If you’re a client or a regular reader of my property investment and property tax blog, you may have seen one of the previous articles I’ve written about the benefits of investing in commercial properties using a Self-Invested Personal Pension (SIPP).
I’ve advised clients for years to consider taking control of their pension funds to invest in property, particularly those who are higher rate taxpayers, as they benefit the most from the ability to gain tax relief when contributing to a pension.
The reason why some didn’t want to invest via SIPPs was because SIPPs can only invest in commercial, not residential, property, and the latter has typically enjoyed much higher capital growth than the former.
But in the post-2015 Budget world, I think that it may be time for some to rethink the issue.
Commercial property now has a significant advantage over residential property when it comes to tax and believe it or not, even if capital growth continues at the same rate for both residential and commercial property as it has in the past, the investor who chooses commercial property bought inside a SIPP could end up far better off than the higher rate taxpayer who invests in residential property.
The main reasons for this are:
While residential properties will be subject to the mortgage interest relief restrictions from next year, commercial properties will still be able to deduct all financing costs from their earnings before calculating profit.
Commercial property attracts different stamp duty rates to residential property, and there’s no 3% surcharge for owning more than one.
By buying property within a SIPP your earnings and capital growth will be tax-free, although you’ll have to pay tax when you withdraw the funds in future. You can take the first 25% of any pension pot tax-free, then the remainder will be taxed at your income tax rate at the time.
In my experience, commercial property generally enjoys higher yields than residential property.
Crunching the numbers
Residential properties incur 20% costs for voids and maintenance, commercial properties 10% (as maintenance costs are usually the responsibility of the tenant in commercial leases), and holiday lets 35%.
Yields are 5% for residential (based on the UK average of LendInvest’s Buy-to-let index) and 6.3% for commercial (based on estimates in the International Property Forum report The Size and Structure of the UK Property Market: End-2015 Update).
Property growth will be the same as for the past 10 years. According to Land Registry figures, the average UK house price rose 28.1% between 2006 and 2015. According to the IPF report, which used Valuation Office Agency data, Scottish Government data and MSCI’s IPD data, the value of UK commercial property rose from £867bn in 2006 to £871bn in 2015, effectively a rise of 0%.
Of course there are areas where growth has been higher (or lower) than this, but by choosing UK averages as a basis for comparison, I believe that a reasonable and accurate property investment picture is clear.
There are a lot of variables that could also lead to different conclusions. These include:
- Tax reliefs being withdrawn in the future for pension contributions.
- Residential property prices doubling in value, as they have during various other 10-year periods.
- Stamp duty rates or CGT rates changing over time.
- Yields increasing or decreasing for either commercial or residential properties.
- Mortgage interest rates on limited company loans falling in line with standard buy-to-lets, something that could well happen as more investors move their properties into limited company structures to avoid mortgage interest relief restrictions.
- High LTVs no longer being available on residential property, something that is already happening in some areas due to the way lenders calculate the rental cover needed to secure finance.
I believe that it isn’t just growth you should think about when investing – tax is something that has just as much, if not more, of an impact on your return on investment.
To find out more about how our team of property tax accountants can advise further, please feel free to get in touch here.