Bricks and mortar investments look compelling against a backdrop of struggling markets but choosing the right vehicle is crucial
With continued turbulence in the markets, there is an increase in the number of clients discussing commercial property investments with their advisers.
You can see why clients can perhaps more easily understand investing in bricks and mortar, and that it provides them with a comfort the investment actually exists.
With low inflation and interest rates, the yields on property can also be very compelling.
We all know the advantages of using a pension scheme to purchase commercial property, but it is vital the client keeps in mind the prime purpose is to provide for their long-term financial needs in retirement, and those of their family.
This is because commercial property ownership is not without its risks. These risks can range from a lack of diversification through to tenancy voids where, without the rental income, the property becomes a liability and, in some cases, has to be sold.
When looking at which Sipp provider to partner with, there are a number of other considerations.
There are the obvious provider due diligence questions, such as financial strength, ownership structure, robustness of procedures and so on.
But there are also questions around property block insurance, solicitors and VAT. So let’s take a look at those in more detail.
First of all, will the Sipp provider allow your client to choose the solicitor for a commercial property purchase or will they insist on a panel solicitor?
This is a really important decision as the solicitor will be acting on the client’s behalf and reporting back to the Sipp provider on the transaction.
While the client may prefer to use a solicitor’s firm they have hired previously, it is important it has the relevant experience when dealing with a commercial property purchase through a Sipp. Cheap could turn out costly in the long run.
Then there is the use of a mortgage to fund a purchase. The maximum level of borrowing by a client’s Sipp is 50 per cent of the net asset value of the Sipp and secured against the purchased property or other assets of the pension scheme. Some Sipp providers have now removed the ability to use borrowing, even though it is permissible under current regulations.
If a client wants to use borrowing, then looking for a provider that will consider any reputable commercial lender or borrowing from a third party will be important.
The loan is usually based on a capital and interest basis, although sometimes just interest only. This ability to fund a property purchase within a self-invested arrangement can be very useful.
Advisers can add even more value for clients in this area by having an understanding of the implications of VAT.
This is very complicated, as a property is either “subject to VAT” when built (for example, many new buildings are usually automatically registered for VAT) or can be “elected for VAT” (such as for development work).
If you and the client decide to register the pension scheme for VAT and opt to tax the property, this will enable them to reclaim any VAT on the purchase price. This will need to take place before the property is purchased. Similarly, if the client is developing or refurbishing the property within the Sipp, any VAT incurred may also be reclaimed.
Opting to tax means that VAT will be chargeable on the rent paid and, to complicate the administration, quarterly VAT returns will also be required.
This is a decision that needs to be made carefully, as VAT will also be chargeable on the sale price when the property is sold. Advice is therefore imperative.
If the client gets the VAT status wrong, it can have major tax implications. Many advisers choose to work with a VAT specialist if there is not one within their business.
Finally, there is the issue of insuring and managing the building once it is purchased. We often hear from advisers that their clients have not necessarily thought this through.
In many cases, appointing a property manager makes sense. In fact, some Sipp providers will insist on one being appointed.
They will undertake a number of functions, from insurance through to monitoring the property.
Insurance is an area that has received media coverage recently, with some Sipp providers being criticised for not having adequate cover within their block policies.
Good providers will have adequate insurance in place, but it is important you and your client are aware of the cover, whether it is taken out with the client’s chosen insurer or under the Sipp provider’s block insurance.
David Fox is director of sales and marketing at Dentons Pension Management