With house prices still rising strongly, more people than ever are turning their backs on traditional pension funds in favour of property. Many are already using their buy-to-let properties as part of their retirement plans.
Now the government has come up with two schemes that should further encourage high net worth investors to see property as a way of saving for a pension. Residential property can now be included in self-invested personal pensions (SIPPs) for the first time. And in his recent Budget Chancellor Gordon Brown announced the long-expected consultation on property investment funds (PIFs). Such products already exist in the US where they are known as real estate investment trusts, or REITs. They enable people to invest in a professionally-managed portfolio of commercial, industrial, office and residential buildings and enjoy the same tax treatment as those who invest in property by buying to let.
Although most PIFs are likely to concentrate on new-builds, some will include existing properties. They will allow people to invest in property without the hassle of looking after a buy-to-let investment if they choose to take on the role of landlord themselves. Investors benefit from a portfolio of buildings rather than investing directly in one property to let. And when they want to cash in it should be far easier than selling a house. What impact this will have on the buy-to-let market remains to be seen.
Many buy-to-let owners already see their property as part of their pension and from April 2006 the chancellor will make this official by allowing them to buy residential property within a self-invested personal pension, giving them the tax breaks available on all pension savings.
As Ray Boulger, senior technical manager at Charcol, explains, a higher rate taxpayer can benefit greatly from this tax relief.
“Not all of the pension will be available as a lump sum,” he says. “Nevertheless, if you have a £60,000 pension fund, this is worth £100,000 with 40% tax relief so you can still draw down a significant sum or proportion of the £60,000 you originally put in. These tax benefits are therefore worthwhile.”
Any rent paid on the property would go into the SIPP untaxed, as would the proceeds from selling the property. Any income paid by the SIPP after retirement would, however, be subject to Income Tax.
The chancellor hopes PIFs and SIPPs will encourage the building of much-needed new homes, possibly cooling the housing market whilst offering a broader range of retirement investment options. The government also hopes that investor cash will be used to boost the provision of private rented accommodation, further easing the UK's housing shortage.
But will this prompt a rush of inexperienced investors into the market, pushing house prices up still further and making it even more difficult for people to buy their first homes? And will these products encourage people to put all their eggs in one basket?
Investing in property, a sector which has performed spectacularly well in recent years, may seem a logical approach to pension planning. But IFAs warn that it is a dangerous strategy to depend so heavily on any one asset, especially when the value of property, as with any other asset, is not guaranteed to keep rising. Halifax figures show that property prices have risen by around 350% over the past 20 years. But the FTSE 100 has risen by a similar amount making the two markets equally attractive investments over the long-term. Even adding in average rental yields and dividends there is not much to choose between them. There have been big peaks and troughs in the performance of both equities and residential and commercial property, not necessarily at the same times.
Diversification is therefore essential. As then FSA chairman Howard Davies pointed out in February 2003: “Commercial property prices often seem to move contracyclically to equities which is one of the characteristics that makes real estate an attractive option for portfolio diversification.”
Davies was introducing an FSA review of property investments, the results of which were announced in February this year. It found that IFAs understood these products reasonably well and concluded that no significant regulatory action is required. But the FSA also warned that, as product providers broaden their marketing beyond specialists and offer new products, “the possibility of mis-selling by advisers who do not fully understand the inherent risks in these products may increase”.
Now is the time for advisers to get acquainted with these deals. The Treasury is consulting on PIFs and responses must be in by July 16 though no date has been set for the introduction of PIFs. The Association of Mortgage Intermediaries will be producing its own guidelines.
“This consultation is in response to concerns that barriers in the tax system may be contributing to distortions in the market for property investment resulting in poor liquidity, barriers for smaller investors entering the market and high debt financing levels, all of which may be hindering progress toward a more stable and efficient market,” says a Treasury spokesman.
“We have all been concerned at the increasing tendency of investors to put all their eggs in the buy-to-let basket,” says the Association of Investment Trust Companies, which welcomed the consultation.
The schemes have also had a largely positive reception from IFAs, though they urge caution.
Speaking after the Budget, Jason Hollands, a director at specialist ISIS Asset Management, felt the government's emphasis was on boosting housing supply rather than providing an exciting investment vehicle.
“The focus will be on residential property and many investors are already heavily exposed to this asset class,” he says. “The area where most investors are underweight is commercial property which has quite different dynamics to the residential market.”
Other brokers agree. “I don't think we need more investment in property,” says Mark Osland, director of Fidelius. “I would urge caution on those who want to invest in residential property.”
And Trevor Youens, director of Flower IFA, says brokers must be aware that this is a specialist market. “Be careful. As the FSA has pointed out, you are giving investment advice when talking about these products, even if only in residential property.”
