May 2008

Property props up pensions

We are all experts on property! It is one of the most broadly discussed topics across the dinner table or at the bar. We all live, work, play and relax in buildings and therefore we should know what property is all about. However, when people say they own property, one naturally assumes it means they are in the residential market and although the size of the UK residential market is four times that of the commercial property market, it is the latter that is most commonly invested in pensions. Indeed under the 'A-Day' changes, owning residential property in a personal pension fund is no longer allowed as a direct investment.

Because many of us already own a residential property, we do have investment exposure to this and a number of people are already relying on their residential holdings to support them in their retirement. Why then have even more exposure to property within your pension plan?

The answer is diversification and the fact that property behaves differently from equities and bonds and inclusion within a mixed portfolio can reduce the risk in a portfolio, while maintaining returns or alternatively, by keeping the same level of risk, can even enhance returns.

Performance

"What about the property crash?" I hear you all say, and indeed, property is very close to our hearts and remains in our memory a long time when it does badly. However, over the last 37 years it hasn't done that badly with only five negative years in that period compared to seven in equities and six in bonds.

In fact the great crash at the end of the 1980s and the early 90s actually showed a less dramatic fall in prices than in the stock market.

Property prices also tend to move in line with wage inflation and their correlation to this particular measure of the economy is quite high.

Property therefore seems to be the perfect pension asset. A great deal of its total return is made up of income, its price tends to go up with wage inflation, it is predictable, lacks volatility and has defensive qualities in a falling stock market.

All attributes that pension funds should be seeking and it is surprising that the majority of larger pension funds do not have substantial exposure to property in their asset mix. Interestingly, many pension funds have absolutely no exposure to residential property and thus, when considering a personal pension, this should certainly be taken into account.

In our research we have seen that the majority of large pension schemes have under 10% allocation to property on average, whereas personal pension plans have seen a dramatic increase in this level and now stand well above 20% and, in some instances, as high as 50% in commercial property. It therefore appears that when an individual controls the asset allocation, a higher proportion of property is being included, whereas where this discretion is with a pensions manager, a lower allocation seems to be acceptable.

We are, however, seeing actuaries increasing property allocations for a number of pension funds, somewhere in the order of 15% and in our view this is getting towards reasonable levels of between 15% and 20% where we believe property can make a difference.

Access for individuals

So how does an individual access property investment bearing in mind that residential property as a direct investment is precluded by regulations and commercial property tends to come in fairly unwieldy lumps?

The answer is that there are well over 400 property funds in the UK which allow access by individuals and their pension funds to a wide range of different property assets ranging from West End offices through to retail parks, shopping centres, nursing homes, student accommodation and industrial estates.

Entry levels vary, but in some instances these can be as low as £25,000 and for smaller funds, there are a number of Authorised Property Unit Trusts with a balanced approach to life that give access for as little as £1,000 a month.

One, however, must bear in mind that property is a long term investment and advice to our clients is that they should have a five year time horizon on any property investments made and not expect to have ultimate liquidity in the interim.

This is because the costs of transacting property are high, including potentially 4% stamp duty, legal costs, surveyors fees, etc. and these costs are, of course, eventually borne by the investor. Therefore, property is not something to buy into and out of on a regular basis as one can with equities or bonds.

In the long term, property should reduce the risk in the portfolio while maintaining returns and as pension funds mature, provide a higher level of income distribution than can be achieved from either bonds or equities.

Philip Ingman
Managing Director
SPREFS