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The Henley Group, which has been operating in Hong Kong since 1989, has established itself as "the financial advisor of choice" for a large part of Hong Kong's British expatriate community. Although the Group's reputation has been built around the provision of professional, tax efficient investment advice, this advice has historically been focused around more traditional offshore investments, including pension and life insurance products.

In this article Antony Michell, owner and Managing Director of The Henley Group Limited, explains the increasing attraction of property as part of a pension portfolio and how such investments may be structured in the light of the new pension legislation being introduced in the UK.

Historically individuals have planned for retirement by contributing both monthly and lump sums toward a pension scheme. Over the last few years we have received an increasing number of queries from clients interested in using physical property (rather than property funds) as part of their pension portfolio.

Whilst this can partly be explained by the strengthening of property markets and weakening of equity markets certainly from 2000 to 2003 (see Figure 1), there are other factors that are making clients look more closely at property.

No time or age restrictions apply when realising your investment good for those considering early retirement!

No limits exist as to how much of your profit you can withdraw traditional UK pensions (unlike tax efficient offshore savings plans) restrict the lump sum you can draw.

Property returns come in two flavours: rental income and capital growth which can be utilised up to and throughout retirement.

Property investments are tangible. You have direct control over your investment, rather than delegating to an unknown fund manager or pension provider.

Property investments can be tax efficiently geared through the use of favourably structured mortgages with attractive rates.

From April 2006, commercial properties can be added to a UK pension portfolio using the new Self Invested Pension Plans (SIPPs) legislation.

Whilst these factors do make property investment appealing, it should come as no great surprise that the Association of British Insurers suggests that the key to retirement planning is not to rely on just one investment. It strongly recommends a balanced portfolio of cash, bonds, equities and property.

In a recent report Alison O'Connell a director of the UK Pensions Policy Institute said that "Saving in property is often proposed as an alternative to saving in pensions. But only a wealthy minority will be able to invest in property other than their own home. For most people, property will be at best a complement to occupational or personal pensions, not a substitute - the majority of people will not have enough housing equity to allow them to retire without saving in other assets."

Although more wealth is held in housing than in private pensions, and property has done better than pension funds in recent years, the report argues that, long-term, pensions do slightly better. Since 1970 pension funds have increased on average by 11.6% while property has grown by 11.1%, indeed Figure 1 shows that the returns have been close over the last twenty years. But thanks to the recent boom in house prices, one in eight of all working people now expect property to be their main source of retirement income.

So accepting that property should be included as part of a balanced retirement portfolio, what are the different ways that physical property can be included in a pension portfolio? And what are the relative advantages and disadvantages of the various approaches?

We still come across clients that are banking on the sale of the family home and a move to a smaller property to release sufficient funds for their retirement - maybe through the purchase of an annuity or the establishment of a tax efficient investment portfolio.

Whilst this approach potentially offers a significant tax benefit - you don't have to pay capital gains tax your principal private residence trading down can be a risky strategy.

You may not be able to sell your house or it may fetch less than you hoped. Remember that retirement is becoming more and more expensive, particularly when including the costs of long term health care.

Although we always reinforce that an individuals perceived level of lifestyle at retirement will be dependant on their existing spending patterns stop spending and start saving now - as a very rough rule of thumb you'd need to release at least £300,000 to fund a relatively modest retirement.

Over the last few years the British Government has been encouraging individuals to invest in "Buy to Let properties. This approach involves buying a property specifically to let out to tenants with the intention over the long term of generating an income and also hopefully seeing an appreciation in the value of the property a capital gain.

Of particular significance to British expatriates is the expansion from April next year, in the type of assets that individuals can place in their pension funds this will make property investment even more attractive. Individuals will be able to add UK and overseas commercial properties (The initial proposals included residential property but the UK chancellor amended the proposal to make the inclusion of residential property less attractive, in December 2005.) under the new self invested pension plan regime (SIPP's). For the first time, this will allow individual investors to build up property portfolios where both the income and capital gains generated are free of tax. However, it should be noted that the rules governing SIPP's are very detailed and specialist advice should be sought if you are a property investor that anticipates retiring in the UK.

It should be noted that although many clients are convinced that they have got the location of their Buy to Let property right, many have failed to spot the common pitfalls associated with such investments.

In most countries it is far more tax efficient to utilise a mortgage to buy an investment property rather than purchase for cash - but it is critical that the right type and amount of debt is established at the outset.

With Buy to Let properties it is often a good idea to establish a tax efficient savings vehicle to repay the mortgage rather than opt for a repayment mortgage otherwise as the debt falls, even if the income remains static, the tax bill will rise.

Be aware that void periods and unexpected repairs and maintenance costs can very quickly wipe out any profits that you had planned to use to repay the mortgage. A good letting agent should very quickly be able to justify their letting fees (often as high as 16%), by significantly reducing administration and void periods.

Make sure that you obtain professional advice first when considering the viability of such a potential property investment. We have had clients that found themselves subject to capital gains tax, income tax and inheritance tax in the UK as a result of an investment, even though they were not actually living in the UK in some cases the individuals were not even British expatriates!

Buying property overseas has become increasingly popular. We have received so much demand in recent years from clients wishing to purchase properties in Thailand, Bali and Australia that last year we established Henley International Properties Limited, headed up by property guru John Brun, to specifically search out properties in international markets for clients and non clients alike.

Recent figures from Spain show that 42% of real estate buyers in the last year were British and that over 500,000 Brits own a home there (Datamonitor's 'Buying Property Abroad' report 2004).

The obvious reasons are sun, sea and sand. It can also be a good investment if you decide to let your overseas property - you can benefit from a regular rental income and use this towards retirement planning.

Do bear in mind that it is very likely that you will have to pay tax on the capital gain you make on the eventual sale of the property - in Spain such gains are taxed at up to 35%.

At the outset you need to decide whether you are looking for capital appreciation, rental income or simply somewhere to enjoy your holidays typically at a significantly greater annual cost than you would ever spend on a five star hotel. If your main objective is rental income, the choice of area in which to buy will be by far the most important decision you will make.

Buying a home in Asia is not the same as buying in the established markets such as the UK and Australia. In Asia the key to successful property investment is still about the three "L's" not location, location, location, - instead it is all about location, land title and legal structure. There are also local tax rules that you need to get to grips with. So you'll need to do your homework or have someone do it for you - skimping on specialist advice could cost you dear.

Again from April next year, overseas properties can be added to UK SIPP's. However, the impact of local taxes on the overall investment returns will also need to be taken into account if considering such a route.

In summary, you should ensure that you receive professional advice today to ensure that you end up with a suitable portfolio in the future - a portfolio that is balanced, as tax efficient as possible and involves limited administration. There is a lot to be said for keeping things simple, particularly in retirement. Most people would rather be relaxing by the pool than spending all day managing their retirement portfolio!

If you would like more information on this topic please contact us

This article first appeared in the September edition of the Britcham magazine, "Britain in Hong Kong", but has been updated to take account of the recent changes in the proposed SIPP legislation.