The Rent Review Specialist
Pension Plan
01/01/2014
A pension is a long-term commitment and tax relief is attractive, but setting-up fees and on-going charges for pension plans can be disproportionately high. I suggest thinking inside the box. The question to ask is: would the proposition be worth buying if there were no tax advantages? Many property investment schemes and plans are sold on tax advantages but unless the property itself makes sense as a long-term investment then I suggest the only likely advantage would be for the scheme promoter and manager of the plan.
Generally, commercial property is a depreciating asset. Since costs of buying (including Stamp Duty) and selling, and non-recoverable expenses during ownership, can be substantial, to get your money back, the value of the property must increase by enough to cover all those costs, plus loss of interest on your equity, plus adjustment for inflation, and allowing for tax on the gain. If, when you want to sell, the value has not increased by at least enough to cover all those costs and adjustments then you would either break-even, or be worse off.
There is a school of thought that treats property investment as an annuity. Provided the tenant is financially stable and likely to remain sound for the duration of the term of the tenancy, buying an investment for yield, regardless of the value of the asset may be lucrative. Even so, it is all too easy to overpay for income. Furthermore, unless the landlord’s interest is leasehold, (in which case the interest would probably revert to the freeholder on expiry (subject to any rights to renew or enfranchise), the property would revert to the landlord on expiry of the tenancy (subject to any rights of the tenant to renew) and any difficulties in reletting or otherwise disposing of the property could cause problems for the landlords.
For a SIPP (self-investment personal pension), generally buying a shop property investment for a pension based on tax advantages is not the best way to go about creating a pension. Unless the purchase is wholly a business-expense, in which case what I am about to say does not apply, the snag with buying property for investment because of the tax advantages can lead to the prospect of getting tax relief ignoring the prospects for the property as an investment itself.
I am sure there are many landlords that over the years since SIPPS were introduced in 2000 nowadays own properties that have fallen in value with no obvious likelihood of going back up to the price paid. Of course, when you are buying long-term, the occasional drop in value is only to be expected, but the question is whether any fall in value can be reasonably expected to be offset by any rise, or whether the ups-and-downs over the period of time simply cancel out each other.
Since most propositions are going to decline over the years, because of the principles of marketing, it is very much a matter of timing: the challenge is to sell and let someone else buy the slack before it becomes obvious that the investment is not going to perform. To some people, the idea of dumping on the unsuspecting might be thought anti-social, but when it’s your money you’re investing why stick around just in case?
The question is: long-term buy and hold, or long-term buy and lose?
Generally, commercial property is a depreciating asset. Since costs of buying (including Stamp Duty) and selling, and non-recoverable expenses during ownership, can be substantial, to get your money back, the value of the property must increase by enough to cover all those costs, plus loss of interest on your equity, plus adjustment for inflation, and allowing for tax on the gain. If, when you want to sell, the value has not increased by at least enough to cover all those costs and adjustments then you would either break-even, or be worse off.
There is a school of thought that treats property investment as an annuity. Provided the tenant is financially stable and likely to remain sound for the duration of the term of the tenancy, buying an investment for yield, regardless of the value of the asset may be lucrative. Even so, it is all too easy to overpay for income. Furthermore, unless the landlord’s interest is leasehold, (in which case the interest would probably revert to the freeholder on expiry (subject to any rights to renew or enfranchise), the property would revert to the landlord on expiry of the tenancy (subject to any rights of the tenant to renew) and any difficulties in reletting or otherwise disposing of the property could cause problems for the landlords.
For a SIPP (self-investment personal pension), generally buying a shop property investment for a pension based on tax advantages is not the best way to go about creating a pension. Unless the purchase is wholly a business-expense, in which case what I am about to say does not apply, the snag with buying property for investment because of the tax advantages can lead to the prospect of getting tax relief ignoring the prospects for the property as an investment itself.
I am sure there are many landlords that over the years since SIPPS were introduced in 2000 nowadays own properties that have fallen in value with no obvious likelihood of going back up to the price paid. Of course, when you are buying long-term, the occasional drop in value is only to be expected, but the question is whether any fall in value can be reasonably expected to be offset by any rise, or whether the ups-and-downs over the period of time simply cancel out each other.
Since most propositions are going to decline over the years, because of the principles of marketing, it is very much a matter of timing: the challenge is to sell and let someone else buy the slack before it becomes obvious that the investment is not going to perform. To some people, the idea of dumping on the unsuspecting might be thought anti-social, but when it’s your money you’re investing why stick around just in case?
The question is: long-term buy and hold, or long-term buy and lose?
Growth
01/01/2014
The rate of growth is a combination of rental and capital growth. Although capital growth is often rental-dependent, a higher price may be obtainable from an owner-occupier rather than an investor or developer. Also, because a difference can exist between the value of a property and a proposition, investment sentiment can affect growth.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.
A recent sentiment, that came into being in 1999 or thereabouts, is "yield compression" - essentially a gamble on interest rates. For example, a shop investment let at £20,000 a year and priced at £200,000 (yield 10%) when mortgage interest is 5% might be thought a bargain, so the price goes up to reflect the difference between the return and cost of borrowing. Nowadays, we have what I call 'confidence compression' where buyers are banking on capital growth as the gap narrows between the cost of borrowing and the investment yield.
Capital value is calculated by multiplying the estimated rental value ("ERV") by the yield (or year's purchase) that the market would require at the date of valuation. Note I say estimated’, not actual. A shop let at £20,000 a year in 2005 might not fetch £20,000 a year in 2010 if offered to let on the same terms and conditions in the lease as in 2005. The estimated rent might be more, or less.
Yield is the actual rental expressed as a percentage of the capital value. Year's purchase (“YP”) is the yield expressed as an integer. For examples, an investment priced at £300,000 the rent at £15,000 would yield 5%. The year's purchase is 100/5 = 20 YP. In my opinion, use of YP enables a more readily identifiable indication of investment prospects because it tells you how many years are needed for that amount of rent to recoup the purchase price.
Rental growth reflects one or two factors, or a combination of both: 1) demand and supply of the sort of shops that suit the prevailing requirements of tenants that are in the market for premises; and 2) whether, in comparison with other premises and their tenancies, there is 'something' in the wording of the tenancy that would justify a greater rent.
Although a shop property that is let is an investment, not all shop investments perform, or are capable of performing. For example, there may be no likelihood of the rent increasing, or no likelihood someone else would pay more than you, so you might not get your money back and depending upon the market when you want to sell you might not be able to attract a buyer. Also, a great many shop investments with no chance whatsoever of performing are created by cunning sellers to attract naive buyers into paying far more than the property would be valued at.
Many investors become successful, despite mistakes. Often, achievements outweigh the cost of mistakes, but all that means is that they have benefitted from market momentum. When the market changes, as it does and sometimes suddenly, negative events can overtake achievements. With shop property, one worst thing that could happen is that the property becomes vacant and unlettable at a rent that would give you a proper return on the investment; and whilst you are hoping to attract a tenant, the building is deteriorating and empty property rates are draining your resources. The other thing is foreclosure and being made bankrupt. Of course, the worst may not happen: but what does happen more often than not is that the investment fails to perform: the rent never increases and the value falls.