SIPP It and See… Part Two: Why Commercial Property Investment doesn’t need to be a game of chance

We’re approaching the time of year when families get together and inevitably the board games come out. Monopoly is always a favourite of mine. My strategy is to acquire as much property as I can and sit back and watch the rent roll in from the other players. If only real life was as easy as the game, I would be a billionaire by now!

Commercial property investment can offer great opportunities for investors but, in the real world, it’s not quite as easy as a board game and comes with its own unique set of considerations. Investors wishing to enter this sector will need the advice of not just their IFA, but also the legal support of property lawyers and the technical knowledge and guidance of property surveyors working together to get them the best result.

Last month, in the first part of this article, we looked at how Progeny can help clients to set up a Self-Invested Personal Pension (SIPP) for commercial property investment. In this, part two, we will be looking at the pros and cons of commercial property investment and how the Progeny Group is uniquely structured to support clients in their aspirations in this area.

The benefits

A good commercial property investment can return regular rental income and offers good scope for capital growth as the value of the building increases over time.

Investing in commercial property allows investors to diversify from their standard portfolio and presents a way of providing returns beyond equities and bonds. A good commercial property investment can return regular rental income and offers good scope for capital growth as the value of the building increases over time. This potential for strong capital growth makes investing through a pension an attractive option. As property is ordinarily held for a significant length of time, longer than other pension assets, there’s a greater capacity for making large gains. The yield on property can also often be higher than the dividends from funds and equities.

Another of the key advantages is tax efficiency. As with all pension funds, when the holder of their company makes a contribution, they will receive tax relief from HMRC. If these funds are then used to acquire a property, the price of the property is effectively being subsidised by the tax relief the pension holder receives from the Government. If the property increases in value, as pension schemes don’t pay capital gains tax, this increase would not be taxed following the sale of the property. Paying the rental income from the property into the pension fund also means it can be reinvested to grow tax-free in the fund.

The opportunities for owner-managed businesses

An attractive option for owner-managed businesses is buying their work premises through their pension and renting it to themselves. This allows them to pay themselves rent in a tax-efficient manner.

An attractive option for owner-managed businesses is buying their work premises through their pension and renting it to themselves. This allows them to pay themselves rent in a tax-efficient manner. It can also be an effective way of freeing up cash to invest or use as working capital elsewhere in the business. In cases where the property is initially owned by the company, or the company directors personally, using pension funds to buy it can also be a way of releasing cash back to the individual or the company, as the money would be paid from the pension scheme as cash in exchange for the property.

Buying commercial property through a pension also offers a level of protection. A property held in a pension scheme is considered entirely legally separate from the pension holder or his or her business. If the business or the pension holder fall on hard financial times, the property remains protected from creditors. This can be a way of helping businesses or business owners manage risk.

Things to be aware of

There are many benefits to investing in commercial property but it’s important to be aware of what you’re entering into as it can be a minefield for the uninitiated, and is not to be taken lightly. This is where it’s particularly vital to have the right financial, legal and property expertise at hand to ensure you are protected and that your investment has the best chance of delivering what you want from it. Here are some of the areas you’ll need to consider:

Costs – As with any property purchase, there is always a risk that the sale may fall through, with all the lost sunk costs that this entails. Anyone wishing to invest in a property via a SIPP can add the further costs of setting up the SIPP to these lost sunk costs if the purchase of the property hits the buffers. Once acquired, managing the property can be expensive and the costs associated with it can quickly mount up. These include maintenance of the building, legal fees for drafting leases and the cost of marketing the property and finding new tenants, amongst others.

Liquidity – If you can’t find a tenant for your property and it lies empty, or there are rent arrears, this could lead to a liquidity crunch. If it’s purchased through a pension, this lack of regular rent could result in the investor having to make contributions into the pension themselves.

Selling the property – Property can also take time to sell. As an investment, it’s different from other options in that it’s not always possible to sell a part of your holding in the way you can with, for example, funds or equities. This may cause problems if the investor wants to take benefits from the investment or when they die.

Strength of the covenant – The important thing from an investor’s point of view is that they have a steady income stream from the property. Landlords-to-be will need to assess the covenant strength of a potential tenant – i.e. their financial stability and profitability – before renting out a commercial property. If it’s not a strong covenant with a good trading record, is there a guarantor in place? If the tenant encounters financial problems, this can help protect the landlord’s income.

The lease – When letting the property, the lease needs to be examined closely to ensure there are no gaps or oversights that would leave the landlord/investor vulnerable. It’s also important to know what term the lease is for and if and when there are any tenant break clauses.

Rent reviews – An investor will need to know how regularly the rent can be reviewed on the property, (typically every 5 years) and on what basis? For example, is it reviewed to open market value or the Retail Price Index or is there a fixed schedule of rent increases? The investor needs to know the details as this will be providing their income stream.

Repairing obligations / reinstatement provisions – What are the obligations of the tenant concerning repair and decoration of the property? A full repairing and decorating obligation commits the tenant to doing this but if this is limited by a schedule of condition the tenant doesn’t have to return it to any better state of repair than it was in when they entered into the lease.

The reinstatement provisions should require the tenant to remove any alterations they have made to the property, to remove their fixtures and fittings and to hand the property back in the same state they entered it or better. If a tenant isn’t required to do this, it becomes a cost for the landlord to meet.

Successful investment in commercial property demands not just the expertise of financial advisers, but also of the legal professionals and surveyors who specialise in this area. Providing an exceptional service for clients means looking beyond the investment element and considering all of the wider issues and how they relate to one another.

At Progeny Group we pride ourselves on this joined-up approach: the right investment advice from Progeny Wealth, along with legal support from Progeny Corporate Law and a network of property advice to tap into from the surveyors and relevant property sector professionals. We start by thinking about what the client is looking to get from their investment and provide the tailored support to help them achieve this.

With the right approach, investment in commercial property never needs to be a game of chance. If you would like some help in understanding your options for investing in commercial property, please get in touch.

Please remember that the value of investments and income from them may go down as well as up and you may not get back the amount originally invested.

This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and the value of investments can fall as well as rise. No representation is made that the stated results will be replicated.

Alex Shaw

Associate Director, Wealth

Alex joined the company that would become Progeny in August 2008.

Learn more about Alex Shaw