The good times must be back. When you see the Sunday papers casually referencing the fact that “this office development would be an ideal purchase for your pension” it is a sure sign that the country is back on it's feet again. Well it must be for some people anyway.
Whether the good times are back again or not I will let you decide, instead I would like to detail how buying property through your pension works. There are several ways of getting exposure to property via your pension. Let’s look at each now:
Buy a Property Fund
This is where you take even a relatively small amount of money (usually €10k or more) and you invest in a fund that has property in it. Funds usually have quite a number of properties in them but can range from funds with 1 or 2 properties right the way up to some funds holding 60-80 Irish Properties sitting in the fund.
All costs and charges are dealt with within the fund and if the fund borrows money from a bank to buy a property the bank can’t chase you personally for the loan if things go wrong. Funds are typically liquid but sometimes the fund manager can impose a 6 month ban on withdrawals.
Contrary to popular understanding a REIT is an investment in equities not in Property. When you buy a REIT you buy shares in a company that owns properties. However, the thing that needs to be clear is that the share price of the REIT can go up and down based on prospects (good or bad) of the company. In other words, there is more than the underlying property values driving your investment up or down. Again, REITS are liquid and you can buy into them with small amounts of money.
These tend to be for larger investors who are considered to be what’s called “Professional Investors”. They need to have a minimum of €125,000 available to invest. Sometimes these funds invest in just one off projects, for example the purchase of a stg£100mil office block in London. Or it might invest in a group of 4 or 5 shopping centres in Germany. Liquidity can be an issue and sometimes these funds will see you without your money for 5, 6, 7 or even 10 years.
All of the above options are designed to club people’s money together so they can get access to bigger deals and have a professional management company operate it for them. Sometimes they work brilliantly, sometimes they are disastrous, but any financial advisor who has been around since the crash will now be able to identify the problems that brought some funds tumbling to the ground in recent years and help you avoid the same mistakes.
But what if your goal is to self-manage, what if you want to own something you can see and touch and feel. New clients of ours often complain about “investments” because they are so far removed from them, they often don’t understand them and sure “you can’t beat a little rent.” This post isn’t about arguing the merits of these observations but rather to look at the advantages and disadvantages of buying property using your pension.
If you have decided you are buying a 3 bed-semi around the corner and you are going to rent it out.. should you:
- A - Buy it yourself?
- B - Get your Pension to buy it?
Taking Option A first, if you buy it yourself you will have to:
- Come up with the deposit from your after tax income
- Borrow the money in your own name from your bank
- Do any repairs from your after-tax income
- Pay tax on the rent
- Pay capital gains tax on the disposal
If you go with option B.
- You make contributions into your pension from your before tax income
- This before tax amount is used to pay the deposit
- The pension fund borrows money from the bank and if the deal goes belly up the bank can only take the property back, they can’t chase you personally for any shortfall
- Repairs and renewals are paid for by the pension i.e. from your before tax income
- There is not tax to be paid on the rental income
- There is no capital gains tax on the disposal
So, what are the disadvantages of getting your pension to buy that 3-bed semi?
- 1 - You cannot buy a property that is connected to you in any way
- That means, you can’t buy a house that you own or anybody connected to you through blood or marriage owns
- Nor can you buy it from a business associate
- You can’t buy a premises connected to your business
- 2 - You can never own the property personally or sell it to somebody you know.
- 3 - You will get less money from the banks.
- Because the banks can only chase you for the property itself if things go wrong, you will only get about 60% of the purchase price when buying.
- 4 - Banks can only give you a 15 year capital and interest loan.
- 5 - The pension owns the property, not you.
- At some point, you will want to get access to the money in the pension. Although everything in a pension grows tax free withdrawals from pensions are subject to tax. (amount and type of tax will have to be covered in a different post!)
- 6 - You can’t “flip” a property or engage in “property development”.
- 7 - Some pension providers will insist you have a property management company in place, others won’t and will allow you to do it yourself.
- 8 - Some pension providers will make you pay for their legal costs when it comes to the purchase. These figures vary from provider to provider so shop around.
- 9 - Unless you are very senior, if you’re part of a big group pension scheme its highly unlikely your scheme rules will allow you to buy property.
I am not saying we should all go out and start buying up property, in fact this post should only be seen as a whistle stop tour of the property investment options available for people with pensions.
The merits of any individual buying any property is something that only a full financial plan with a decent financial planner will uncover. One word of warning though, property isn’t everything. Right now, a well-diversified, well-constructed portfolio will have about 4% exposure to property. If you buy a property today what will your exposure to property be?