Nigel Bennett highlights the importance of good financial forecasting when planning a SIPP commercial property purchase and the three main areas advisers should consider in this regard.
Acquiring a commercial property via a SIPP can often be compelling – provided the property is a good one with the chance for a steady and rising income stream supported by a good tenant (who will often be the client’s own business).
The purchase may be driven by the need to move to new premises to support expansion plans or it may simply be the client wishes to have more control of the property rather than be at the whim of a third-party landlord.
Often clients have already identified a property but need to know whether they can afford it and the attractions of buying via their pension fund as well as the potential downsides of such a transaction.
Most clients will be working off some sort of spreadsheet to help with their decision, allowing them to model the cashflow and alter the assumptions to take account of various scenarios. Here are the three main areas that need to be considered when producing financial forecasts.
What will it cost to buy the property – taking into consideration not only the purchase price but also other costs such as VAT, if applicable, stamp duty land tax and professional fees, taking in what assets are already available in existing readily transferrable pensions, and how any shortfall identified may be met?
Planning for shortfalls raises the prospect of borrowing, bringing in additional members, making top-up contributions or structuring the purchase so the pension scheme owns a fractional share of the property.
Sometimes a combination of all the above options is best – these are all areas where a financial planner will add extra value, being able to consider available contribution allowances, borrowing limitations and, of course, the impact of the Lifetime Allowance.
What income will the pension scheme receive, how often will this be paid, when will this be reviewed and what outgoings will there be?
Often clients compare the pension scheme option with alternatives, such as buying the property personally or via their own business. In which case, many of the calculations and risk factors are very similar, but there are of course issues that need to be considered.
If there is borrowing, there needs to be allowance for repayments of capital and interest. While it may be good to pay off the loan as soon as possible, there is a risk that setting too short a term with high payments could create negative cashflow.
At the other end of the scale, banks will ordinarily insist the term of the loan cannot be longer than the length of the lease – longer lease periods may create a liability for stamp duty land tax (England, Wales or Northern Ireland) or land and buildings transaction tax (Scotland), thereby increasing the costs.
Clients should not forget the primary purpose of any pension fund is to provide pension benefits and so there needs to be an exit strategy. I have met a number of advisers who have been involved with SIPP property purchases in the past, only to find they have had a poor experience when it comes to accessing the pension fund a few years later – to the extent it has put them off this type of planning.
This may be partly due to the inflexibility of some providers, or just simply the fact property is an illiquid investment. Depending on the preferred means of taking retirement benefits, it may be necessary to sell the property and a forced sale or poor market conditions at the time could result in the SIPP receiving a lower price than the client may have ideally wanted to accept.
For some SIPPs that borrow, it can take time to get to the point where surplus cash from rental income is available for reinvestment. For this reason, it is not uncommon to build up other assets outside of the property/mortgage account, allowing additional funds to meet future benefit needs.
What happens if any of the assumptions turn out to be incorrect and how might the results and attractiveness of the proposal alter under given circumstances?
Losing a tenant can create not only an income void but also create liabilities as, dependant upon the individual property, the responsibility for business rates, insurance and maintenance of the property may fall upon the pension scheme trustees, depleting the fund if a new tenant cannot be found quickly.
As with any investment, performance can be affected by the prevailing economic conditions as well as legislative and taxation changes. The costs of these transactions means property is typically held as a longer-term investment, so the effect of future changes should not be underestimated.
Naturally we do not know what the future holds, but for the right client with the right property and a secure tenant we have seen this work very well. Good cashflow forecasting is one of the ways you can help your clients with their choices.
Nigel Bennett is sales & marketing director at InvestAcc