Please Note: This Article is 9 years old. This increases the likelihood that some or all of it's content is now outdated.

On 14 March 2013, LandlordZONE reported that growing numbers of retirement savers with self–invested pension plans (SIPP) are building up their pension pots by putting money into commercial property, the main reason for the increase that business owners are buying their own premises. Along with obvious tax advantages, it is suggested buying your own premises to form part of your pension is probably a good move. But is it really?

When a business tenant becomes the landlord as well, a different mindset is called for. Criteria for choosing premises for occupation differs from what is needed for appraising whether the property would make a good investment. With an arm’s length relationship, the landlord owns the property, not the tenant’s business. When the parties are connected, the tenancy can be structured to be tax advantageous but, while tinkering for tax is prudent, for property investment it may be wrong. For example, when the business pays more than market rent, an objective appraisal of the investment would be over–rented, and quite possibly down-valued.

The same applies when, for a tenant, ownership enables a new lease to be granted when the business at the premises is sold as a going-concern. Business owners selling a going concern will grant a new lease to the buyer with the rent either low deliberately in order to maximise the price for the business, or at a level the business can afford. A low rent to begin with assumes that on review the rent would be increased to full rent. But that way of thinking presupposes, all other factors constant, that the terms and conditions of the lease are designed to achieve the higher rent on review. Often they are not. As I said in my article in the February newsletter, leaving the drafting to a lawyer can be a mistake. As for the rent the business could support, it is quite possible the amount would exceed the market rent at the review date, resulting in no increase. Since, per business tenancy law, the tenant’s ability to afford more is irrelevant, it is not uncommon for an initial rent to remain unchanged over the entire term of lease; and thereafter, to make matters worse, the rent lower on renewal of that lease. Moreover, not all businesses are property-specific: a buyer might relocate the business, get rid of the lease or vest in a dormant company, and leave the landlord with less-security.

For pension planning, the higher yields that commercial property offers may seem good value compared with the peak of the market about five years ago, and with lower returns and volatility elsewhere a high–yielding investment, particularly where the relationship between landlord and tenant is not arm’s length, safety of income with relatively little hassle commercial property may fit the bill. But there is more to commercial property than immediate yield. Essentially, property is a depreciating asset whose investment potential is a combination of capital and rental growth, neither of which are necessarily linear nor logical. It is possible for capital value to go up or down or remain the same regardless of the rent, and similarly for rent to remain unchanged for years regardless of growth elsewhere. Property is an illiquid asset so while a commercial property investment can be mortgaged, cash is only realisable when there is a buyer at the price required. Even when an investment is regarded as an annuity, there is no certainty the tenant would remain solvent or renew for a term or at a rent commensurate with pension-requirements. As for saleability and funding, there may also be a difference between valuation theory, buyer expectations and mortgage lending criteria. The only ways to profit are either to buy a bargain or when the capital value of the property if sold with vacant possession or subject to an existing tenancy exceeds the purchase price including all costs during the ownership, tax payable, loss of interest on equity, and adjusting for inflation.

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All types of business premises fall within the commercial property remit; shops, offices factories, warehouses, pubs, leisure, etc. Property has a reputation as a hedge against inflation and agencies report that commercial property does increase in value, but the commercial property market is not one big market where everything happening necessarily affects each individual property. Furthermore, because there is no standard form of lease, the terms and conditions of the actual lease can make or break the investment. As for pricing, shrewd professionals can dupe the inexperienced buyer into over paying; a tenant may be expected to pay more than an investor. A difference, often substantial, can exist between the value of a commercial property with vacant possession and the same property let; also the remaining duration of the contractual term can affect value, so too the identity and financial status of the tenant in occupation. During the boom years, the driver for rising prices was yield compression, even though the intrinsic value was often unchanged. Countless investors sucked in by the momentum now find themselves lumbered with commercial property which has gone ex–growth and where the property may well be unsaleable without accepting a thumping great loss.

For successful investment in commercial property, the art and skill is all about judicious choice. Pension planning is a long–term commitment to uncertainty. If you are going to buy and hold commercial property in a SIPP then the question is whether the proposition stacks up if you ignore the tax advantages and any tinkering with the tenancy. As for advisers, the people on your side should also be able to think long–term. It’s no good jumping on the bandwagon, demand for commercial property is intertwined with infrastructural changes in the business sector. For the investor, whether landlord or tenant, the ability to select the right commercial property from a vast array of propositions is about identifying the places and properties that still have potential for growth and investment performance.

Michael Lever
The Rent Review Specialist
Established 1975

Please Note: This Article is 9 years old. This increases the likelihood that some or all of it's content is now outdated.


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