The Advantages and Pitfalls of Investing Your Pension in Property

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1 The Advantages and Pitfalls of Investing Your Pension in Property

2 Contents Introduction Pension changes Is property investment right for me? Advantages of property investment Other types of property investment Property investment bonds Property investment funds Real estate investment trusts Property investment trusts Regulation of funds Summary About the Author

3 Introduction With recent changes to the law surrounding the release of pension capital, new investors now seem eager to access money from their pension and invest in property. Simon Morris, a property advisor to investment funds and bonds, explains the risks of this strategy and the calculations investors need to make before investing a lump sum in property. This guide also looks at alternative property investment vehicles open to investors.

4 Pension changes On 6th April 2015 reforms came into effect that allow people who are 55 or older with a defined-contribution pension to remove their money as a lump sum instead of buying an annuity. Retirees are allowed to remove 25% of their pension fund tax-free, whilst the remainder will be taxed at the same rate as income. Research indicates that a third of people between 45 and 64 may cash in their pension pots to invest in the buy-to-let market. Statistics show that every 1,000 invested in the buy-to-let sector in 1996 is now worth 13,048. With interest rates remaining low, property seems like a relatively risk-free investment opportunity. An expert in property investment field, Simon Morris, will in this guide, talk potential investors through the risks and rewards of putting your money into property.

5 Is property investment right for me? Investment is, and has always been a risk vs reward game. While new rules mean that those over 55 may be able to withdraw 25% of their pension tax free, the rest of the lump sum will be taxed at a considerable rate. Can you recoup this money through property investment? If so, how long will it take? And how big is the risk that you could lose everything you ve saved for? For those looking at investing a pension lump sum in the buy-to-let market, there are many risks to consider: The Time Factor. Property investment should be considered a longer term investment, while it is possible to make money on bricks and mortar property quickly (by renovation or changing a property into a multiple occupancy investment), in most cases property investments should be looked at over a ten year period. If you re at retirement age this may not be feasible due to time constraints. Investors believe they ll have time to deal with direct property investment but in reality this can be very time consuming. Dealing with lawyers, surveyors, architects, builders, tenants and estate agents can and will take over your life. Tenants can be unreliable and property could remain empty for periods of time this results in an investor covering the mortgage and bills when the property is unoccupied. Property prices do increase, but they can also plummet. Your original investment is not secure or guaranteed. London has seen significant house price rises in the last few years, but these increases are not UK-wide, so do your research in terms of location and history of property prices. Interest rates are currently low, so if you are using a pension lump sum as a deposit and buying the property with a mortgage, it s likely that interest rates will increase and so too will your repayments. Potential investors need to take several measures before they cash in their pension as a lump sum to invest in property. Ideally, investors should reserve taking out a lump sum as a last resort and use an Independent Financial Advisor (IFA) to help you weigh up any decision. An experienced IFA will examine your appetite for risk against your expectations regarding yield, to point you in the direction of the right financial product for your circumstances. Buy-to-let may not be the right choice for you, but there are other ways to make investments in the property market.

6 Advantages of property investment In the UK we love property and have an obsession with home ownership first and foremost, with many of us putting in many months and years worth of research before we purchase our first property. While there have been slumps in the property market in the past, this hasn t concerned most homeowners who tend to see property as a long term investment and that any slumps can be ridden out. One of the advantages of owning property either residential or commercial is that it s an uncomplicated asset. Houses or commercial property don t need a great deal of understanding as an asset class, we all know that owning bricks and mortar property in whatever form is a tangible real investment. If there s a housing market crash tomorrow you ll still own the same house, the same four walls and a roof, and your tenants will still pay the same rent, your asset itself will essentially remain unchanged. This is a great advantage over the volatility of some stocks and shares in which your entire holding can become virtually worthless overnight. Investors know that with patience the market for property will rise again. And as a real asset property has the ability to rise in price with inflation. The stock market can do this too, but it s a tougher ride. Historically, looking back over the past 50 years property is just about the best investment anyone could make, and is one of the reasons behind the Baby Boomer generation holding the lion s share of the UK s wealth today. At the moment, property, throughout the UK is looking a very attractive investment, especially for those looking over the long term. The market conditions, combined with an investment into an easily understandable real asset will continue to make property a popular and advantageous investment.

7 Other types of property investment You don t need to invest in bricks and mortar stock to capitalise on UK property. You could consider property bonds and funds. They can provide you with tax advantages when they re used within an ISA wrapper and some products guarantee your initial investment. Again, advice from a IFA will help determine if this is a good investment choice for your circumstances, and remember to always choose regulated investment types. Bonds and funds, particularly when bought within an ISA wrapper can be a genuine alternative to owning bricks and mortar stock. With the right independent advice, returns can be made without the headache of dealing with tenants and other variables.

8 Property Investment Bonds Fixed income property bonds are available and some offer healthy returns in the region of 6-10%. These are proving an increasingly popular option for new investors looking for low risk and high yield.. How do property investment bonds work? Bonds are a fixed income investment product that are issued by companies as a way of raising finance. The bond issuer pays the investor for the privilege of using their money in the form of interest payments known as the coupon. The interest payments are made at a determined rate and on a determined schedule. The bond will have a maturity date in which loan is repaid to the investor. So, with bonds you ll know exactly how much you ll get back if you hold the bond until maturity. Bonds can be traded on the market and a bond s price can change daily like any other equity. You can buy or sell bonds at any time, you don t need permission from the bond issuer to sell the bond. Bonds can be affected by changes in interest rates, but this is off-set by the advantages of knowing your long-term return. Offering a good, safe investment and typically providing a secure income and healthy capital return property bonds could prove useful to those looking at investing a lump sum. With the property market widely predicted to show healthy returns in 2015 and beyond a fixed income property bond is way to take advantage of property price gains without having to physically own and maintain any property yourself. Advantages of property bonds: Fixed income Healthy returns, which can be in the region of 6-10% Return on the original investment on maturity Can be traded like any other equity An easy way of taking advantage of predicted property market rises A conservative investment that has the potential to provide large gains Less volatile than equities

