November 30, 2011

Pensions into Property before Infrastructure

While it is a noble aim, it is unlikely to succeed in the short term. Pension funds are very conservative – they need to be if their many members are to be protected. They don’t like to invest in areas where they do not have detailed knowledge.  At the moment only 2.5% of British pension funds’ assets are invested in infrastructure.

Pension funds understand equities, bonds and gilts. They understand the steady returns from property investment. They are learning about more creative vehicles such as interest rate swaps. But while pension funds have told the Government they like the idea of infrastructure in principle, there is no immediate way to invest directly in infrastructure without going through expensive City fund managers.  So who will set up a new direct investment structure?  The Government?  How long will that take?

There is a much easier and quicker way to unlock the money in British pension funds.  Small self-administered pension funds (those with less than 12 members) are now able to invest directly in commercial property and to lease the property to the sponsoring employer.  Both the purchase price and the rent have to be assessed by an independent valuer, so the whole procedure is at arm’s-length.

But larger pension funds are only able to invest 5% of their assets in “employer-related” property.  The Government could simply remove this 5% restriction, provided the property purchase and lease-back were bona fide arm’s-length transactions.  The property would be legally owned by the trustees of the pension fund, and so separated entirely from the employer’s assets.  If the employer failed, the trustees still have a valuable property to sell.  While the employer remains healthy, it will pay a market rent to the trustees, and from the pension fund’s point of view the rental income will be steady and predictable and will not be taxed.  Everyone seems to gain.

Property is a well-respected, safe long-term investment that returns more than UK gilts or equities.  The Government has it in its power to make this change tomorrow – a long time before the proposed infrastructure fund gets off the ground.

Just a thought.

If you have any comments on this blog please contact Roger May on 020 7583 2222 or [email protected]

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