regime, where property investors were prevented from selling their pension holdings on to business associates, friends or family members.

Even so, it may still be safer to invest in syndicates that are being promoted by property companies, rather than attempting to set up your own structures – especially as an incorrectly-structured syndicate could fall foul of Her Majesty's Revenue & Customs (HMRC), which could lead to a severe tax penalty. Either way, though, your investment will not be regulated by the Financial Services Authority. So if there were problems with the syndicate, or the promoter, you'd have no redress from the Financial Services Compensation Scheme.

As Fergus Lyons, of Sipp provider AJ Bell says: "It could be a risky game, there's no question."

Neil Young, of property manager Young Group, also notes that property is "the largest asset class out there that's not regulated".

That said, Sipp providers do have fiduciary duties as trustees and can turn down investments they are not satisfied with. Charles Staveley, of lawyer Mills & Reeve, says: "The Sipp providers I see are very sensible, level-headed individuals who would want to know as much as possible about any investment before they allowed it."

Investors should also be able to use syndicates linked to reputable property companies.

Meanwhile, Claire Madden of Hotbed, which offers investors packaged units of commercial property and private equity, says: "Never say never, but we're focusing on our two main areas of expertise at the moment."

Tom McPhail, of Sipp provider Hargreaves Lansdown, notes that syndicates could be cheaper and simpler than direct property investment. All costs will be included within a syndicate and covered by the initial investment, whereas making direct investments entails a range of charges.

Gearing

Using syndicates will also allow investors to increase the levels of gearing (debt) on their property investments. Gearing enhances returns but adds risk – for example, if a property is untenanted for a while, interest payments could cripple a syndicate.

But the level of gearing allowed for Sipps was reduced when the new pensions regime came into force on 6 April. Until then, it was possible to borrow up to 75 per cent of the value of a commercial property investment, whereas now it is only possible to borrow up to 50 per cent of your Sipp's value. Mr Young notes that there was "huge demand" for commercial property in the first quarter of 2006 from Sipp investors keen to use the more generous old rules.

Syndicates are able to borrow on commercial terms, though, which is normally up to 85 per cent of the value of a property transaction. Peter Weir, of Sipp provider Suffolk Life, points out that investors could borrow up to 50 per cent of the value of their Sipp to boost their investment in a property syndicate, which could then gear up again. He adds that 50 per cent gearing on Sipps is also possible for other types of investment, provided you can find a willing lender.

Unfortunately, HMRC could take a dim view of high levels of gearing by DIY property syndicates. Ms Hallett warns that HMRC could look through the gearing on syndicates put together by IFAs for their clients, taking the view that such structures are designed to abuse the rules on gearing levels.

She also warns that gearing up to invest in a syndicate can be highly dangerous. "We would err on the side of caution with any proposition of that nature," she says.

Direct property investment

Direct investment in hotels, student halls of residence, prisons, nursing homes and hospices could be attractive, although gearing would again be limited to 50 per cent. Liam Bailey, of property adviser Knight Frank, certainly sees opportunity here, as these areas should perform differently to the rest of the residential property market, affected by the ageing population, rising student numbers and rising prison sentences.

Mr Bailey explains: "People are interested in residential but they realise the easy money's already been made – you've got to work harder to find the right sector or location that's going to outperform the average." And in these sectors, even though the chancellor is keen to encourage investment, there should be no risk of oversupply, according to Mr Bailey. He says: "The safety net in the UK is the planning system – you've got to prove a demand."

But Mr Law points out that syndicates and individuals should not be investing in student flats on a buy-to-let basis. Instead, they should be buying large blocks, which can be managed. Retail investors may even have an edge over institutions here, as fund managers find it hard to invest in residential property because it is difficult to find developments large enough to accommodate the sort of money they would like to invest.

One area to beware of is hotel rooms, though, as staying in them would make them ineligible and expose you to the penalty tax. Although overseas property is treated the same as UK property in terms of the new rules, you should avoid French reversion schemes as well, as these would be treated as direct, unexempt residential investments and penalised accordingly.

If you are interested in taking advantage of the new rules on residential syndicates or direct exempt investments, you should seek thorough advice from your IFA and Sipp provider before taking any decisions. A hasty investment, made without sound advice, could prove to be very costly.

Property funds

Instead of investing your Sipp in residential property through a syndicate – or directly, for the exempt sectors – you can also take diversified exposure to residential property through your Sipp by using residential property funds. It has always been possible to hold such funds in your Sipp but far more of these funds are likely to be made available, as interest in property investment inside Sipps grows.

Residential property funds can be open-ended or fixed-term investments and they, too, often use gearing to boost returns. You can also pick generalist funds or funds that specialise in areas such as student accommodation or retirement homes.

For example, Assetz offers a generalist UK residential fund (requiring a minimum investment of £5,000) and is also launching a limited fund investing in property development (£50,000 minimum). Residential property funds are unregulated, though, and must be bought through IFAs.

You have more options when you invest in commercial property inside your Sipp. Commercial property syndicates and limited partnerships allow highly-geared investment. And several Sipps can club together as informal syndicates to buy commercial properties, sharing the transaction costs and using gearing of up to 50 per cent of each Sipp's value.

Professionals can even buy their own premises through their Sipps and are allowed to use the properties – rent must be paid to the Sipps, but can be set against tax. Under the new pension rules, you can invest up to 100 per cent of your income in a Sipp every year (capped at £215,000), allowing you to boost your pot to enable a property purchase.

Alternatively, a simpler approach to investing in commercial property is to use mainstream commercial property funds. This route means that you need not run the risk of having your Sipp portfolio dominated by a single asset class, which can be a danger of buying direct property in your Sipp.

Investment trusts can use gearing, but open-ended funds cannot.

Alternative assets

Another area where investors were disappointed by the chancellor's backtracking was alternative assets, such as art, wine and classic cars. These were to be allowed in pensions, but then it was announced that they would be taxed punitively, in the same fashion as direct investments in (non-exempt) residential property – up to 70 per cent, in other words.

However, it has now transpired that it should be possible for syndicates investing in alternative assets to be held in Sipps, provided they meet the same criteria as those for residential syndicates. The only alternative asset that HMRC will not countenance through syndicates is racehorses. Alternative asset funds can also be held inside Sipps. Gold can be held directly through Sipps, provided it is of a tradeable standard.

But be careful about investment in shares of your own company, if you are a director. If your stake in a company is greater than 20 per cent, your investment could be taxed at up to 70 per cent by HMRC.

Mr Weir warns that the greatest danger is unquoted shares (which are eligible for Sipps), as these are the smallest companies and so it is possible to hold larger stakes. A particular area of concern is that family holdings can be lumped together with yours, which could take you over the 20 per cent level unwittingly.

Cash

Investors often forget to check the rate of interest paid on cash held in their Sipps, but this could have a significant impact on your returns.

Even if you do not see an investment case for cash within your Sipp, it is likely that you will hold cash at times, prior to making other investments.

It is hard to earn good interest on cash in Sipps, though. Paul Hoban, of IFA Bestinvest, says: “Trustee cash doesn’t seem to be able to obtain the same kind of rates as pure deposits. It’s been a consistent problem.”

Luckily, you do not have to stick with the cash account offered by your Sipp provider and can ask for your cash holdings to be outsourced to another Sipp cash account.