Xentum – A Guide to Buying a Commercial Property in a Pension

For business owners, owning a commercial property such as an office within a pension can give significant advantages over holding that commercial property personally or through a business.

There are risks to doing this which must be taken into account and it’s important to put any deal within the context of the business owner’s financial plan. If the business owner is over 55 and wants to take money from his pension in the short term, then investing in a potentially illiquid asset such as an office would not make much sense.

Xentum’s philosophy is that the plan always comes first before deciding whether any deal makes sense in that context.

Pensions

There are two types of pension that can invest in commercial property:

• SIPP (self invested personal pension)
• SSAS (small self administered scheme)

SSAS

A SSAS can be beneficial in 2 scenarios:

• The business owner wants his pension to lend to his business (loanback).
• The pension is to be used to buy shares of a business connected to the owner of the pension.

The downside to a SSAS is that it must be registered with HMRC, a process that can take anywhere up to or above 3 months during a busy period, so for property purchases that have a deadline to meet, a SSAS isn’t likely the right fit.

SIPP

In most other scenarios, a SIPP may be more beneficial, especially as they can be set up on the same day that an application is received.

Residential property

Residential property cannot be held in a pension. The pension provider will do due diligence before they set up the pension to ensure that they are able to hold the property.

Transfers of existing pensions

A business owner will likely have been contributing to pensions over a number of years. They typically have more than one pension with different insurance companies from previous jobs and these types of pension can’t be used to buy commercial properties, meaning transfers into a SIPP or SSAS are required.

Pension contributions

Once transfers are complete, the main issue that many business owners will have is ensuring that they have built up enough assets within the pension to be able to buy the property. This is one reason why pooling assets may sometimes make sense.

Contribution allowance for the 2019/20 tax year = £40,000

You also have the ability to use any unused allowance from the 3 previous tax years, so there is a maximum of £160,000 that is potentially allowable as a contribution.

Contribution allowance for the 2018/19 tax year = £40,000

Contribution allowance for the 2017/18 tax year = £40,000

Contribution allowance for the 2016/17 tax year = £40,000

There is scope to significantly increase the value of the pension by making large employer pension contributions from the business to use up any unused allowance, assuming there is enough free cash in the business accounts to be able to do so.

Since the 2016/17 tax year, the annual allowance has been reduced for some high earners,  dropping from £40,000 down to a minimum of £10,000. As a starting point it is important to check taxable earnings on previous tax returns to ensure the amount is below £110,000. If not, it is advisable to take financial advice to understand what can be contributed as tax charges will be levied if too much is contributed.

Borrowing

In addition to contributions, a SIPP or a SSAS can borrow up to 50% of the net assets. Lending must be completed at a commercial market rate. Some pension providers allow personal lending too, but again at a commercial rate.

The lender will typically require a first legal charge over the property.

VAT

This is an important part of the deal to consider. If the property is VAT registered, then VAT is payable on the purchase price. The pension must have enough in assets (taking into account any borrowing too) upon purchase to cover the VAT.

VAT is then returned to the pension upon completion of a quarterly VAT return, at which point the lump sum can be used to repay a significant amount of the borrowing in this case.

Valuation & rent

The pension provider will require a RICS qualified surveyor to value the property and to provide a rental valuation. There is no scope for the business to control the rent that is payable to the pension, it must be a market rate.

If borrowing from a bank, the lender will require a valuer from their own preferred panel, so it makes sense not to duplicate valuation reports and to use the bank’s valuer.

Property purchase and ongoing management

Some providers will allow a part purchase of a property within a SIPP/SSAS, there is not enough in the pension to make a full purchase.

The pension provider will require a due diligence questionnaire to be completed on the property to ensure that they are happy that the property meets their requirements.

Depending on the complexity of the purchase, some providers may insist on the ongoing use of an independent property management company, which may be a significant cost. Where the provider does not insist on this, it is important to take time to understand whether you are able to complete the tasks required by the pension provider should you wish to self-manage the property as they reserve the right to insist on an independent property manager should tasks not be completed.

It is important that any mortgage is covered by the ongoing rental income and the pension provider will scrutinise this as part of their due diligence.

Timelines

It is expected that from offer to completion, a purchase can take anywhere from 6-12 weeks, however this can be longer if transfers from existing pensions are required and financial advice is being sought.

Where transfers are required, some pension providers will insist on completion only taking place after the 30 day cancellation notice for the pension transfer has expired. This should not be an issue due to the 6-8 week timeline, however it shows the importance of starting the transfers as early as possible. Existing pensions providers can take time to transfer the pension assets to the new provider after the request.

A SSAS can take up to and above 3 months to be set up.

Case study

Michael is a 40 year old 100% shareholder of a limited company in Manchester.

In 2014, the company had built up a lot of cash in the business on the back of strong contracts with national firms and bought their office for £300k with £140k of borrowing.

Michael wanted to take his business to the next level in 2020 by investing in expanding the team, meaning larger office space was required. He estimated the purchase price of a new office to be £475k.

There was cash of £150k in the company account. Michael had 3 pensions which combined were worth £280k and had built up through his time in employment at other agencies when he was younger and regular employer contributions from this business.

The Xentum team spoke to Michael’s accountant, obtaining tax returns from 2016/17 onwards to understand whether Michael’s allowance had been affected due to being a high earner.

Michael was taking salary and dividends that totalled £95k, meaning the full allowance was potentially available, however due to his regular contributions, Michael only had £120k of annual pension allowance remaining for this tax year.

Michael was happy to contribute the £120k as the equity in the original office was to be realised upon sale.

The new property was VAT registered.

Initial purchase figures:

Transfers & contributions:

Pension fees:

Borrowing:

Purchase costs:

Surplus with maximum borrowing – £10,900 (taking into account fees within pension listed above).

Michael doesn’t need to borrow the maximum amount of 50%.

The purchase releases £155k (after fees) to the business. £90k of the original £150k was used for the employer contribution, leaving £60k at the time. This deal allows the agency to purchase the larger office and leaves the cash account at £215k, allowing for the planned investment into the team.

Upon the quarterly VAT return, the £95,000 VAT payment on purchase will be returned to the pension, allowing for a significant portion of the borrowing to be repaid.

Financial Planning

At Xentum, we believe that before you commit to such a complex transaction that you should have a solid financial plan in place and the solution should fit this financial plan.

We have many business owners as clients with this structure, however all of them have been through our financial planning process WealthPlan™ to understand where this solution fits in.

One of our core values is #planfirst and its important that you don’t get drawn into complex structures without understanding the impact on the whole of your financial picture.