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Source: Property Mall.com
Gains in British residential market
pose taxing problem for investors
Using surplus cash made from
increased rentals to pay off a loan can bring unwelcome dilemmas
Most people with an interest in residential
property are aware that prices are rocketing in Britain. Hong Kong-based
investors who were fortunate enough to enter the market in the late 1990s or
earlier have seen spectacular gains in value.
They have also seen significant increases in rents
they receive. For many, this has created a dilemma. To understand why,
consider the circumstances of a typical property investor in this position.
Often, they will have obtained an interest-only
loan to buy a house or flat in London. The loan is usually pitched at such a
level that the interest payments together with other allowable expenses are
more or less equal to the rent, leaving no surplus exposed to British income
tax.
However, many of these landlords have been able to
increase the rent over the years in line with increasing values. As the
revenue stream has exceeded costs, a sizeable surplus sum has built up in
many cases. And here is the dilemma: if property investors use this money to
pay off part of the loan, will there be unwelcome tax consequences?
Recall that we are speaking of an interest-only
mortgage, and the main reason for structuring it this way is normally to
mitigate tax.
If the extent of the borrowing was reduced, there
could be significant income tax exposure in the future because the reduced
level of the loan would create lower interest to offset. So, purely from an
income tax perspective, it might not make sense to pay off part of the
principal.
But there is another, less obvious matter to
consider - inheritance tax (IHT). All assets in Britain are subject to IHT,
no matter where the owner resides. However, in calculating the value of an
estate for IHT purposes the net value of assets is used - that is, the
property value less any applicable debt. If an investor paid off part of the
loan, this net value figure relating to the property would rise, thus
increasing the potential IHT.
Surely, some would say, if someone were to use a
British-based cash sum (which would be part of an estate) to reduce the
balance of a loan, the net effect would be tax neutral.
This is certainly true for Britons, who will be
liable to IHT on their worldwide assets. But we are principally considering
investors based in Hong Kong, who are non-UK residents and not domiciled in
Britain. These people could place any surplus cash on deposit offshore,
removing it from British IHT, keeping the loan in place to maximise their
reduction in overall UK-based assets. For such investors, income arising
from the offshore deposit would also escape British tax, as it would arise
outside the country.
But a decision like this is not always reached
entirely on the basis of logic, or purely to minimise tax exposure. Often,
individuals dislike the idea of indebtedness, whatever other factors may
apply. In such cases there may be strong personal and emotional reasons for
taking certain action - including reducing a British loan taken out to
assist the buying of an investment property - tax notwithstanding. Whatever
view one takes, important financial choices should never be made without
professional advice.
For British income tax and IHT purposes, the most
beneficial tax strategy would probably be to maintain the loan at its
present full level and remove any surplus cash to an offshore deposit.
Whether that will be the most emotionally satisfying option is another
matter.
Alan Lester is a partner in London
chartered accountant HW Fisher & Co. -
July 21st 2004 SOUTH
CHINA MORNING POST
U.K. House Prices Rise Near Quickest Rate in 13 Years
U.K. house prices rose at almost their
strongest annual pace in 13 years in December, the Nationwide Building
Society said, making it less likely the Bank of England will cut interest
rates.
Prices rose 25.3 percent from December 2001 to an
average of 117,206 pounds ($189,000), the U.K.'s fifth-biggest mortgage
lender said. That was near the 25.5 percent gain in the year through
November, which was the fastest pace since 1989. House prices rose 1.7
percent in December after a 2 percent gain in November, Nationwide said.
``We expect rates to rise over the course of
2003'' which may damp demand, said Nationwide economist Alex Bannister. The
Bank of England will probably increase its benchmark lending rate to as much
as 4.75 percent by the end of this year.
The U.K. central bank trimmed its key lending rate
seven times in 2001, to a 38-year low of 4 percent, encouraging consumers
who fuel two-thirds of the economy to borrow and spend. Europe's
second-biggest economy expanded 0.9 percent in the third quarter, the
fastest rate in almost three years, boosted by the building of new homes.
The central bank's governor, Sir Edward George,
and his chosen successor, Mervyn King, have called the pace of last year's
house-price gains ``unsustainable.'' The bank forecast in November that
inflation would push past its 2.5 percent target much of next year partly
because of house prices.
`Robust Market'
Housing-market activity ``remained robust'' in December, Nationwide said in
today's report. Some 147,000 houses were sold in October -- the latest
available figures -- an increase of 5 percent compared with the same month a
year earlier.
