SIPPs Pitfalls for Property Investment
Hotels Attract Big Money
Copyright: David Lawson - first published Property Week August 2005
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Investors and agents are counting the months to what appears an opportunity for huge extra profits in holiday and fly-to-let property. From next April residential property will be allowed into self-invested pension plans [Sipps], bypassing capital gains tax and easing income tax on rents. That will come as welcome news to agents like Peter Cornwell, a partner with Marsdens Cottage Holidays, which specialises in the intensive management required, ranging from changing bedsheets to dealing with tenant emergencies.
The market is already booming as investors tap surplus equity in primary homes and gear up with easy loans. Second home ownership has risen 15%, with more than 1m households now registered, says Cornwell. But the pot at the end of the pensions rainbow may have some serious cracks, particularly when buying abroad.
Firstly, Sipps are not individual playthings. They must be run by an independent pension fund administrator and trustees. That involves higher up-front costs and ongoing charges which have to be set against potential extra returns. Buyers intending to use second homes for their own families will also have to pay a market rent. Admittedly this goes into the pension fund, so the benefit may come back, but advisers are still not clear about whether this outweighs costs.
In fact, no-one can be certain what the rules will be until the Inland Revenue issues clear guidance. Only last month advisers were caught on the hop with a consultation paper which appeared to muddy the waters on whether property could be sheltered against inheritance tax via personal pension funds. This kind of bureaucracy palls beside potential hurdles if investors aim to buy abroad. Even within the so-called single market of the EU laws vary enough to cast huge uncertainty over wrapping buy-to-let and holiday property in pension funds.
In Spain, for instance, a trust cannot own property, so investors would need to set up a shell company. Some have been doing that for years to avoid inheritance tax and recently were caught on the hop by EU recommendations which could mean huge back-tax bills. There is also no agreement between European countries on the tax position of pension trusts. Rents in Spain are liable to 25% tax with no provision for being set against interest charges. Capital gains are also taxed at a hefty 35%. Tax arrangements in popular eastern and central European countries are even more open to wide interpretation and those nations could take years to consolidate into European standards. Buyers could find themselves calculating benefits based on UK exemption then slapped with huge unexpected local bills.
Even at home the tax situation is far from clear. Buyers have a tendency to start with the idea of offsetting costs by renting out for part of the year but give up because they don’t like strangers in their home. Or they may drop out of renting once local tax bills start arriving, relying on capital gains to make the investment worthwhile. Yet the Inland Revenue may take a tough line, assuming the property is available for family use the whole year and imposing a ‘benefit in kind’ tax.
And all this time the property is not really a family home at all. You can’t repaint the living room or replant the garden let alone build an extension to allow space for granny’s wheelchair without applying to the administrators. They, as representative of the pension fund, are the real owners. They will not, of course, be unreasonable. But what about the time you want to get your brother-in-law to do the painting in exchange for a free holiday? Or use a nice old man in the Tuscan village to cheaply relay a floor? Pension trustees must stick to legal rules and could demand more expensive registered workers. Add this to the extra risks of buying abroad and some major names are already making it clear they will not allow overseas property to be wrapped into the Sipps they administer.
That could create huge pressures on UK tourism property. If buyers shun overseas homes and pile into the West Country, Lake District and Wales with the same fervour they have conventional buy-to-lets, prices will explode overnight, sparking the kind of political controls on outside buyers already creeping into regions where locals have been priced out of the market. Agents also fear that a fast-expanding pool of property could quickly outstrip demand for space. Lettings are already highly seasonal and there may simply not be enough holiday tenants to go fill all the extra property. Tax benefits are no use if income dries up and values drop.
Starwood Hotels & Resorts is selling the legendary 233-room Hotel Danieli in Venice to The Statuto Group, a prominent Italian real estate holding company, for 177 million Euros. Jones Lang LaSalle Hotels and Deutsche Bank advised. Hotel investment has boomed in the last couple of years, says Mark Wynne-Smith, European CEO, Jones Lang LaSalle Hotels. He anticipates this to continue rising by at least 10% for portfolios and 5% for single assets in 2005.
Analysts will be closely watching the impact of London terrorist bombings on tourism bookings, as the UK has been the main focus for investors, representing 58% of single asset transactions and 75% of portfolio deals in the last year, says JLL. In the meantime, the market is in overdrive. Three portfolios worth almost £1.5bn are up for sale as owners look to cash in on rampant demand from institutions and opportunity funds which cannot find enough other property to soak up the billions pouring in.
Marriott is the biggest player, with 46 hotels offered by agents CBRE worth more than £1bn. Jarvis and Artesian Property are also understood to be seeking offers for some or all of their hotels. Not everyone is selling, however. MWB is raising more than £100m in equity and debt to expand its Malmaison and Hotel de Vin chains in preparation for a stock market flotation in the next two years. The logic behind this surge of sales is simple: operators make more money out of management than property. A few years ago that would have involved a straight sale and leaseback but these deals tended to weigh balance sheets down with rent obligations. Nowadays they tend to involve straight sales tied to management agreements. Hoteliers are betting they can sell their reputation and brand as much as the property, and so far investors appear to be happy to take them on.