Commercial property is a popular alternative asset for investors seeking long-term returns in a self-invested personal pension (Sipp). The commercial property market offers compelling yields, often in the region of 6 per cent to 10 per cent, and plenty of tax advantages for investors. “It’s always been the cornerstone of the bespoke Sipp market,” says Gareth James, head of technical at broker AJ Bell. “Investors like the tangible nature of bricks and mortar as an asset, and benefit from rental payments boosting their retirement pot.”
However, the golden rule, as with any investment, is to do your research before investing and, given the complex nature of this form of investment, seek professional advice. As with all other investments, there is no guarantee of returns, and there are particular pitfalls to beware of when investing in commercial property.
The appeal of commercial property
You can hold any physical UK commercial property as an investment directly within a Sipp, including offices, shops, pubs and hotels. However, Sipps typically invest in industrial premises, such as warehouses or industrial units.
Claire Trott, chair of the Association of Member-Directed Pension Schemes (Amps), says: “People who are used to dealing with the commercial property sector in their professional lives tend to be the ones who buy an entire property using their Sipp as they understand the issues surrounding it, and the market.”
Alternatively, you could invest in your own business premises, effectively turning this into a pension fund. Any rental payments are paid into your pension instead of benefiting a third party. “We see a huge range of different businesses buying their premises in this way – including solicitors and accountants,” says Mr James. “It’s not restricted to a particular business type and accounts for about 50 per cent of our investors in commercial property within Sipps.”
By holding your business premises in your pension, you may be able to use your pension savings as a source of business funding. Whether you are buying a property for your business to occupy, or as an investment that will be rented to a third party, there are several tax advantages.
Justin Modray, director of Candid Financial Advice, says: “You are likely to have received tax relief on the contributions you’ve already paid into your Sipp and there is no tax on rental income or property value growth within the pension.”
Selling a property held in a Sipp will not trigger capital gains tax (CGT) because any growth in the property's value belongs to the pension, rather than to yourself or your business. Pensions are not subject to CGT.
The value of your Sipp can also be passed on to your heirs outside of your estate for inheritance tax (IHT) purposes. This makes holding a commercial property within a Sipp a potentially attractive way to leave money to your family, who may be able to draw a tax-free income from this after your death.
The cost of buying a commercial property tends to mean it is the only asset investors hold in a Sipp, at least to begin with. However, the hope is that a surplus of rent will build up after any loans are repaid, enabling the investor to invest in other assets over time.
“But investing in any type of commercial property via a Sipp is a complex area,” warns Ms Trott. “Investors need to get advice, and use a good Sipp administrator and a knowledgeable commercial property/Sipp solicitor – people who understand the structure of this type of investment.”
Buying a property with your pension
There are several ways to buy an entire commercial property using your Sipp. You can purchase the property using money in the pension fund or, for example, if you already own the property through your business it could be sold to your Sipp to release cash back to the business. However, sale and purchase costs, including CGT and stamp duty, will be incurred.
If you need to borrow to fund the purchase of a commercial property, the Sipp can get a commercial mortgage, typically from a high-street bank. You can borrow up to 50 per cent of the value of the Sipp, with the loan repaid by the rental payments from the property. This restricts the value of a commercial property to £300,000 if you have, for example, £200,000 in your Sipp.
However, you can contribute up to 100 per cent of your earnings into a Sipp, up to a maximum of £40,000 in the 2019-20 tax year. You can also use carry forward to use your annual allowance from the previous three years, potentially contributing a maximum of £160,000 in a single year. This could boost your buying power over time.
You are also able to split the purchase of a single property between several Sipps. “For example, a family may club together to invest in a property, or a group of company directors could buy their business premises,” says Mr James. “But in this case, you have to be sure that you won’t fall out with the people you are investing with – managing a property with people you don’t get along with is not going to be pleasant.”
Security against any loan defaults comes from the value of your Sipp or the property, rather than your business or other personal assets.
Commercial property pitfalls
There are various complexities to take into consideration before using a Sipp to invest in commercial property. If the property falls in value or there are void periods, your Sipp may substantially fall in value. Property is also an illiquid asset – less easy to buy and sell than investments listed on public markets.
