Commercial property, pensions, and the pandemic
Market conditions are creating an uncertain landscape when it comes to commercial property, whether that be rising prices, limited appetite for lending on the high street or potential rises in taxation. I am going to discuss how pension consultancy and professional administration could help.
Thinking of buying a property for your business or for investment purposes? Utilising existing pension funds and complementing them with additional contributions can assist.
A SIPP or SSAS could engage in a joint purchase, increasing your buying power, which could help buy a property the business really needs.
This works really well when the company is considering buying a property rather than renting. That is, if the business has the funds and can afford to buy a property, it could be assumed they have the prerequisite profit to contribute to a pension scheme on behalf of its owners. If so, it would be prudent to consult an adviser regarding annual allowances, tapered annual allowances and carry forward capacity. These contributions could attract corporation tax relief, potentially providing a 19% discount on the property purchase if the property is subsequently bought by the scheme.
Upon purchase and lease back of the property, the business will be due to pay rent. Some may ask, why would you instigate a rental liability for the company? Assuming the company is profitable, the rent can be considered a deductible expense for the business, thus, reducing profit for Corporation Tax purposes, while increasing the pension scheme value at the same time.
Moreover, it would be prudent to note that the rental growth in the pension scheme does not diminish the member’s ability to contribute up to their own respective limits.
Whether using a pension scheme or not, borrowing has always been a consideration when looking at buying commercial property. It is no secret that commercial borrowings have been harder to secure for businesses over recent years, however, there is clearly less appetite for third party lending, that is, borrowing where the existing or future tenant is a third party.
But who says you need to go to the high street? The loan can come from the member’s personal funds or a company. Therefore, you could line your own pockets rather than that of a lender. One must be mindful that the terms of the lending should be established on a commercial basis and documented accordingly.
Once the property or a portion of the property is in the pension scheme, it benefits from a tax efficient environment. The property is free to appreciate and generates rental income to the scheme without the burden of tax. Conversely, if the company owned the property it would be subject to tax on the gains upon sale and any rent received would also be taxable.
Moreover, the asset is segregated from the business and wider estate, which can be advantageous in terms of both IHT and exit planning.
The growth and rent can be captured in the scheme and remain outside of the estate. The funds could also be subject to the favourable death benefit rules associated to pension schemes. That is, if a member passes away before they are 75 their beneficiaries could draw from the fund entirely tax free. Alternatively, post-75 any income the beneficiaries receive would be subject to their marginal rate.
In terms of exit planning, the business could be sold without the property, thus enabling the scheme to hold onto a naturally income producing asset, which in turn could fuel the member’s pension in retirement.
While there are clearly many benefits to consider, there are also risks, including investment risk, default risk, liquidity risk and environmental risk to name but a few. We should be mindful of the risks when assessing the suitability of the transaction and potential returns.
Investment risk could be experienced in the fluctuations in property or rental value. While commercial property is historically an asset with a low level of volatility when it comes to capital value, it can still be subject to fluctuations. Market considerations and/or even market sentiment may have an adverse effect on values, which could have an impact on the member’s associated retirement strategy.
Default risk is associated to the underlying tenant. The strength of the tenant is always a consideration. If the tenant vacates for one reason or another, there is no one to pay the rent, which services the debt if borrowing was used.
Moreover, while gearing can enhance return on investment, it can also enhance losses. Whether these are caused by market conditions, the loss of a tenant or increases in interest rates, the losses on a geared property investment can be exacerbated if there is associated borrowing.
Liquidity is another prevalent risk, especially when there are multiple parties involved. Property is generally considered an illiquid asset. Rental receipts are a good source of regular liquidity to pay pension benefits, but the option to withdraw 25% tax-free of your pension income is something that could be tricky if your scheme value is predominately made up by property. This highlights the need to remain cognisant of drawdown requirements and accentuates the benefits of ongoing advice in these cases.
Engaging with Mattioli Woods can help you asses the risk while considering all your available options. Options that are made a reality due to our integrated model that allows us to deliver some of the most flexible pension solutions in the market.
Glen Marshall is a wealth management consultant at Mattiloli Woods.