Total gross mortgage lending probably rose to a
record of more than 215 billion pounds last year, Nationwide estimated.
That's an increase of about 36 percent from the previous year and more than
twice the peak reached during the last surge in house prices at the end of
the 1980s, the lender said.
``Remortgage and equity withdrawal continue to
boost mortgage lending, with the former accounting for nearly 40 percent of
all lending and the latter at record levels,'' Bannister said.
U.K. house prices are likely to continue rising
this year, though at a slower pace of about 10 percent, Nationwide
predicted. London prices will probably gain about 5 percent and prices in
northern England some 15 percent.
``With affordability stretched, interest rates
rising, confidence declining, and employment and income growth sluggish,
it's possible that certain pockets of London and other hotspots around the
U.K. may see house-price falls at least for a period,'' said Nationwide's
Bannister. - By Reed V. Landberg and Iain Rogers
Bloomberg
2 Jan 2003
London
landlords struggle
Rental
returns elsewhere hold their own compared with other investments
Landlords
in the capital are feeling the pinch with rental returns in some cases
sinking to below mortgage interest levels.
Strong
growth in residential property values during the past five years has led to
average gross yields falling by 2.4 per cent nationally, according to
FPDSavills Research.
Gross
yields from British property are 9.1 per cent, compared with 11.4 per cent
in the spring of 1997.
The
average net yield, after allowing for management and maintenance costs, is
6.5 per cent, a level close to rates of finance on investment mortgages.
Richard
Donnell, director of FPDSavills Research, said considering recent
stock-market volatility and levels of return on savings accounts the net
yield from average British residential properties seemed relatively
attractive.
When
capital growth is taken into account and expressed as a total return,
residential property has performed well in the past five years compared with
other assets. Rental and capital returns totalled 16.8 per cent last year.
FPDSavills
expected continued capital growth but at a lower rate than during the past
five years. It predicted total net returns this year of 11.5 per cent.
Despite
the forecast slowdown in capital growth, FPDSavills said during the medium
term the rise in average residential values would be sustained, because in
many parts of the country housing remained affordable.
Furthermore,
cheaper levels of long-term finance would keep the upward pressure on
values.
These
factors would continue to attract investors, Mr Donnell said. The national
picture was rosy but there were some parts of the country where investors
needed to be more wary, he said.
These
locations were where capital values had grown strongly during the past five
years or where new residential development activity had added high-value
stock in new or emerging-market areas.
Mr
Donnell singled out central London, where the average gross yield from
residential property was 6.5 per cent. After allowing for costs, net yields
stood at just 4 per cent, a level which was below rates of finance.
Bank
of England interest rates are 5 per cent, with commercial mortgage rates
higher, some at about 6 per cent.
"Below-average
yields in these locations mean investors are banking on strong capital
growth to help offset the lower rental yields," Mr Donnell said.
"They
may have to use higher levels of equity to ensure the net rental income
covers the mortgage payments."
Rising
rents have helped cushion the blow for some London landlords. According to
DTZ Residential's latest quarterly Prime Central London Residential Report,
rents rose 6.5 per cent in the year to March. The districts of Mayfair,
Kensington, Knightsbridge, Belgravia, Regents Park and the City of London
were covered in the report published last week.
However,
falling yields, rising sales prices, concern about the health of the United
States economy and increased competition between landlords meant the
lettings market was tight, with many landlords having to spend their way out
of trouble.
Regina
Poon, associate director in charge of central London lettings at DTZ
Residential, said: "We're feeling the pinch a little. It is a bit
quiet."
Higher
yields were available provided investors bought good-quality properties and
spent money on decorating or refurbishing them to a high standard.
One
of her clients had achieved a 9.72 per cent gross yield on a two-bedroom
flat he bought close to Trafalgar Square, because he had furnished it to an
exceptional standard, she said.
The corporate tenant had paid three years' rent up-front.
To furnish a home to a sufficiently high level, investors needed to spend £12,000
(about HK$132,681) to £15,000 on a one-bedroom flat and £25,000 on a
two-bedroom, she said.
Unfurnished homes sat on the market for months, because there was no demand.
Net yields would be hit by the high expenditure on furnishing, Ms Poon said,
but landlords prepared to hold on to their investments for at least five
years believed it was worthwhile, particularly when gains from future
capital growth were added.
- South
China Morning Post
June
2001
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