David Gibbins, manager of the TM Hearthstone UK Residential Property fund, discusses the favourable tax treatment that comes with holding residential property funds in a SIPP
At this time of year, many people are rushing to review their opportunities to invest in a tax-efficient manner before the April deadline. For self-invested personal pension (SIPP) clients, the numbers involved can be significant.
Investors in the current tax year can put up to £50,000 into a SIPP, which can attract up to 45% tax relief depending on how much an individual earns. They can also carry back their allowance to previous years, resulting in up to £200,000 of contributions and the associated relief.
One asset class these investors tend to overlook is residential property, as most believe they cannot access this via their SIPP. At first glance, this seems at odds with the undeniable appetite in this country for holding residential property as an investment, whether their own home or buy-to-let. Why is this?
Back in 2006, the pensions 'A-Day' intended to lift restrictions on the types of investment allowed in pensions. However, the government subsequently announced it would restrict residential property from these changes.
The purpose was to stop people claiming tax relief on holiday or second homes, but it inadvertently blocked what one national newspaper estimated as £10bn of new capital from personal pensions flowing into private rental accommodation.
However, the restriction does not apply to funds. Residential property funds can provide further tax efficiency, particularly if they are structured as a property authorised investment fund (PAIF) and, therefore, enable investors to avoid tax within the fund – a significant benefit to those holding the fund within a pension.
Compared with buy-to-let, a pooled fund is able to own a broad spread of properties, giving the fund diversification and economies of scale.
The outlook for the sector remains undeniably strong. The UK private rented sector is thought to be worth nearly £1trn, according to Savills, and recent research suggests property prices are commencing a period of strong, sustained growth.
Indeed, Savills predict that by 2018, house prices across the UK will rise on average by 25.2%, with rental income growing by 21%.
Many may see this as an opportunity to buy-to-let but, typically, direct ownership comes at a cost in time and money. The realities are that the ongoing costs of property maintenance, coupled with mortgage repayments and the risk of voids, can weigh heavily on the rental income generated.
Landlords will also have to contend with income tax and capital gains tax if they decide to realise assets. There is also the spectre of inheritance tax in the event of a landlord's death.
Investing via a personal pension negates a lot of the tax and administrative implications of direct ownership. Also, due to tax relief, higher rate taxpayers could see as much as £200,000 invested in a buy-to-let residential property fund for a net contribution of £110,000 via a SIPP.
Commercial v. residential
Commercial property funds have been a consistent choice for pension investment for many years. The emergence of residential as an alternative with lower volatility, greater liquidity and historically better total returns is now being recognised. Indeed, a number of institutional investors have also entered the sector in the past six months.
Many clients like the idea of an investment they can relate to and the long-term risk and reward profile of residential property is very attractive.
But advisers have been wary of making a recommendation because many funds have chosen structures that result in them being categorised as unregulated collective investment schemes (UCIS) in the UK. However, there are exceptions, which are regulated and authorised by the Financial Conduct Authority.
Many investors see residential property as a long-term investment, not speculative and a more secure home for their money than the stock market.
A quick analysis of land registry data, which is free and publicly available, supports the view that the value of residential property across the UK does actually increase over most time periods.
Making your clients aware of the opportunity to invest their SIPP in buy-to-let may encourage them to maximise their contributions before the April deadline.
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