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Commercial break

Life is not easy for investment advisers on Sipps and SSASs. Their recommended equity investments have dropped significantly in value, their cash deposits are earning 4 per cent – if they are lucky – and their fixed-interest investments have performed well but are not the place

for new investment if rates look like rising. As clients continue to make contributions, where can liquid cash go?

“No more equities,” the client will say and “Can&#39t you find me something more interesting/profitable than cash on deposit?”

The obvious alternative is property. Residential property is largely excluded as direct investment is not allowed and there are few residential collective investments available. So why not look at commercial property?

Commercial property partnerships generally buy quality commercial property costing upwards of £15m, with London office blocks costing up to £80m. The partners consist of personal and pension fund investors, the latter investing through a specially arranged UK exempt unit trust. This mechanism avoids any problems which could be associated with the maximum lending restrictions contained in pension legislation.

The partnership borrows up to 85 per cent of the purchase price on what is known as a non-recourse basis. This means that the investing partners are not personally liable for the bank loan and the bank only has the property itself and the rental income stream as security for the loan.

Typically, the tenant will be in the blue-chip category, for example, Sainsbury, B&Q or a large professional practice, and leases run for 20 to 25 years with five-year, upward-only rent reviews.

The two principal questions of investment are what is the upside and what is the downside? Let us look at the latter first.

The investor puts in a cash sum – usually between 15 and 20 per cent of the cost – and it is possible to lose all this. But how? Well, it is possible that the property could fall by 30 per cent in value. If it did, and if investors voted to sell at that time, they would lose all their cash investment but no more, since the bank has no call on them personally.

But why should a partnership sell if it cannot do so at a profit? If it has a good tenant who continues to pay rent, it would be better advised to hold the property and wait for a recovery in prices. The interest rate on the loan is fixed and, taking a very long-term view, over 20 or 25 years, the loan should be totally repaid from the rent and the investors should be left with a valuable, unencumbered property.

Most property partnerships sell after five or 10 years when they are showing a profit after the first or second rent reviews. The worst case is if the tenant goes bust and the property cannot be let. Even then, the most that can be lost is the cash investment. This illustrates how important the tenant&#39s covenant can be as, provided the tenant pays the rent, the downside risk is minimal.

Having looked at the most gloomy scenario, let us look at the upside. This is considerable and unlimited, which is only to be expected with gearing of five to seven times.

It is perhaps easiest to look at an example. This is taken from a recent actual purchase of a B&Q retail warehouse for £19m at a yield of 6.75 per cent, with 86 per cent gearing.

The table below gives an indication of the annual returns which are possible on different assumptions. The variables are the rate of rent

increase and the purchase yield – that is, rent divided by capital value – at which the property is sold. The advisers to the partnership – a leading firm of surveyors – estimate that retail warehouse rents will grow over the next five years at 3.7 per cent a year and a sale at a purchase yield of 6.75 per cent seems a reasonable assumption. Based on a conservative 3 per cent a year rental growth, this provides an annual return of 14.3 per cent on an investor&#39s cash investment.

Generally, a property partnership will be advised when a suitable sale opportunity arises and partners will then be able to vote as to whether or not they wish to sell. Usually, a two-thirds majority is required for a sale to take place.

Although there is no recognised market in partnership interests, it should not be difficult to find buyers at a reasonable price in the event of a sale being required by a Sipp or SSAS on the death of the pensionholder. It would be quite usual for the IFA advising the seller fund to also have other clients who could take on the partnership interest.

Obviously, Sipps and SSASs pay no tax on profits on sale. Individuals do pay tax on capital gains, subject to taper relief.

There must be a case for looking at property partnerships for Sipps and SSASs, if for no other reason than this gives the fund a better balance in terms of asset allocation.

One last thought. If deposits yield 3 to 4 per cent, medium-dated gilts under 5 per cent and inflation is about 2 per cent, how long will commercial property with blue-chip rental returns of 6 to 7 per cent be available in today&#39s low interest rate environment? If investors judge 5 to 6 per cent to be the right yield for this commercial property in future, that gives potential for a substantial uplift in capital values.

Incidentally, property partnerships pay advisers well. Two per cent on the 100 per cent partnership investment can equate to as much as 14 per cent on the cash investment. Combining good advice with profitable remuneration is always a nice position to be in.

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