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Commercial property is a long-term investment and holding it in a Sipp is a tax-efficient way to save. By Annie Shaw

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The commercial property sector, which suffered a battering from the recession, is once more catching the eye of long-term investors looking for solid returns. With fears of a correction in equity markets and investors increasingly nervous about the residential property market, commercial property is arousing renewed interest, particularly among those looking for assets to hold within a pension fund.

This is despite the continuing decline in demand recorded throughout 2010 by the Royal Institution of Chartered Surveyors’ commercial market survey and forebodings about prospects for the economy in general.

Informed Choice managing director Martin Bamford says: “There is never really a bad time to invest in property, assuming it is a long-term investment and you are prepared to hold on to the asset through periods of market volatility. The UK commercial property market has recovered reasonably well over the past three years but there is still value to be had. While this might not be an asset class for excessive bets in 2011, property does remain very important for diversification within a pension portfolio.”

For investors choosing exposure to property, this leaves the choice of how to invest, with options stretching from buying bricks and mortar directly, buying shares in property companies or investing in property funds. Which an investor chooses will, of course, depend on where the invest-ment fits within their general portfolio and their investment timescale.

Those opting for funds can choose unit trusts, open-ended funds, investment trusts or real estate investment trusts.

Holding property directly probably carries the most risk for the inexperienced investor but if it is held within a Sipp it can be an ideal and tax-efficient way for an entrepreneur to provide himself with business premises and retirement saving at the same time.

For those looking for shorter-term holdings, Yellowtail Financial Planning managing director Dennis Hall believes that would-be commercial property fund investors might have missed the boat.

Hall says: “The best time to enter the commercial property market was probably about two years ago, when yields were high and Reits were trading at well below net asset value.

“Right now, there is more supply than demand, so the short-term outlook is less good than the longer term. With the economy looking shaky for the next three years or so, corporate tenants are going to be cautious about their property spend. Only the very best properties and the very best tenants will avoid any serious fallout in this sector.”

Last month, the Association of British Insurers’ quarterly consumer survey noted that the number of people who see property as the best long-term investment had fallen by almost a third in the last quarter of 2010 to its lowest level yet.

While this sentiment is likely to reflect investors’ dependence on the value of their own home or buy-to-let residential property as a basis for long-term saving, those who are now turning to more conventional investment-based pension plans to secure their future will be looking at other property options as part of a diversified portfolio. This particularly applies to those opting for a Sipp, where their own business premises can be embraced by the plan.

Bamford says: “A direct property investment in a pension scheme is usually done for business rather than purely investment reasons, with Sipp property purchase using accumulated pension funds to provide desirable business premises and hold the asset in a tax-efficient manner.”

Hall agrees: “Small businesses owning their own property can still benefit from putting their business property asset into their pension and bigger firms/partnerships can use group Sipp arrangements or SSASs to get round the lifetime allowance restrictions.”

The recent slump could even work in their favour since, if the value of the property to be transferred has fallen over the past couple of years, now could be the perfect time to move it into the pension scheme.

Hall says: “Transfer property in when the capital gain is low and avoid capital gains tax when the recovery really bites. Property ownership within a Sipp also provides a way of paying rent into the pension fund, which is particularly useful when the £50,000 annual allowance is maxed out, as rent does not count towards that.”

Nevertheless, aside for funding one’s own business, direct investment in commercial bricks and mortar can make sense in the right location with the right tenant.

Popular sentiment suggests that excess capacity in the commercial property market could soon be mopped up by the entrepreneurs who, according to the coalition Government’s view of the future, will fill the employment gaps left by cutbacks in the public sector.

While cynics might say this view derives more from hope than anything else, at the end of last year, Deloitte’s annual Entrepreneurship UK survey reported that more than 90 per cent of the UK’s entrepreneurial businesses expected to grow their revenues in the next 12 months, with a similar percentage forecasting double digit revenue growth for their businesses over the next three years and four out of 10 projecting growth to exceed 50 per cent.

Additionally, many businesses such as supermarkets, which deserted town centres for out-of-town shopping centres several years ago, are now returning to our high streets in mini-market form. Similarly, new financial outlets such as the new Metro Bank are opening in high streets while businesses such as retailers that started out on the internet are looking for a bigger bricks and mortar presence, if only for increased warehousing.

It goes without saying that extreme care needs to be taken when choosing a property but there are significant advantages to be had

Hall says: “Pension schemes allow both the rental income and the capital gain to be sheltered from tax and as property is fundamentally an income-producing asset, they are well suited to pension investment, particularly when the pension will rely on drawdown in the decum-ulation phase.”

Investors who want exposure to the sector but do not necessarily want to touch the bricks will most likely be happier with an equity-based vehicle.

Hall: ’Only the very best properties and the very best tenants will avoid any serious fallout in this sector’ for those who make the right choice.

Property company shares are probably best confined to those with an extensive and resilient portfolio in the current climate. While the sector has seen a bounce over the past quarter, key markets such as central London have seen a swathe of new developments, causing a risk of oversupply.

That just leaves funds. When it comes to choosing, Hall is sceptical about the prospects for retail and says short-term investors should steer clear for the time being at least.

He says: “Retail is probably best avoided for now. I would be looking at funds that provide office space for blue-chip comp-anies as well as government contracts. There will be opportunities throughout the coming 12 months to buy into the sector more cheaply than the long-term average. Eventually, we will see yields rising again and later still an increase in capital values.

“Short-term investors should beware but long-term investors should consider entering commercial property rather than trying to time the market. We cap commercial property exposure at 15 per cent for our most aggress-ive investors, from around 5 per cent for our more cautious investors.”

Exposure to commercial property can also come from infrastructure funds. Hall adds: “These invest in enterprises where buildings such as schools and hospitals are leased to the government/local authority, etc, and provide a decent return based on rent and the asset-backed security value.”

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  1. Although generally provided as UCIS, closed ended property partnerships are a great way of investing into commercial and residential property.

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