Land and Inheritance Taxes - the Investor Opportunity

To investors, U.K. land and inheritance tax structures can be a golden opportunity.

Most UK investors in land and other assets wish to minimise the tax burden to their heirs. There are means to accomplish this -- and to realise tax deductions.

Taxes on land investments in the U.K. are unquestionably complex, as much as they are in most parts of the world. Part of the country’s history with real estate includes intentionally attracting outside investments (from non-citizens and non-residents) as a means of furthering investment and development.

The country’s Inheritance Tax (IHT) structure has been in place since 1986, and includes a spousal exemption that hinges on a transferable nil rate band policy. It allows for surviving spouses and civil partners to receive up to 200 percent of the nil rate band, from which they can distribute asset value (or cash) to relatives. The nil rate band is adjusted for inflation, last established for the 2010-2011 tax year at £320,000 and will be reconsidered for increase in April 2015. Up to that amount the tax is 0 percent, while value above it proceeds are taxed at 40 percent.

Following is a collection of how the tax structure affects land investors, starting with rules that apply to inheritances:

• For UK residents, taxes apply to inheritances of UK land, as well as property income, gains and transactions of real property. This can include rental income from property, profits, rent and capital gains.

• Non-residents of the UK are not subject to a tax on capital gains from UK assets, including land.

• “Moveable” (non-land) and “immoveable” (land and mortgages) investments are treated separately under UK inheritance tax statutes. Upon a landowner’s death, where the property is located falls under the rule of lex situs (laws that apply to the location). Even if the deceased had lived in France for ten years, his or her land in the UK is taxed according to UK statutes. Only the moveable assets (e.g., art, jewelry, securities outside of the UK, etc.) are free from UK IHT.

• Marriage does not make the spouse an automatic co-owner of the property of the property. Only if the spouse is written into the property title does he or she continue to own it without paying IHT upon the death of the other spouse.

• A landowner can give away land, within limits, while still living as long as it is not done to avoid the claims of creditors. All rules regarding IHT transfer taxes apply.

Some applications of real property actually result in tax deductions. For example, gifting of farmland under the provisions of the Agricultural Property Relief can provide tax deductions for the benefactor in the tax year in which the gift is made. Donations of assets including real assets such as land to a UK-registered charity can also provide deductions to the benefactor. Individuals who elect to sell property to a home reversion plan, an Equity release scheme, are allowed to write the income stream proceeds into a trust for beneficiaries by way of a life insurance policy.

Is the Opportunity to Buy Raw UK Land for Development Past?

There is unquestionably a recovery in residential and real estate values in England. But that doesn’t mean that opportunities for investors have passed.

It would be wrong to describe the land and housing market in the U.K. since 2007 as a “rollercoaster.” The physics of a rapid drop followed by a flat line and now, finally, a slow but steady climb would not be likely in an amusement venue such as Thorpe Park in Surrey, Blackpool Pleasure Beach or Alton Towers in Staffordshire.

In fact, the ride that investors, homebuilders and would-be homebuyers have been on the past several years has been far from amusing and certainly not fast moving. The precipitous drop from the housing bubble peak of 2007 has meant that builders were reluctant to construct new homes because buyers were having a difficult time coming up with the necessary deposits required for purchase while banks concurrently imposed stringent limits on who qualified for a mortgage. Not only did homes fail to maintain value, but raw land that is ripe for development went undeveloped.

Note this all occurred while the British population registered a 7% growth rate over the century’s first decade.

So while development remained stuck in place, demand was building. The mistake many make, say analysts, is to consider the entire UK as a single market. In fact, it varies considerably from city to city and region to region. The rapidly increasing housing prices in London and the South East are driven in part by well-off foreign investors seeking refuge from unstable economies in their home countries (in the Eurozone, in particular), in the Middle East and China. But the slow increase or non-increase in land and housing values in other parts of the country presents a very different story.

According to PropertyWire.com, a global property news service, homebuilders in the UK saw sufficient sales activity in 2013 such that they are now seeking serviced land elsewhere, outside the “hot” markets of London and the South East. The publisher notes that UK Greenfield land values rose by 1.4% in the first quarter of 2013, an annualised growth rate of 3%. But still, this varies greatly from location to location.

