Following poor performance by my investment funds, should I be investing my pension fund in property?
There is no doubt the property sector has become increasingly attractive following the poor performance of equity markets since 2000.
Property offers the dual benefits of rental income and capital values which usually increase over time.
There are two ways in which you can link your pension to the property market – either by purchasing a commercial property or investing in a property fund run by a manager such as an insurance company.
Taking the direct route, if you have a self-invested pension, you can use your fund to buy a commercial property which can be rented out to a tenant. If you do not have sufficient funds, the pension fund can borrow from a lender and effectively take out a mortgage to buy the property, using the existing pension fund as a deposit.
The self-invested pension can be on either a company or personal basis. Slightly different rules and regulations apply but the principle is broadly similar.
The pension owns the property either outright or via a mortgage and collects rent. It can eventually sell the property. As pensions have tax exemptions, any profit from selling the property will be free from capital gains tax and rental payments are treated as tax-free investment growth.
With a commercial property fund run by a manager, you buy units in a big fund that owns many properties. The fund receives rent from the tenants of the properties and pays out costs for management and refurbishment. Periodically, surveyors assess the capital values of the various properties and any gains or losses are factored into the fund's unit price.
There are pros and cons for each route. Buying your own property gives you more direct involvement and control. If you rent the property to your own business, you can become your own landlord. This is often very attractive but you must remember that it ties the value of your pension more closely to your business and that can be a disadvantage if you ever experience financial problems.
To be able to buy a property, your pension arrangement has to be set up on a self-invested basis and this may involve additional flat fees. There are also all the usual costs involved in buying a property such as stamp duty, legal fees and survey costs.
Individual properties are not cheap and you have most if not your entire pension fund tied up in a single investment, which can be risky.
Linking to a property fund can be done within your existing pension plan and you are free to choose how much exposure you want by adjusting how much you invest. The fund will contain many properties of different types, for example, offices, factories and shops, all over the country. So, in theory, this type of fund will be safer than buying a single property yourself although it will not necessarily give such a high return, either.
Property funds themselves need careful analysis. The best-performing property fund in 2000 was relatively small. Some of its property that was in such high demand then has subsequently fallen in value and the fund returned negative amounts in 2001 and 2002.
Another indicator of stable returns is to look at the yield or rents achieved by the fund over several years. Rents tend to be less volatile than capital values, that are, in any case, only a surveyor's opinion.
A property fund that is actively managing its property will often be able to achieve higher yields by renovation and refurbishment rather than selling an older property and buying another. The average value of the property held could also indicate whether the managers prefer big prestigious projects in the big cities or whether a wider spread, including smaller suburban properties, is preferred.
The amount of cash held by the manager is also of interest. Often, when assessing funds, too much cash reflects badly on a manager. But when buying and selling is expensive and it can take a long time to find a buyer in a poor market, a healthy cash balance may be useful.
If you need to access money held in a property fund at a time when the property market is in recession, the managers usually have clauses that give them the right to delay paying you by six or 12 months. Such a clause is less likely to be imposed if the cash balance is higher.