“Commercial property can add useful diversification to an investment portfolio, particularly for investors looking for income," says Danny Cox, chartered financial planner at Hargreaves Lansdown. “But this sector is not without risk. Property is less liquid than equity investments, meaning it is not as easy to trade. Anyone who has ever tried to buy or sell a flat or house knows that these transactions take time and can be costly.”
You also pay fees and charges on top of the typical costs involved in buying a property, which could potentially see you out of pocket by a greater amount if a purchase falls through. “You’ll need to factor in expenses when buying a property, including stamp duty of up to 5 per cent, legal and conveyancing costs, and potential additional Sipp administration charges,” warns Mr Modray.
You need to guard against void periods when you might not have a tenant, as this could have a dramatic impact on your pension pot. “It’s vital to understand the local market when you buy a commercial property," says Ms Trott. "If you put everything into the property and borrow on top of this, but it ends up empty, you won’t be able to pay the loan back and will be forced to sell the property to pay the bank back. Investors [in commercial property] should get all the professional advice they can, and try not to overgear.”
Getting professional advice will help you understand exactly what you are buying and where the returns will come from, so you avoid ending up with your Sipp dominated by a large, single asset that potentially stops paying tax-free income and could be extremely difficult to sell.
Mr James warns against holding commercial property in a Sipp to prop up a failing business. “You would be putting all your eggs in one basket,” he explains. “ If your business fails and the property is empty you’ll still have to pay business rates and administration charges to the Sipp provider, and there can be significant tax charges to pay if your business can’t pay a commercial rent.”
Other ways to get commercial property exposure
Conventional investment wisdom suggests that you should avoid relying on a single commercial property to fund your retirement. That’s unless you are an expert in this area, or have taken all the necessary advice, fully understand your investment and have plans to invest in other assets in the future. Typically, however, this involves more risk than most investors would be comfortable with.
But commercial property can be a portfolio diversifier because it behaves differently to other assets you might have exposure to within a Sipp, such as bonds and equities. And there are other ways to get exposure to it.
You could, for example, invest a small portion of your pension in a commercial property fund. Rather than being focused on a single commercial property, the money invested would be spread across dozens of different properties and potentially able to take advantage of a variety of trends in the market. But whatever type of commercial property fund you invest in should only be held as part of a widely diversified portfolio, as no one can say for certain what the future holds for the property market.
Shakhista Mukhamedova, divisional director of fixed income and alternatives at wealth manager Brewin Dolphin, says that there are several trends within commercial property with the potential for compelling returns. “We have been focusing on the sectors with the strongest rental growth and which are the least cyclical, so they do not depend on how the economy is performing," she explains. “One example is student accommodation, which we invest in via a specialist property fund. This strategy specifically targets locations with favourable supply/demand dynamics, and has the potential for stable rental growth throughout the business cycle.”
There are plenty of commercial property funds to choose from, but there can be problems with holding illiquid assets such as commercial property, which cannot be easily bought and sold, in open-ended investment funds. It is far harder to sell an industrial unit, say, than a share or bond. So, for example, if many investors suddenly want to sell their holdings during a period of economic instability the commercial property fund's managers may be forced to use their cash reserves to meet redemptions or stop withdrawals.
“When considering a physical property fund always check to see if it has at least a quarter of its assets in cash and shares," suggests Mr Modray. "Otherwise, if investors head for the door the fund may have to temporarily close its doors while it sells properties [to reimburse the investors taking their money out of the fund], which can take many months.”
Alternatively, real estate investment trusts (Reits) and other closed-ended property investment trusts can be held in Sipps. Reits are essentially listed companies that make property investments, but instead of holding a share of the underlying holdings, the investors in them own the Reit's shares. The Reit's shares are traded on a public exchange, so should be relatively easy to buy and sell. Likewise, with property investment trusts, you also buy a share in an investment company that buys property rather than a property portfolio.
Mr Cox suggests TR Property Investment Trust (TRY). “TR Property has been managed by Marcus Phayre-Mudge since 2004 and is invested in a mix of property-related shares and physical property," he says. "It has a dividend yield of 2.9 per cent and is up an impressive 96 per cent over the past five years [to 27 November].”
AJ Bell suggests getting exposure to commercial property via a low-cost exchange traded fund (ETF) such as iShares UK Property UCITS ETF (IUKP). But this does not invest in physical property – rather it invests in the shares of UK-listed property companies and Reits.
