INVESTING IN LONDONProperty tax & market insight

Summer 2017

London residential market snapshot

The residential sales market shows meek signs of stability

The prolonged uncertainty due to the political environment in the UK, coupled with affordability issues, continues to stifle purchasing activity in the capital, especially in the higher price brackets. The affordability challenges appear to be intensifying, with rising inflation continuing to erode real incomes.

According to the latest data from the Office for National Statistics, annual earnings growth moderated to 2.4% in February from 2.6% at the end of last year. Additionally, Consumer Price Inflation (CPI), increased to 2.7% in the year to April 2017, up from 2.3% in March 2017. The combined effect of these economic parameters is likely to strengthen the emerging holding pattern of consumers, who are increasingly reluctant to commit to any major purchases resulting in a 27% decline in transaction volumes (Land Registry).

On a more positive note, however, the quarterly rate of decline of values in prime Central London appears to be slowing, with both Q4 2016 and Q1 2017 registering an average decrease of 0.4%, following sharper falls in the first half of last year. Key submarkets within prime Central London, such as South Kensington (2.1%), Knightsbridge (1.3%) and Chelsea (1.0%) showed signs of revival, with an increase in prices for the first time since Q3 2015.

Given these conditions, we forecast a -0.7% fall in prime Central London capital values by the end of the year. Assuming Brexit negotiations enter their concluding phase towards the end of 2018, we expect a marginal 1% rise in prime Central London values during 2018.

Revival in demand for houses in prime Central London

Elsewhere, in the lettings market, rental values across prime Central London

registered a slight upward movement during Q1, with average rents rising by 0.2%; the first positive increase in over a year. This has nudged average weekly rents up to £1,411, from £1,406 at the end of last year.

This widespread decrease in rental values until early this year has translated into a revival in enquiries for homes in the two to five-bedroom bracket, as rental rates appear to have fallen to what are perceived to be acceptable levels. This has in part aided the 0.8% uplift in average rents for houses in the three months to the end of March. Houses in Westminster (7.6%), Belgravia (7.0%) and Mayfair (4.2%) were the largest contributors to this growth.

We forecast a marginal 0.5% increase in rental values in 2017, followed by a 1.0% rise in 2018. Cumulative growth over the next five years should reach 9.2%.

Introduction

The ever evolving political climate in the UK has given rise to a rapidly changing property tax environment. In this time of global economic uncertainty, buyers and investors continue to target UK real estate as a safe haven asset class and as such, it is more important than ever to have a clear understanding of the property tax obligations, both for domestic and international buyers.

Cluttons, a leading international property consultancy, and Trowers & Hamlins, a leading international law firm, have partnered together to help review the current state of London’s property markets and outline all current tax obligations, which we present below.

Investing in London – Property tax & market insight

Tax considerations for investment into UK residential real estate

When investing into UK residential real estate, careful tax planning and advice are important to keep tax costs down and thereby maximise the benefit of the investment. Specifically, there are six principal UK taxes to be aware of:

Stamp Duty Land Tax (SDLT)

SDLT is payable on completion by a purchaser of UK real estate. It is calculated by reference to the purchase price (or rent) paid for the property, and the type of purchaser. It is payable at different rates on “slices” of the purchase price, the top rate being 12% on the purchase price above £1.5 million.

There is a 3% SDLT surcharge in certain cases, so the top rate becomes 15% on the purchase price above £1.5 million. For example, the surcharge will apply to an individual investor (whether UK resident or overseas) who already owns a home, including a home abroad.

There is also a 15% top rate on corporate purchases if the purchase price is more than £500,000, but there are a number of reliefs e.g. if the property is let out.

Annual Tax on Enveloped Dwellings (ATED)

ATED is an annual ownership tax payable if a property worth more than £500,000 is owned by a company or other type of corporate vehicle. The annual tax cost varies between £3,500 and £220,350, depending on the value of the property. Reliefs are available, notably when the property is rented out to unconnected third parties.

ATED-related Capital Gains Tax (ATED-CGT)

Payable on sale of the property at a rate of 28% of the profit, if, and to the extent that, the property was subject to ATED. The tax applies only to gains accruing from 6 April 2013 to the date of sale.

Non-resident Capital Gains Tax (NRCGT)

Payable by non-UK tax resident individuals and “narrowly held” companies on sale of the property, potential liability can vary between 18% and 28% of the gain depending on the status of the seller. There are some very limited reliefs available. The tax applies only to gains accruing from 6 April 2015 to the date of sale, and ATED-related CGT takes preference.

UK tax residents are subject to capital gains tax (if individuals) or corporation tax (if a company).