Savills, the real estate firm, cautions that distinctions should be made between values driven by market rate housing and social housing. With less government support for the latter, the averages actually represent greater demand in the market price sector. They point out three factors that were in play in 2013:

• Private house building starts up 7% – The first quarter of 2013 saw 22,200 new homes under construction, a marked rise over the last quarter of 2012. “There are clear signs of more positive industry sentiment and activity,” says a Savills research director.

• Look to the outer zones of London – The undersupplied middle market is creating a need for homes outside of central London. Government lending schemes are largely targeting the homes valued at under £600,000.

• Larger homebuilders have the cash – While a shortage of cash has caused many homebuilders to scale back the size of projects, the UK’s eight largest builders reported net profit growth of 33% in 2012. This means they have the capitalisation to increase the volume of their work.

In summary, the opportunities to invest in the housing market, particularly in buying UK land, are quite mixed. It depends on local economies and the scale of development being targeted.

In shifting economies such as this, the tendency is to find creative solutions. One is that real estate development risk is now often shared between investors who purchase and prepare land and homebuilders who deliver the final product. Investors are assembled by specialists who read where UK land development is (or can be) supported by local infrastructure. Those investors and their advisors also try to identify where a use designation (zoning) can be achieved, say, to convert Greenfields to residential property. With that accomplished, and site-specific infrastructure built (streets, utilities, etc.), a homebuilder can then buy lots and build, investing capital only in this late stage. Regardless of whether raw land prices are at historic lows or are climbing, this split risk enables all participants in development to better predict returns on their investment.

Individuals who consider participating in land investment should speak with a personal financial advisor. Along with other types of alternative investments, the opportunity should be weighed against overall wealth portfolio considerations.

How Undeveloped Land Is a Better Investment Diversification Strategy

Any investment diversification strategy should involve undeveloped land.

Don’t trust the national numbers on housing values as the final word on all real estate investment. Regional differences are significant and opportunities abound.

The conundrum for investors who are intrigued with UK land and real estate is, with a growing population and so little building in the past decade, why aren’t more houses being built?

After all, Census 2011 showed a growth rate of about 7 per cent since 2001, a much healthier addition of population than most countries found in the Eurozone. England and Wales in particular are a strong draw for immigration, and the birth rate has remained relatively strong even through the financial recession of the past six years. Exacerbating this further, pensioners are living longer and in greater health, keeping granny from moving out of her granny flat.

Savills research offers some data and analysis that suggests some fundamental ways in which housing will be built in the years to come. It offers a different perspective to anyone involved in land development, as investment on UK strategic land and raw acreage is most adaptable to market needs before buildings are constructed.

Specifically, the firm offers the following data points:

Regional differences mask home prices – Overall, homes in Britain have seen an average value increase of 6.4 per cent since 2007. Which is all well and good, except it masks the differences between North and South: in the South East and London, increases in home values are in the ballpark of 10 to 20 per cent. In the North of the country, values have fallen. This is not to say a land investment in those areas will not make sense, as real estate is sometimes tied to hyper-local factors. But the larger point is that in London and the South East, better opportunities are likely to be found.

Generation rental – Of greater significance is the shifting of ownership to rental for many middle class families. Savills reports “the value of Britain’s private rented stock has risen by 42 per cent over the past five years and an extraordinary 250 per cent in the past ten years.” The 4.8 million private homes that are rented today represent 17 per cent of all dwellings, when just ten years ago to-let housing was a mere 10 percent of the national inventory. What has caused this? Increasingly, working families are unable to afford the necessary deposits required for purchase, and tighter lending standards by banks also make it more difficult to get mortgages.

Best opportunities for those with cash to invest – All those rental homes still need to be built, begging the question: Who will finance them? According to the director of Savills research, “There is now a real opportunity for investors with cash, particularly those ready to invest for income, because capital value growth will be muted over the mid term.”

Real estate developers are on the front lines, constructing the right buildings for the market. But before they can do that, land investment companies identify parcels nearest to where building of one type or another should take place. This often is where employment is growing, or for any other reason the population is sufficient to fill new housing. Strategic land development will usually involve property zoned for agriculture or commercial or industrial purposes which local planning commissions will identify as more appropriate for residences, factoring for local economic conditions and growth opportunities.

Individuals who want to participate in land development and investing in real asset classes should first work with a qualified, independent financial advisor to be certain they are working with legitimate players and that the investment fits their overall financial goals.