Resolving purchase issues for mixed-use commercial properties in SIPPs
While problems exist for SIPPs looking to directly hold, mixed-use commercial properties there are ways to resolve the issues, says Martin Tilley, director of Technical Services, Dentons Pension Management
2016 was a tricky year for investors. Stock markets have risen and fallen often based on market sentiment rather than fundamentals. Bond and cash yields have continued to remain only just positive and property funds have been suspended, revalued and opened again. Around this, inflation has started to tick upwards.
Pension investors have been tempted to seek returns in other assets sitting outside of the regulated arena. I’m not talking about scams, although these continue to be a worry, I’m referring to an increase of interest in directly held commercial property.
Holding property directly presents its own challenges and risks. Some are enhanced due to the lack of diversity and greater illiquidity above even a commercial property fund. It can however, offer some advantages in terms of no hidden valuation or management fees diluting returns. By far the most common characteristics attracting investors mentioned to us are, the ability to see and touch their investment, see the investment yield accumulating by way of a regular rental income stream and the control of costs.
SIPPs and SSASs have often been used by individuals looking to acquire the property from which their businesses trade, but more recently there has been an increase in the number of investors seeking property leased to third party tenants.
Attraction of yield
Any long-term property investment is dependent upon the strength of the tenant and this, to a large degree, will determine the yield. It is this yield which has proven attractive and investors have been seeking this and finding them often in properties appearing at auction.
Purchase of property at auction also presents its own problems. Most often completion must occur within 28 days of the auction, which for either a new SIPP or one which is to be funded through transfers, falls foul of the statutory cancellation rights which cannot be fully waived to allow purchase in such a period. In any event, a SIPP operator will want to give their prior acceptance to any property. This generally means it is necessary to establish the pension vehicle well before a particular property deal can be done.
Common properties that have been proposed are high street shops with established tenants and yields for these can be attractive. Often however, these properties which are freehold can include residential flats above them. Even though these flats may have been sold off on long leaseholds, the reversionary value at the end of the lease belongs to the freeholder and this, along with any ground rent payable are regarded as a financial interest in residential property, which is taxable. Although the values of the residential element and tax payable on them might be small, SIPP operators will not want to hold any taxable investments within their asset books for fear of further regulatory or revenue scrutiny.
Resolving the issues
There are ways of accommodating these investments, although none are straight forward. If the purchase is not at auction and the vendor is open to negotiation, it might be possible to ask if the title of the property could be split so that the long leasehold of the commercial element can be separated from the freehold. This is the desired route, as the pension can then purchase the long leasehold interest directly from the vendor. Following which, in a separate transaction, another party; perhaps the member, personally acquires the freehold interest. The freehold which includes the financial rights to the residential reversion and any ground rents thus remains outside of the pension scheme.
Even with an incentive of perhaps a contribution covering the vendor’s legal costs, this might not always be possible. Even if it is, the agreed purchase price of the combined property will need to be split between the buying parties and evidenced by an independent professional valuation. This is irrespective of the purchase being from an unconnected party, the member and pension, being connected must act on arm’s length terms.
Where not possible, an alternative route is for a party, perhaps the member, to acquire the property outright but simultaneously grant long leasehold of the commercial premises which the pension scheme buys from them. This again achieves the desired result of the residential elements being kept outside of the pension. An independent valuation verifying the value of the leasehold commercial element would again be required, but the additional downsides include:
• Duplicated conveyancing costs of the initial freehold and subsequent leasehold purchases
• Duplicated Stamp Duty Land Tax on the value of both transactions
• The need for the initial freehold purchase to be funded, albeit for a very short period, by the member.
Irrespective of these complications, the desired outcome and investment yield is often so attractive that the initial costs of acquisition are still more favourable than alternative investment mediums.