9 As a property advisor to Investment Funds Simon Morris has lately seen a rise in popularity of property investment bonds and it is a way to take advantage of the buoyant property market, although you should always do your own research thoroughly. Before you invest in a Bond ensure that you are aware of the following: The type of property that the Fund is investing in, i.e. Office, Commercial. The locations of the property within the portfolio. London and Manchester are two of the UK s favoured locations at the moment. But be aware of the strategy of the properties purchased, along with research prices, trends and the economy, in the related areas. The level of risk you re signing up to. There are funds available now that guarantee the initial capital invested. Higher risk usually is balanced with higher yield, but be aware of the risk level of the fund, especially if you re investing funds set aside for your retirement. Check the management charges. Are they paid up front? How do they compare with other Funds? Be aware of how long your money is tied up for. Can you release your investment quickly, or is it tied into a period of time?

10 Property Investment Funds Bricks and mortar funds A number of physical properties are purchased by the fund, spreading the risk across the properties. Returns are made from an increase in value of the properties, but also the rental income. Benefits of direct commercial property investment funds Longer lease lengths (e.g. five years or more), result in a reduced risk of empty tenancies, along with upward-only rent reviews. This means that rental income increases at least by the rate of inflation each year. The Fund Manager is responsible for sourcing tenants, investing in property in prime locations, and negotiating lease lengths. Risks If the initial capital is tied in, buying or selling property can take long periods of time, making it difficult to sell your holding in the fund quickly. If you re looking for quick returns this type of fund may not be ideal for you. Property values may decrease. Watch out for clauses in the contracts that allow Fund Managers to lock down the fund with exceptional circumstances. If a number of Investors are looking to reclaim their cash, under FCA rules, property funds can suspend trading for 28 days, whilst they try to raise enough cash by selling properties, to meet the repayments of Investors. This period may recur until the fund has enough capital to meet redemptions; previously in unstable times, this period lasted as long as a year.

11 Property Investment Funds Indirect commercial property funds This is property investment once removed. The funds invest into companies, who have large property portfolios. Associated shares are listed on the Stock Exchange, and traded on a daily basis, no different to any share trading. Due to the daily trading, unlike with direct commercial property funds, there are no liquidity issues, so investors can move in and out of the fund with ease, and access their cash. Returns are reaped as they would be in any other investment in shares; through share price appreciation, and dividend income, rather than directly through property price increases and rental income. But while you get the benefit of the liquidity of an equity-like product, you also get the volatility of investing on the stock market.

12 Real estate investment trusts The great majority (over 80%) of these property companies are known as Real Estate Investment Trusts (REITs), and have greater tax benefits, than other listed property companies. REIT companies don t pay corporation tax on their assets, on the condition that 90% of profits are paid to shareholders as dividends, which in turn, could mean higher pay outs. REIT investors pay either 20%, or 40% tax, because they re classed as property-letting income. Property investment trusts Alternatively, you could invest in property investment trusts, which will pool your money to buy property and property company shares. The difference between these and REITs, is that they re considered to be like any other company, so tax on dividends is only 10% for basic-rate payers, and 32.5% for higher-rate payers. Investment trusts can do things that unit trusts and OEICs can t. For example, many property investment trusts use gearing - a process whereby the companies borrow money - to boost the amount they can put into property, beyond what you have invested. While this can enhance gains in a rising market, it can magnify losses if returns fall.

13 Regulation of Funds It s recommended that any investment you sign up to is regulated and authorised by the FCA (Financial Conduct Authority). If the Funds Management Company goes bankrupt, the investment belongs to you, and you are protected as the investment remains in place. A trustee or depositary is appointed to oversee and safeguard the fund s assets (your investment). Their objective is to oversee the management of the fund, and ensure that the fund is run with the best interests of its investors in mind. Regulated funds have rules in terms of what a manager can and can t do so be aware of the following: There are limits in the type of investments that can be made. There are rules in terms of the information that the fund manager gives to you. Restrictions on the way funds can be promoted and sold. Regulations governing the charges and costs you pay

14 Summary Summary Property has nearly always been stable in terms of longer term investments. The current UK economic climate does show signs of people hoping to make quick investment on larger amounts of capital. Investment into property-based investment funds for investors with 35k+ can offer attractive % s at a relatively low risk. If you are serious about investing a lump sum from a pension into property, Simon Morris offers the following key pieces of advice:- Ensure that the Fund is regulated. Ask questions in terms of; - Management Fees - Types of Property that the portfolio includes or may include - Examine the funds business plan, ensure that the property is UK centric and spread across diverse holdings. Some funds guarantee the initial capital invested check the details for this. Keep an active interest in the health, management and performance of the fund. Watch out for changes in the Management Company. Keep an active eye out on property and financial news. Don t risk funds needed for retirement income.

15 About the author Simon Morris is an Independent Property Consultant with over 15 years experience in property investment. Simon actively works with a number of funds and high net worth individuals, advising on property purchases, to ensure investments made into property, are measured in terms of risk, and bring solid return on the initial investment. To read more about Simon Morris please visit his blog:

16 The Advantages and Pitfalls of Investing Your Pension in Property