Some years ago, an overseas investor enquiring about my services suggested that most surveyors do not understand tax and property. I told him I was no exception. We chuckled. I also told him that a UK investor had told me that it is always a mistake to invest in property for any tax advantages, because tax comes under the heading of ‘political ideology’ which is inherently unstable, and open to change at election time. It is therefore advisable to invest in property without regard to any tax advantages beforehand, instead to consider any tax angles as a bonus. The overseas investor said that if my UK investor were representative of the thinking then that was a good example of why most surveyors do not understand tax and property.
Now, it’s possible that the tax treatment for ownership of UK property by overseas investors differs from that for UK-based investors, that I do not know. What I do know is that when you exclude the tax aspects available for investment in property, the proposition might not be as appealing. Generally, any distortion in the market as a result of tax angles is likely to result in a pricing differential. Being old enough to remember when it was possible for two or more people buying a residential property on mortgage to be able to obtain relief on their respective share of the mortgage interest, as well as tax relief on the cost of borrowing for any improvements to the property, I can recall how much more expensive it became to fund a mortgage and improve one’s home when those reliefs were scrapped.
Some readers may not care for my views on what I am about to opine, in fact my late father, a chartered surveyor (BSc (Est Man), FRICS) could never understand my attitude on this particular point, but in 1997 when the UK had a Labour government and Gordon Brown became Chancellor of the Exchequer I wrote to Mr Brown suggesting that the tax-relief available on mortgage interest for buy-to-let investors should be withdrawn. I thought it inequitable that investors could enjoy tax relief, but owner-occupiers could not. The subject was more complicated than I had thought. In those days there was no question that buy-to-let was not considered a business and following objections from large companies concerned about subsidiary arrangements the possibility was abandoned. Since then, whether the subject of whether BTL should really be regarded as a business, as distinct from a hobby, has been considered again, i guess because, with BTL having become so popular. it is apparently easier for the Government to identify the number of tax-payers that enjoy tax relief and categorise the class of investment without prejudicing the tax relief claimable by other businesses generally.
One way to build an empire in both the residential and commercial property market is to remortgage the equity in capital growth. Interest-only mortgages, which can exaggerate the amount of equity, are not a new financial product, but are commonly used with BTL. Unlike residential property BTL, commercial property has one important advantage and that is the concept of the ‘upward-only rent review, which as I have said elsewhere does not mean the rent would necessarily have to go up, that maintains at least the same rent payable (depending upon the structure of the review clause) either from the start of the lease or from each rent review until expiration of the contactual term. The ‘upward-only’ rent review is the bedrock of the commercial property, enabling the investor to plan with certainty, the only risk that the tenant might go broke and any AGA prove worthless.
There is another factor that benefits the commercial property market more than residential, which is that the value of a commercial property is often higher when the property is let than when vacant. Consequently, the value of the yield (rental income) will depend upon investment market sentiment and yield-compression, the relationship between interest rates and the property income (including reversionary rent) will also affect capital value.
For landlords, there are more non-recoverable expenses with BTL residential than commercial property. A good example is IPT which is rising to 9.5%, an increase which will be of little consequence to commercial property landlords because generally tenants reimburse the insurance premium. With BTL residential, legislation tends to be more draconian and tenant-protective, with Local Authorities keen to enforce often zealously and ensure private sector rented housing stock is not abused by the unscrupulous.
I appreciate that BTL landlords provide a valuable service to the residential property market by providing homes for people that do not want to buy or cannot afford to, but rent instead. But let’s face it, there are not as many developers of homes as investors. The housing supply hasn’t increased as a result of the influx of BTL investors: bluntly, BTL is really only about transfer of title/interests. Increase in housing supply is a product of development, whether new building on land from scratch or conversion of large buildings into smaller units. To my mind, it is developers that qualify more for the definition of business, far more so than, for example Mr and Mrs X who having a few bob to spare take out a mortgage on a residential property merely to derive a spare time income for their personal use. The ‘mom and pop’ type of business does not sit well with experienced professional property investors, many of whom are privately delighted that the Government is making life harder for amateurs by withdrawing some tax relief from the BTL equation.
So why is investment in commercial property more deserving of my definition of a business? The answer is to with ownership and economic stability. Commercial property is capital intensive and for most businesses release of the capital for use in other parts of the business is more efficient and cheaper than borrowing. One reason many companies engage in sale-and-leaseback is to free up the capital for use elsewhere in their businesses. Whether the companies do as well with what they spend the proceeds on as do the investors that buy the properties from them may be moot point, but that’s not the issue: the point is that successful business is naturally progressive, the occupants of commercial property are in business and amongst their suppliers are landlords.
Personally, I think BTL is on the wane. Not only because of the change in tax relief, but that BTL is a cottage-industry. In the same way that Japanese car manufacturers started selling cars with what we used to pay for as extras included in the price, and Barrett Developments and others applied the same principle to the sale of flats and homes, fitted kitchen, etc, so the big boys with deep pockets are entering the residential property market and providing a fresh approach to what tenants might reasonably expect for the money. In many areas, there is already an oversupply of residential properties to let. It only needs a shift in expectation amongst tenants of what can be rented for the same sort of money for those landlords that are used to charging just as much if not more for run-of-the-mill property that is not in the same league to find that the supply of decent tenants dries up.
A perennial challenge with residential property is mortgage lending criteria. Every so often, criteria changes. It is too early to say whether better to buy BTL using a company, but whatever the conclusion, bank lending criteria is a separate issue. Every so often too, the Bank of England issues a warning about lending to the property market of which traditionally only the most cautious of banks take any notice. Lending on property is very profitable for the banks, juicy fees for substantial transactions. The Government is intent upon increasing the housing supply which may be good news for buyers, but places a cap on capital appreciation in many areas. Remove capital appreciation and BTL primarily for rental income is going need management wits. With commercial property, the permutations that the market offers may not all last indefinitely but, with a Government intention on the UK being open for business, the tax perks with commercial property could well have the edge.