Inheritance Tax (IHT)

IHT is a tax at 40% on the value of UK assets owned at the date of death, and on certain lifetime gifts. Historically, IHT planning was possible by using offshore companies to own UK residential property. However recent government proposals have sought to remove this option, so as to bring into the IHT net UK residential property owned by a closely held offshore company. These proposals were due to take effect in April 2017, and though postponed, they are currently still widely expected to come into force although the start date is unclear (it may still be April 2017).

Income Tax (IT)

IT is an annual tax on UK source income, for example, rental income, at rates varying between 20% and 45%. Limited relief is available for associated loan interest payments by individuals; and interest paid by corporates may also be subject to restricted relief according to current government proposals.

Investing in London – Property tax & market insight

Prime Central London in numbers (Q1 2017)

REGENTS PARK

MARLEYBONE

MAYFAIR

SOHO

WESTMINSTER/ VICTORIA

ST. JAMES'S PARK

COVENT GARDEN

CHELSEA

BELGRAVIA

KNIGHTSBRIDGE

SOUTH KENSINGTON

KENSINGTON

HYDE PARK

ST. JOHN’S WOOD

HOLLAND PARK

NOTTING HILL

£1.76m

£693 p

£2.61m q

£1,331

£2.91m

£1,224 p

£2.40m

£1,157 q

£2.92m q

£1,293 q

£4.34m q

£1,846 p

£2.20m q

£988

£2.51m

£1,253 p

£4.35m

£1,696 q

£2.83m q

£1,405 q

£2.75m q

£1,314 q

£2.80m p

£1,396 q

£3.63m q

£1,889 p

£2.83m q

£2,041 p

£3.14m p

£1,356 q

Average property prices

Average weekly rents

Quarterly % change (Q1 2017)

Source: Cluttons

Investing in London – Property tax & market insight

London office market snapshot

Resurgence in international investor confidence

Activity amongst overseas private investors, sovereign wealth funds and institutions remains healthy as we enter Q2. This is largely linked to the continued favourable benefits to these groups of investors from the weakness of sterling.

In general, there has been a growing positive attitude towards the long-term prospects for London, which is reflected in the fact that total investment volumes into Central London offices during Q1 2017 were 90% up on Q1 2016, totalling £3.85 billion (Property Data). The overall proportion of overseas investment into Central London offices over the same period has surged to 82%, from 59% in Q1 2016.

We have also noted that the office market’s low yielding environment has

not been a deterrent to international investment. Seasoned investors are comfortable with low yields, particularly if they are relocating capital to London due to its perceived safe haven status.

Those looking to place ‘refugee capital’ away from geopolitical turmoil in their own home markets do not appear to be fazed by the ongoing yield compression in the Central London office sector. While the appetite to purchase appears to be growing, opportunities will only be considered where strong covenants, long leases and inflation links are in place.

Dip in occupier activity

Away from the investment market, occupier activity remains subdued. Overall take up in London’s office market during Q1 2017 was 2,210,000 sq ft, 37% down on Q4 2016. Throughout the course of 2017, headline rental values

and capital values have remained largely stable with no real change registered; however, this masks the fact that net effective rents continue to dip due to a rising number of lease incentives being offered by landlords.

While overall activity levels are markedly down on this time last year, there is a deeper market for offices in the £60 psf to £70 psf range, especially in the West End.

The general nervousness stemming from the impending Brexit negotiations is also driving a rising number of requests for break clauses in 10-year leases for office space in the 5,000 sq ft to 10,000 sq ft bracket. Landlords are keen to minimise void periods, especially as supply levels continue to tick up in pockets of Central London.

Investing in London – Property tax & market insight

Tax considerations for investment into UK commercial (non-residential) real estate

Similar to residential real estate, when acquiring UK commercial real estate for investment purposes there are various UK tax issues to be considered. Some key issues are set out below:

Stamp Duty Land Tax (SDLT)

The top rate of SDLT on commercial real estate is 5%.

Value Added Tax (VAT)

The purchase of commercial real estate may or may not be subject to VAT. However, with proper planning, VAT is not normally a cost of ownership of commercial real estate.

Corporation Tax (CT)

A company which is tax resident in the UK will, broadly speaking, be liable to CT on the income from, and any capital gains, arising from a commercial property. Various reliefs and deductions are potentially available.

Income Tax (IT)

Income tax is payable by all investors on UK source income, for example, rental income, at rates varying between 20% and 45%, depending on the status of the owner. Limited relief is available for associated loan interest payments by individuals; and interest paid by corporates, for whom full relief is currently available, may also be subject to restricted relief in future, according to current government proposals.

