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Budget 2014 - pension changes and real estate, it shouldn't be about buy-to-let.

The 2014 Budget introduced dramatic changes to Defined Contribution pension provisions with changes to Defined Benefit pension provisions to follow. The key change that has received much media attention is that policy-holders will no longer be required to purchase an annuity but can instead draw down a lump sum in cash. This has a number of consequences for the real estate industry.

 

Will the cash be invested in property?

 

There has been considerable speculation that the changes will encourage cash lump sums to be drawn and invested in buy-to-let properties. This may be the case, but were suitabl,e fund products available then investing through property funds would be more practical in many cases. Unfortunately the attractiveness of real estate funds for retail investors is diminished by the regulatory requirements for retail funds and the way that the investment platforms operate. The presumption is that investor protection for retail investors is provided by liquidity. Unfortunately real estate is an illquid asset class. Lquidiity comes at a significant cost.

 

The trade off between liquidity, volatility, performance and risk were discussed in the report "Unlisted funds, lessons from the crisis" written for the Association of Real Estate Funds (AREF) by John Forbes. More information on the report is available here.

 

The report was used by AREF in lobbying the FCA for changes to the liquidity requirements for real estate funds marketed to retail investors. The  AREF letter to the FCA can be downloaded here. This letter related specifically to the permitted links rules for insurance products. The comments are applicable to the rules for Authorised Funds generally. In view of the changes to the pension rules, it is important that the real estate fund rules are amended to match.

 

It is also important that the consultation on the treatment for stamp duty land tax (SDLT) for Property Authorised Investment Funds and Tax Transparent Funds reaches a positive outcome. More details are available here.

 

Longer term impact

 

The changes will have longer-term impacts for pension provision that will have an indirect impact on investment in real estate funds. These include:

 

i)  The removal of the requirement to purchase an annuity will diminish the available investment capital of providers of annuities, including many traditional life insurance companies who are major investors in real estate as an asset class;

 

ii) The changes are likely to increase the attractiveness of defined contribution pension schemes. This makes it important for the real estate industry to develop more fund products that are suitable for the DC market..

 

iii) Conversely defined benefit schemes are likely to become less attractive. This  may be compounded by the reaction of life insurance companies to the DC pension changes. Some commentators believe that life insurance companies losing their annuity business will move aggressively into the defined benefit pension scheme buy-out market..

 

These changes are likely to accelerate an existing trend away from DB pension arrangements and traditional life products to defined contribution provision, the consequences of which will be very significant for the real estate industry.