The object of a pension is to provide an income during retirement. A pension is an accumulation of money that has been saved over the years. In practice, bare savings are rarely enough. Instead, savings are often used to buy an investment. Investment is about buying something to appreciate in value, with the aim of becoming better off than you are now.
Pension planning has allies and enemies. One ally is interest. Interest is money paid by someone else for use of the savings. Another ally is compound interest: interest paid on interest. Long-term, the monetary result of compounding can be substantial. Another is tax: the offer of tax relief is the government’s way of encouraging people to help fund their own retirement, rather than rely entirely upon the state.
The chief enemy is inflation. Inflation erodes buying power. Paradoxically, tax is another enemy: despite the lure of tax-relief, taxation is a playground for political tinkering. Another enemy is uncertainty: a pension is for the future, which could be decades away. Many people have difficulty in making sense of now without having to try to work out what might or might not happen in several decades.
The best investment is cash savings in an interest-bearing deposit account with a reputable regulated financial institution: the process of accumulation is a straightforward upward-only path which, apart from inflation, is risk-free. For those for whom rates of interest are considered derisory, there are alternative forms of investment all of which promote, in exchange for loss of control of the cash, the thought of a more rewarding experience.
Any alternative to cash savings is not without its risks. Since the ultimate is cash, any alternative investment must provide ease of liquidity: to convert an asset into cash at short notice is paramount.
Buying into a store of value in the hope of capital appreciation requires a leap of faith. Whether there is income during the period of ownership, there has to be an exit route: someone to pay at least the same price as paid whenever the investment is liquidated. The existence of buyers and sellers creates a market and more liquid the market and fluid the process of transaction the easier it becomes to take the risk.
A reputable form of investment is property. Property has a reputation as a long-term hedge against inflation. It pays to buy something that is normally in short supply. On the Mark Twain principle ‘buy land, they don’t make it anymore’, as a store of value, the demand for property is generally considered to be sufficiently stable to be worth the risk of venturing into an illiquid form of investment. It is illiquid because each transaction depends upon the seller finding a buyer at the price wanted.
Another attraction of property is that property is a mortgageable security so bank lending criteria can make a difference to the price of property. Whether it makes a difference to the value of property is another matter entirely. The price obtainable by a seller depends upon the attitude of the buyer.
Unlike residential property whose full value requires vacant possession, commercial property can go up in value when let. The price that commercial property investments fetch will depend upon a host of factors, including but not limited to the identity of the tenant, and the term of the lease. Moreover, because the dynamics of investment are separate to the fundamental value of the property, the price can also vary with yield compression: a layer of capital appreciation that is a product of sentiment.
Different permutations for investment in commercial property add to the risk involved. Know-how is everything. Get the time to buy, manage and sell spot-on and you are laughing all the way to the bank. Get it wrong and you could end up losing a packet.
There is something else to remember when investing in commercial property for your pension. When choosing a proposition from the hundreds that are on the market every month, it is easier to go wrong than get it right. There are simply so many pitfalls that even the more experienced can be fooled into thinking they’re onto a winner.
The main hurdle to overcome is the psychological tendency to want to reinforce preconceived ideas. Your assessment of the proposition and the investment performance you think it capable of could be wide of the mark. It only needs one or two erroneous assumptions of a technical nature at the onset and/or along the way for a pension plan to become sour. For example, rent review can make or break an investment. Quite apart from naivety around the true meaning of an upward-only rent review, it doesn’t follow that the wording of the review clause could not be interpreted to leave the landlord out of pocket on each occasion, regardless of open market rents rising. Furthermore, since a tenant is not obliged to communicate its intention to the landlord and well-advised tenants never do until obliged, the expectation that a quality tenant’s covenant would endure could be thwarted.
If those scenarios depict too bleak a picture then that is only because we surveyors when asked to sort out the mess that investors have got themselves are finding that the likelihood of problems is increasing the more rising prices make the commercial property market look appealing.
The Rent Review Specialist