Pension funds have long been investors in property, using up to 20% of their total funds at times to invest in a variety of properties in the UK and abroad.  This is for good reason – property has historically held its value exceptionally well and produced high quality, predictable revenue streams.  So, on the assumption that you have a pension fund already with a pension institution the likelihood is that your money will, in part, have been invested into property assets.

During much of the 1990s pension funds reduced their allocation to property investments, preferring equities.  This was undoubtedly an error - figures show that if pension and insurance funds had continued to hold 20% of their portfolio in the asset class, as in the early 1980s, they would have been cumulatively wealthier to the tune of £14bn in 2004. A figure of this magnitude would have meant significantly lower deficits in the majority of pension funds. Historical evidence shows property has low correlations with equities and bonds. This means the asset class brings twin benefits of diversification and reducing the volatility of the scheme’s funding level. With that in mind, the optimal allocation to property is often in the region of 25% to 30% for a pension fund, significantly above that currently held in the majority of portfolios.

Source: UBS Pension Fund Indicators, WM Survey

There are many reasons why property will continue to perform even in times of lower economic growth or even in times of decline:

1.    incomes from property and the values of property do not rise in line with the performance of businesses (unlike stocks and shares) – they rise in line with the demand for land and property from those living and working in a given area;

2.    rents are not usually linked to financial performance – companies and individuals wishing to occupy premises (offices, shops, hotels, etc) have to pay rent irrespective of their financial position;

3.    the above tends to make property an attractive high yield fixed income asset class which has delivered substantial performance since the mid 1990s:

Source: IPD Annual Index (Property), Thomson Datastream (FTSE All Share and 5 year gilt)

Personal pensions and property

For those with personal pension plans such as SIPPs or an SSAS the option has always been there to use the fund to buy property as long as it is classed as commercial property not residential (there was a brief moment in 2005 when it seemed the then Chancellor of the Exchequer, Gordon Brown, was going to permit a Self Invested Pension Plan to be used to buy residential properties but this was soon rescinded).  The benefits of including property in the assets held in such funds are clear and made even more so when one realises that pension funds can also borrow against the assets, using mortgages to buy properties provided the fund has the income (generally from the contributions you will be making each month or year) to cover the repayments.

However, the definition of commercial property is gradually being extended to cover a number of overseas developments where the principal use will be as rented property either for locals or tourists.  This has opened up the potential for UK SIPP owners to use their pension funds to buy a wider selection of properties.  Now aparthotels, whole resorts and apartment blocks in city centres are all potentially available to SIPP or SSAS trustees as assets for the funds.

Of course, not every property will be suitable and not every investor will want to use their pension fund to hold such property as there are downsides:

•    the property will be owned by the fund, a separate legal entity.  This means all capital gains, rental income and tax benefits accrue to the fund not the individual;

•    the trustees of the fund are legally bound to look after the assets of the fund in the most appropriate manner which may mean maintenance costs will be higher since they cannot use cheap workmen (or you unless you are suitably qualified);

•    you will not be able to use the property yourself (or let connected persons use it) without paying the full commercial cost.  Failure to pay the going rent will lead to a tax charge on you and possibly the fund.

That said, the tax benefits are not to be underestimated.  If the primary purpose of investing in a property abroad is to provide an asset base and/or an income stream for your retirement then doing so at a discount – the effect of the tax benefits – makes perfect sense.  For example, if you contribute £16,000 to a SIPP the government immediately tops this up by 22%, adding another £4,000 to the fund.  If the contributor is a 40% taxpayer he/she can then reclaim the additional 18% meaning that the total of £20,000 made available to the SIPP has actually cost the contributor only £12,000.

In other words, you can buy a £200,000 property for your pension fund for as little as £120,000 cost to you – well worth considering.

So why buy these types of property?

Quite simply, the expansion in the variety of properties available makes the whole system much more flexible and potentially more lucrative.  The advantages of apartments on complexes or in city centres, for example, include:

Management of the property

Frequently such properties are managed for you meaning the trustees of your pension fund no longer need to concern themselves with finding tenants, maintaining the property, collecting rents and all the other headaches to which landlords can be subject.  Rental guarantees, moreover, take the risk out of the investment as unlet property still attracts the guaranteed income often by being part of a large pool of rented property on a resort or estate.

Sale value can be enhanced

If you buy a shop, hotel or office block it is unlikely ever to be anything else.  This means its value will always be a function of the rental income it generates – it can never have a value determined by the demand from those wishing to move to the area to live.  In contrast, an apartment – even one in an aparthotel – can be used as a residential unit by someone who owns it outright (not through a pension fund).  So when you come to re-allocate the assets in your fund (e.g. when you retire and want to take a lump sum from your fund) properties of this nature can be offered as either an investment property suitable for inclusion in someone else’s fund or as a residential property for someone looking to live there.  

The property can be sold on the open market as whichever type of property is likely to generate the greatest value and/or swiftest sale – something that only rarely can happen with other properties (some public houses, for instance).

If you want, of course, you can even buy the property yourself from your pension fund at any time.  The downside being that you will have to pay the full market value as the taxman tends to frown on transactions that use his money to get something cheap unless it achieves his aim which in this case is to ensure people are making proper provision for their retirement.

Surely I need to have a balanced portfolio in my pension fund?

Nobody should put all their pension eggs into a single basket but the beauty of SIPP funds is that you can have one alongside other pension funds such as occupational pensions.  This means you can set up a SIPP for one particular property or development and still have a balanced portfolio by owning more than one pension fund.  Funnily enough, the government is so keen that we all make provision for our dotage that they are not too concerned that we have multiple pension assets.

Obviously, it would be unwise to over-extend oneself by needing to make monthly or annual contributions to numerous funds in order to cover mortgage payments and find that the burden becomes too great to manage.  Failure to make the requisite mortgage payments could render the investment next to worthless – not a good idea if it is to become your ticket to a worry-free retirement.

Nor would it be wise to have too many separate pensions to manage not least because the management costs are likely to spiral and reduce the final returns made by the underlying investments.  But creating a SIPP for property investment can make a lot more sense than simply investing personally in properties you do not intend to use yourself.  The SIPP will not only get the tax benefits at the time you make your contributions but will suffer no tax on the rental income and any capital gains.

Beware, though, of becoming too overweight in property.  Try to spread the property investments across different territories and types – having all of the apartments on a single development would leave you exposed to the vagaries of that market and the development itself.