Updated 20 October 2021.

Holding commercial property in a pension fund has long been a favourite investment strategy of business owners, but in recent years we have seen a rise in enquiries from non-business owners, who are attracted by a regular income stream in the form of rent, with annual yields of over 7% widely available.

However, in these uncertain times, one should also consider the potential downside risks and the outlook for commercial property in general.

Commercial property can be held directly as an investment within a Self Invested Pension Plan (SIPP) or a Small Self Administered Scheme (SSAS). Whilst there are some differences between a SIPP and a SSAS, the general investment principal is the same.

It is important to consider the location of the property, the financial position of the tenant and also the sector in which the tenant operates in e.g. retail or office space.

So how does it work?

There are a few ways in which you could purchase commercial property as a pension fund investment, some examples are given below:

• a business owner could use their pension fund to purchase the commercial property that their business operates out of
• a dentist could purchase the property where their surgery is located
• an individual could use their pension fund to purchase a property with which they have no connection

Permitted investments include business premises, factories, shops, offices etc. Residential property is not permitted.

It is also possible for several people, such as business owners or family members, to pool their pension funds together to purchase property. This means that everyone’s pension fund owns a percentage of the property and a pro rata amount of rental income.

The property is purchased by the pension Trustees and income, normally in the form of a monthly or quarterly rent, is received into the pension bank account. If a loan has been arranged to assist with the purchase of the property, then loan repayments are normally met from the rent received. It is possible to borrow up to 50% of the pension fund value (pre purchase of the property) if required.

For example, if your pension fund has a £500,000 valuation and the property you want to purchase is £600,000 then you could borrow £100,000 to facilitate the purchase. On the other hand, if a business owner or individual has access to cash, it might be possible to make a company or personal contribution to make up the required shortfall and claim the appropriate corporation tax or personal income tax relief.

The property can also be used to generate a retirement income through a pension drawdown option when required.

Tax efficiency

No income tax is payable on property rental income received into the pension fund and when the property is sold, no capital gains tax is payable, no matter the amount of gain made.

In addition, rent paid to the pension fund by the tenant can be tax deductible as a business expense when calculating the profits of a business – an additional benefit to a business owner considering buying business premises from which they operate from.

VAT implications also need to be considered, as the property might be elected for VAT.

The risks

As with every investment, valuations of commercial property can go up as well as down and is influenced by many factors, in particular the supply and demand of property.

At renewal of the lease, the same level of rent might not be achieved leading to a reduction in income. A tenant might decide not to renew, or even go out of business during the lease term, leading to loss of rent payments and therefore requiring a new tenant to be found.

If at the point of sale the demand for your type of property is low, the sale price might be less than cost. In such a scenario your pension will make a loss (albeit rental income would have been received during the lease term).

At point of retirement when a capital sum is required, converting the bricks and mortar of property into cash is not always a quick process. This can often take months rather than weeks as a willing buyer must be found.

What about costs?

In addition to the cost of buying the property, there are additional costs to factor as with any property transaction, including, but not limited to:

• fees levied by the appropriate professional’s involved, such as solicitor fees, a professional property valuation, and advice from your financial adviser
• pension trustee administration costs
• Land and Buildings Transaction Tax depending on the cost of the property

There are also ongoing costs to consider. Most property leases are arranged on a ‘repair and insure’ basis meaning that the tenant meets the cost of insuring and carrying out any repairs required throughout the lease term. And if the property is elected for VAT then the Pension Trustee would normally complete and submit a VAT return.

It should also be noted that if a business owner does use their pension fund to buy the property that the business operates from, rent has to be paid by that business to the pension fund at a commercial rate.

The outlook

During the most recent lockdown, many commercial property tenants asked their landlords for a rent deferral or rent holiday to help see them through this difficult time.

High street retail and the leisure sectors have been particularly affected. Essential retail such as convenience stores and pharmacies remained open whilst non-essential retail, bars, restaurants etc. were closed and have only recently opened up again.

With restrictions easing, new risks have emerged. For example, a shortage of types of fresh produce used in restaurants and a shortage of labour have led to some sectors, particularly leisure, opening on a restricted basis.

With COVID cases on the rise, the risk of new restrictions being imposed during the coming winter months continue to cast a cloud over commercial property.

Many people have been shopping online for the last few months and this could influence how purchases are made in future. If there is less footfall on the high street and sales fall, this could lead to demand for commercial property falling. Lower valuations will follow from both a sale and lease perspective leading to lower valuations in asset prices and future rental income.

It’s not only retail and the leisure sector that’s affected. With many employees working efficiently from home, business owners are now considering if they can operate like this longer term thus reducing the office space they require.

Summary

With a recession looming and potentially less demand for commercial property in future, it has never been more important to assess the location, tenant and sector associated with the purchase.

Every transaction is different and can be complex, so it is important to seek advice from your financial planner at the earliest opportunity.

If you would like to discuss this further, please don't hesitate to get in touch with a member of the Johnston Carmichael Wealth team.

Your Johnston Carmichael Wealth planner will take time to understand the transaction you are looking to complete, consider your pension assets in more detail and talk you through the process. We will also assess your individual circumstances to make sure that investing in property is right for you.

If you do not have professional advisers in place, we can introduce you to experienced professionals to assist with the transaction.