Withholding tax – Non-residents

Tenants of UK property (or the managing agent) are required to withhold tax at 20% on payments of rent to non-UK resident landlords. This is then paid to HM Revenue & Customs (HMRC) and set against the landlord’s ultimate UK income tax liability on rent. It is possible to apply to HMRC to receive rent free from withholding tax.

Where a non-UK resident lender is used to finance the purchase, withholding tax on the interest may also be an issue.

Sale of the Property

Provided the investor is and remains a non-UK tax resident throughout the period of ownership, and the property is held as an investment (not a trading asset), the current position is that there will be no tax on any gain realised on sale of the property. UK residents (individuals and companies) may, conversely, be taxed on the gain.

Tax residency is tested by reference to a complex set of rules and guidance and advice on these should always be obtained.

Investing in London – Property tax & market insight

GREENPARK

HYDE PARK

BATTERSEA PARK

1 2

3 4

65

7

8

9

10

11

12

13 14

15

1716

18

Market Submarket

Prime headline

rent* (£ psf)Q/Q

% change12 month % change

Prime capital values (£ psf)

Q/Q % change

12 month % change

Hammersmith 1. Hammersmith 57.5 0.0% 0.0% 900 0.0% -7.7%

West End 2. Kensington & Chelsea 77.5 0.0% 0.0% 1,275 0.0% -8.9%

3. Paddington 60.0 9.1% 9.1% 1,050 9.4% 0.0%

4. Marylebone 90.0 0.0% 0.0% 1,775 0.0% -4.1%

5. Mayfair 120.0 0.0% 0.0% 2,750 0.0% 5.8%

6. Noho, Soho & Covent Garden 85.0 0.0% 0.0% 1,650 0.0% 0.0%

7. St James’s 120.0 -4.0% -4.0% 2,700 -1.8% 14.9%

8. Victoria, Westminster, Knightsbridge & Belgravia 82.5 0.0% 0.0% 1,400 0.0% 0.0%

Midtown 9. King’s Cross 80.0 3.2% 3.2% 1,250 4.2% -2.0%

10. Midtown 70.0 0.0% 0.0% 1,150 0.0% -4.2%

Southbank 11. Southbank 65.0 0.0% 0.0% 875 2.9% 0.0%

12. Vauxhall & Nine Elms 55.0 -4.3% -4.3% 725 -3.3% -9.4%

City 13. Clerkenwell & Farringdon 65.0 0.0% 0.0% 1,075 -2.3% -10.4%

14. Old Street & Shoreditch 55.0 0.0% 0.0% 1,000 -4.8% -9.1%

15. City Core 70.0 0.0% 0.0% 1,300 2.0% 0.0%

16. Eastern City Fringe 55.0 0.0% 0.0% 850 0.0% -5.6%

Docklands 17. Canary Wharf 47.5 0.0% 0.0% 775 0.0% -8.8%

18. South Quay 35.0 0.0% 0.0% 500 0.0% -9.1%

Central London office market heat map (Q1 2017)

£100+£90-99£80-89£70-79£60-69£50-59Sub £50

Rent psf

Source: Cluttons | *Rents quoted are headline, not net effectivePrime rents are defined as the top quartile of headline rents: excluding penthouses and floors with large terraces, as well as suites in large, iconic towers.

Investing in London – Property tax & market insight

© Cluttons LLP and Trowers & Hamlins LLP 2017. This publication is the property of Cluttons LLP and Trowers & Hamlins LLP and must not be copied, reproduced or transmitted in any form or by any means, either in whole or in part, without the prior written consent of Cluttons LLP and Trowers & Hamlins LLP. The information contained in this publication has been obtained from sources generally regarded to be reliable. However, no representation is made, or warranty given, in respect of the accuracy of this information. We would like to be informed of any inaccuracies so that we may correct them. Cluttons LLP and Trowers & Hamlins LLP do not accept any liability in negligence or otherwise for any loss or damage suffered by any party resulting from reliance on this publication.

For further details contact

CLUTTONS

Tony FordResidential tax specialist+44 20 3641 0476tony.ford@cluttons.com

Faisal DurraniHead of research +44 20 7647 7166faisal.durrani@cluttons.com

Trishika ShettyResidential research analyst+44 20 7647 7251trishika.shetty@cluttons.com

cluttons.com

TROWERS & HAMLINS

Nick GreenPartner+973 17 515604ngreen@trowers.com

Tony PoolePartner+44 20 7423 8381tpoole@trowers.com

www.trowers.com