Is Property a Bad Choice for Retirement?
Long gone are the days of a cushty pension.
Just ‘do you time’ and retire at 50 odd?
For many of the baby boomers you see strolling around – that is their reality – but for the generations after, not so much so (civil servants excluded).
Property really took off as an investing ‘asset class’ from the late 1990s.
A combination of ‘buy to let’ investors, ultra low interest rates, restrictive development regulations and an endless legion of desperate renters has meant that many of these investors have put all their ‘eggs in one basket’.
And this may prove to be very dangerous.
The generally accepted idea is that capital growth (how much the property increases over time) will get ‘cashed in’ and put to use as a retirement pot. If there’s no need to sell property, then the income streams from property can also fund retirement.
Easy-peasy! Just show me the money.
The biggest danger as a retirement strategy is that the capital asset (the property or properties) don’t increase as expected.
And/or too much borrowing is taken against property which erodes overall returns in the long run.
Of course, even the pathway to this eventual goal has its own dangers.
Ignoring ‘void’ periods has been possible whilst the economy has been buoyant. However, this can quickly change once the full impact of COVID – 19 is felt (with the potential for mass unemployment and associated defaults).
These factors in combination with various government ‘tinkering’ with stamp duty and capital tax gains rates are making the outlook for property at this juncture in time (April 2020) a terrible place to be.
Property Investing Alternatives
Besides direct investment into property many investors via ISAs and SIPPs have piled into UK Real Estate Investment Trusts (or REITS).
REITs really got going in 2007 and quickly got torched in the 2008 crash.
Some never recovered.
Back in 2007 the largest property companies converted to REIT status.
In 2012 legislation changes made REITs significantly more attractive both for property investors and providers of capital behind investments. This was driven by the removal of the 2% entry charge and the use of cash by REITS for the purposes of ‘balance of business assets’.
As a result REITs were able to build up significant cash ‘buffers’ for property purchases.
The attraction of REIT status at the ‘Dominant End’?
On an International level REIT are recognised as tax- efficient structures and this makes investment of international capital very easy.
International investors need standardisation of terms they can understand.
REITs are not subject to corporation tax as long as 90% of property income is paid out as ‘property income dividends’ or PIDs
Advantages to big money funds include:
- Indirect investment into property (less hassle than investing directly)
- Access for UK and overseas retail and institutional clients
- Regular income returns
- No stamp duty to pay. In comparison to paying 5% stamp duty land tax on property purchases only 0.5% is paid as treated as ‘share transactions’
- A wider choice of investments I.E. Shopping centres and industrial estates
REIT status Conditions:
- A REIT must hold at least 3 properties.
- A single property held cannot exceed 40% of total value of properties held for rental purposes
- Owner occupied property disallowed (as these are not for rental purposes)
- In terms of commercial property such as shopping centres or office blocks each rental arrangement is effectively treated as a separate property in terms of reporting for REIT
- 75% of ‘Gross Assets’ and 75% of REITs ‘accounting profits’ must relate to property rental business
So with the conditions out of the way what’s the attraction to the end users. Or should I say, what was the attraction?
Is Property a Bad Choice for Retirement – ISA and SIPP Investors
If investment is made via an ISA or SIPP the ‘after tax return’ is 100%. Compare this to if an investment is made into a UK taxable company (I.E. one set up as a property investment company) then after tax return is 81% (19% paid as corporation tax).
If investment is made outside of a tax-wrapper such as an ISA/SIPP comparative benefits are only 5% (regardless of whether you’re a basic, higher or additional rate tax-payer).
So in that respect getting exposure via a REIT has clear tax advantages. As long as the REIT itself generates positive returns.
More analysis on the REIT sector is here. I’ve broken it down into different sectors with REITs, so make sure you check it out.
Why Property is a Bad Choice for Retirement
Property is illiquid. Very illiquid. Valuations can fluctuate a lot.
For direct holdings (or via an LTD) if property is paid off, happy days. But iff you’re overstretched or have taken debt levels to unsustainable levels – there’s big trouble ahead.
In relation to REITs, the main benefit has been to those that set them up. Many of the investors (both institutional and retail) have not got the returns they expected or were led to believe from REITS.
THREAT: A dysfunctional market which has been propped up by ultra low interest rates is about to collapse by 40 – 60 % from highest property values.
Is Property a Bad Choice for Retirement – Pension Poverty
We all know that lack of diversification is dangerous. Textbook stuff tells us to spread investments and share the risk. The cynicism towards many ‘traditional’ asset classes has, in part, fueled the flight to property especially over the last 20 odd years.
This is about to unravel.
Consequently, it’s going to be investors in their 40s and 50s who will be most severely impacted by this and the real threat of abject pension poverty will be a grim reality for many.
Unfortunately, there is no ‘magic pill’ and perhaps the twisted irony is that it will be millennials (those with cash anyway) who will be the main beneficiaries.
For the future generations, that can only be a good thing.