How To Invest In The Property Market Using Your ISA Or Pension

This is something that I am often asked about.

A lot of people that have an ISA or a pension want to know how they can make investments in the property market for a better return.

I will answer this in some detail in this post.

Before I get into the details I want to tell you this right upfront – property prices can go up as well as down. You need to take this into account when you are making a decision to use your ISA or pension fund to invest in a property.

OK now we have got that out of the way let’s have a look at what you need to do.

Investing in the Property Market using your ISA

First of all let’s look at what an ISA actually is. In the UK there is now an Innovative Finance ISA also called the IF ISA. This was introduced back in 2016 and it enables investors to obtain tax free returns from asset backed securities which include property, direct lending through specific online platforms and peer to peer loans.

Prior to the introduction of the IF ISA, the only way that you could get your hands on tax free returns was through a conventional “cash type” ISA or a stocks and shares type ISA. The IF ISA is not just good news for investors; it has had a positive impact on the financing of property development as well.

Since its introduction the IF ISA has been very popular. HMRC records show a year on year increase of 700% in the 2017/2018 tax period. Over £290 million was invested in IF ISA accounts in that period and it shows no signs of slowing up.

What is the reason for this popularity? It is a simple matter of the potential returns. Most people have Cash ISA’s and the average return on these is only about 1% to 1.5% per year. Often inflation is above this so in theory people are actually losing money with these accounts.

An IF ISA has the potential to yield between 3% and 12% depending on the provider. There is a downside and that is that IF ISA’s do not have FSCS protection so there is an increased level of risk.

How does a Property backed IF ISA work?

When you choose to invest in a property development loan, you are banking on the property development selling at the “loan to value” (LTV) percentage so that your capital is returned. So let’s say that a developer borrows £5 million against a development worth £7 million.

There will be two parts to this loan – these are known as the first charge or senior loan and the second charge or mezzanine loan. The first charge is 50% of the LTV so in this case will be £3.5 million. The remaining £1.5 million will make the total LTV to be just over 70%.

Once the developer sells 50% of the development the first charge loan has to be repaid in full. After selling just over 70% of the development they must repay the second charge. This provides you with a high yield investment opportunity.

It is all about risk and return. The higher the risk the lender is prepared to take the higher the yield is likely to be. With the example I gave you in mind, people that had invested in the first charge loan would normally earn a 5% to 6% yield on their capital. If you were part of the second charge action then you could make a return of between 8% to 12%.

One of the things that I really like about IF ISA’s is that it is another way that you can diversify your property investments. As a property investor you know that there are always potential risks so diversifying always makes sense. With an IF ISA you are diversifying in new property builds which you have probably not been involved with before.

Investing in the Property Market using your Pension

The debate about whether pensions or property are better forms of investment has been going on for a long time. A few years ago, a pension fund was seen as a very safe way to save for your retirement. People have changed their views about the safety of pension funds for a number of reasons in recent years.

Most people feel more positive about bricks and mortar than they do a pension fund nowadays. Unfortunately there is a distrust of the financial services industry (some of it justified), so it makes sense that people that have pension funds want to look at investing some or all of it into property.

Today it is possible to transfer your pension into property but you need to be aware that there are some exceptions. These exceptions are related to the type of property that you have would like to invest in.

Some people have the idea that they can take all of their money out of a pension fund and transfer it to property. This is not necessarily the case. Others think that it is fine to transfer their pension into a normal residential property or even a buy to let property. While you could do this you will end up with a hefty tax bill and it would not be worth it.

Another reason why transferring your pension into a residential or buy to let property is not a good idea is because the property then forms part of your estate which means that it is subject to inheritance tax. A double tax whammy!

There are Residential Property Funds that you can transfer your pension into that does not have these hefty tax burdens. The problem here is that you have no say in which properties that are invested in and there are going to be fund management fees and possibly other charges to contend with. But it is better than paying a lot of tax.

Commercial Property Investment is the way to go with Pensions

If you transfer your pension into commercial property then you can actually gain a number of great tax benefits. You could also find that you can benefit from rental income as well as capital appreciation too. And if you decide to sell the commercial property you will avoid paying Capital Gains Tax.

As long as you hold the commercial property in your SIPP (self invested personal pension) you will not be liable for any tax on the income that it generates. A lot of people actually purchase a commercial property to run their business from. In this way the profits from the business can pay off any mortgage and the pension fund receives income too.

As things currently stand these are some of the commercial property types that you can invest in from your pension:

  • Public houses
  • Shops
  • Farmland
  • Restaurants
  • Care homes
  • Office blocks
  • Warehouses
  • Factories
  • Garages

You need to look at the potential of each of these commercial property types before making a decision. Do you want to run a business in the property or just rent it out? Do your homework before you decide.

Advantages and Disadvantages of using your Pension for Property Investment

As you can imagine there are advantages and disadvantages to using your pension fund to invest in property. Here are the major advantages:

  • The prices of property have been steadily increasing in most areas of the country. If this continues then you stand to get a better return than with other forms of investment.
  • It is a way to generate a regular income from your pension investment before you reach the age of 55.
  • If you need cash fast then you can release equity.
  • You will own a property asset which will not be affected by crashes in the market.

And now the major disadvantages:

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  • Property prices could fall – price rises are not guaranteed.
  • If you have to acquire a mortgage to purchase the property then you could end up in a negative equity situation of the price falls.
  • It may not suit everyone to make a large financial outlay on a property.
  • You are unlikely to sell the property fast so it will tie up your money.
  • You may require am mortgage to buy the property.
  • It is likely that there will be costs associated with maintenance and repairs.
  • If you rent out the property then tenants represent a financial risk.

As a property investor you will be aware of most of these disadvantages as they apply to any kind of property investment.

Important Note

What I have provide you with in this post is the facts as I see them concerning ISA and pension property investment. You should not consider me to be an expert in this and I strongly recommend that you seek professional advice if this kind of property investment is of interest to you.

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