Brokers also stress that investors should not rely on any one asset. “If house prices suddenly fall, PIFs could turn into another mis-selling scandal,” adds Youens.
Brokers are also sceptical about the government's motives and doubt that PIFs in their final form will match up to their initial promise.
“I like the idea of PIFs as outlined in their current format,” says Youens. “The government sparks out these wonderful ideas but whether the final version will resemble the proposed format is debatable. The government is in election-winning mode at the moment so I think we have to take any exciting proposals with a pinch of salt.”
Osland agrees. “The form these funds will take is still pretty vague,” he says. “It looks like Gordon Brown is sucking up to his cronies who have plenty of money to invest in property. There are already signs that buy-to-let is no longer a great investment. If even more people try to get on board what will happen to the rental market? And there will be fewer properties for first-time buyers.”
Other brokers echo these worries. “It will be interesting to see the final form of the funds,” says John Stewart, director of PMI. “They will open the way for people with significant personal assets – and there are quite a few – to add fuel to the buy-to-let market fire. These of course tend to be the sort of properties that first-time buyers go for. There was nothing in this Budget for first-time buyers. PIFs will fuel price rises and mean fewer affordable homes.”
Boulger suggests that increased demand for the affordable properties favoured by buy-to-let investors and first-time buyers alike could be alleviated by the sort of rebuilding levels recommended in the Barker review.
“However, given the time the government tends to take to implement such things it's going to be a while before this happens,” he adds.
Youens says plans for more house building are long overdue. “The government has finally realised that the housing market fuels everything and is overheated because of low levels of supply. I welcome Barker's plans.”
Despite worries about first-time buyers, brokers are broadly positive about the introduction of PIFs and the inclusion of residential property in SIPPs. “It was illogical to have left out residential property until now,” says Stewart.
For someone who wants to invest in residential property but doesn't fancy the management involved in buy-to-let, PIFs could be an attractive alternative.
“The downside is that you don't get anywhere near the level of gearing which is one of the major advantages of buy-to-let,” says Boulger.
“It will be interesting to see if the companies offering these funds will offer some kind of loanback facility to compensate for this. I think that is likely though probably not to 85%. If someone has, say, £15,000 to invest in either a PIF or a buy-to-let property, they might well take the view that the gearing available with buy-to-let beats the tax benefits of a PIF but only if they are prepared to spend the time managing a property. It's good to see more choice in the market.”
Boulger also adds that the level of rental demand in the market will be key. “More rental properties will mean rents fall and yields go down, ” he says. “A few years ago it was cheaper to buy than to rent in terms of monthly payments. That is not true any more, at least not in every part of the country. We may arrive at a situation where the cost of renting is cheaper than buying. But the market will find its level.”
The trouble is that the greater the proportion held by investors, the greater the likelihood of volatility. Confidence, says Boulger, is a crucial factor. “But the only thing that could really have a strong negative impact on that would be a sharp rise in interest rates,” he adds.
This is also why investors should not be over-reliant on a single type of asset, including property whether in be in the form of buy-to-let, PIFs or SIPPs. Because by relying solely on the property market investors could miss out on the stock market's upswing just as property starts to slump.
“We seem to have reached the point where prices have come off the boil,” says Mike Fitzgerald, sales director at Brentchase Financial Services. “We have already seen a dramatic fall in the buy-to-let market and yields have been falling for months.”
And as PMI's Stewart points out, property is not a liquid asset. “Houses can take months to buy and sell,” he says. “I would be concerned if someone put all their assets into property as this would leave them extremely vulnerable to market movements.”
But Boulger also says that the property market has something the equity market lacks – a crude early warning system. “One overlooked advantage of the property market is its regional variations,” he says.
“Movements tend to start in London and fan out. This means that if you own property further north you will probably get a few months' warning of the market shifting downwards. You don't get that with the stock market where everything tends to move in unison.”
Although PIFs would protect investors from large losses on an individual property they would still be affected by a general downturn in the property market.
Future rental yields should also be borne in mind. Figures from buy-to-let specialist Paragon showed a rise in yields in February but yields have generally drifted down over the past six months. The lowest-yielding areas continue to be those where property is most expensive, notably London.
The average rental yield nationwide is 7.22%, up from 7.12% last month but down a worrying 11% over 12 months.
Nevertheless, property is still performing well and cannot be ignored by investors. As long as they do not rely too heavily on property or any other single asset and plan their portfolios and their pensions with a long-term view they should be able to cope with a market downturn.
“PIFs are a fresh idea,” says Boulger. “The illiquidity of the housing market shouldn't be an issue since pension planning has to be looked at over the long-term. There will be more money going into the property market, including from people who would not have gone into buy-to-let as it exists. The impact of PIFs on the housing market can only be positive one.”