Secrets Of Success: Brown's property U-turn is spot on
Saturday 10 December 2005
The Chancellor's change of mind over what you will and will not be allowed to put into a self-invested personal pension (Sipp) come next year has, I am glad to say, taken some of the sting out of what I was planning to say about the hidden perils of A-Day, the new pension regime that begins in April.
By removing the opportunity to put directly owned residential property, wines and antiques into your Sipp, Gordon Brown has hardly done the terrible thing that the anguished howls of the financial services and property industry might lead you to believe. Perversely or not, I think it is one of the more sensible things that Brown has done in recent years.
On this occasion, unusually, I find myself sharing the view of Which?, the consumer group. It said a few weeks back that watching the build-up to A-Day has been a bit like standing on the side of a railway line, helplessly watching a train crash about to happen.
For you can be certain that, while the smart, the well-advised and the wealthy will take full advantage of the new pensions regime, as they always do, the less financially sophisticated run a serious risk of finding themselves being taken for a ride.
Look back through financial history and you will find countless instances where doing things for a tax reason alone has led to unfortunate consequences. Combine that with the fact that, in practice, tax concessions tend to be the financial services industry's most potent selling weapon, and the Sipp rules, as originally proposed, were shaping up as a potential recipe for damage to innocent people's wealth. (I have no problems with the Sipp concept, itself, which is an excellent one for anyone who is prepared to take the responsibility of managing their own money, but should the Government really be encouraging so many people down that route?)
It is no surprise to me that the biggest howls of protest about Brown's change of heart have come from the intermediaries and professional firms that have been trying so hard to persuade people to part with their money in order to take advantage of the new rules, for example by buying off-plan flats in the hope of getting an effective 40 per cent discount on the purchase price. Nice work if you can get it (for the advisers and promoters that is), but try as hard as I can, I cannot think of a single valid reason why second homes, designer flats and vintage wine should attract this kind of generous tax benefit.
The marketing men may have lost a nice little earner, but the country, as a whole, is surely better off for Brown's change of heart on this specific point (not least because most of the assets that have now been disqualified already look dangerously overpriced, and the latest wave of tax-induced demand threatened to push prices even higher). Far from whingeing, if it is true that they won't now go ahead with the transaction, those who have been buying flats and wine ahead of the Budget for the promised tax benefit should be grateful for the lesson they have been handed.
Quite apart from the investment risk of chasing tax wheezes, the broader lesson is that governments should never be trusted on tax, as they can and do frequently change the rules to suit the purpose of the day. If you commit too much money to your pension purely for the tax benefits, you are putting that risk right at the centre of your investment strategy - with the added drawback that once committed, you can only get 25 per cent of the capital tied up in your pension back.
On the other hand, the news that real estate investment trusts, or Reits, as they are known, are now to go ahead is generally good news. The absence of a simple, tax-efficient way to own a share of a diversified property portfolio has been an obvious investment anomaly in this country for some time. Even if this is not the best time to start buying into commercial property, in particular, over time it seems a safe bet that Reits will flourish and become a routine part of many private and professional investors' portfolios, just as they have in countries such as the United States and France. (You will also be allowed to put them into a Sipp as well, as the rules currently stand).
It is true that we don't yet know exactly how the conversion charge - the tax that existing property companies will have to pay if they want to convert to Reit status - will be set. Exactly how onerous this proves to be will determine how many quoted property companies eventually choose to become Reits.
The share prices of most property companies have risen strongly in the past 18 months in anticipation of the new regime coming into force, and many already look richly valued, underlining the wisdom of the old market adage: "buy on the prospect, sell on the new".
Nevertheless, a converted property company will not be the only source of Reits. You can be sure that we will soon see a raft of new property funds coming to the market in one form or another, to take advantage of the new regime.
There is probably no need to hurry to put one of these new creatures into your pension, but the attractions of having a significant property element in your portfolio are proven and obvious, independent of the tax-break status.
In Standard Life's annual Global Horizons publication, out this week, Andrew Jackson, the property investment director, points out that annual returns from commercial property have been very strong in the past few years, and may drop from double to single digits during the course of the next few years.
However, even if there is a bit of a bust when the global residential property bubble starts to deflate, property has earned its place as one of the core assets with which investors should be constructing their portfolios, not least because of its diversification benefits.
The chart below illustrates how this might play out for Reits when they appear. According to Standard Life, a balanced portfolio of property, held as a mixture of direct investment, ordinary and geared funds, has historically produced strong returns with relatively low risk. The exceptional returns of Reits in other countries to date have come at a cost of higher volatility - suggesting that there is, indeed, some sort of bubble developing in their shares at the current time.
On that basis, on valuation grounds, the next cycle may be more profitable than the current one.
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