Have recent Budget changes resulted in a paradigm shift?
Over centuries many asset classes have come and gone, many investors have made their money and departed and trends in the investment market have peaked, troughed and disappeared.
Property has been the most significant investment by the vast majority of people in the world for centuries but will we see a significant shift towards different investments and investment classes through recent budget changes that some might describe as an ‘assault’ on property as an investment class by the current government?
What has happened ?
In summary, we have seen three consecutive budgets which directly attack landlords. The sector has been punitively taxed, with stamp duty on buy-to-let properties, mortgage interest relief and now capital gains tax changes.
The tax that Mr Osborne sprung on landlords in his summer Budget of July 8, 2015 is yet to bed in. This is the gradual removal of the ability of small landlords to deduct the cost of mortgage interest from their income before they calculate a tax liability. This will be phased in gradually from April 2017.
This was followed in November he announced that landlords would pay a 3% stamp duty surcharge, which came into effect last month.
It was then further announced that the headline rates of Capital Gains Tax – which is paid on profits from asset sales – will be cut on 6 April from 18% to 10% for basic rate taxpayers and from 28% to 20% for higher rate taxpayers. But there was a sting in the tail for buy-to-let landlords and other property investors in the form of an 8% surcharge to be paid on residential property – which effectively means it will continue to be taxed at the current higher rates.
Mr Osborne said the policies were aimed at “creating a level playing field” in Britain’s under-supplied property market.
In simple terms he is trying to address the balance between first time buyers getting on the ladder and investors out-pricing them. Furthermore, The Financial Times says Carney and the Bank of England worry about “the risk that investors would all seek to sell at the same time if there were a general decline in house prices.”
Buy-to-let buyers snap up property with the sole purpose of renting it out. They generally buy houses with special buy-to-let mortgages that aren’t subject to the same kind of affordability tests as regular ones. Buy-to-let mortgages are generally based more on rental income in areas than the buyer’s means.
The worry is that as interest rates finally begin to rise off record lows, buy-to-let landlords will struggle to meet mortgage repayments and all sell-up at the same time. The flood of housing stock on the market could lead to a price crash. However, many major buy-to-let lenders have already reacted to this by stress testing of rates to assess affordability
Ipso facto, the CGT changes provides an incentive to invest in companies over property.
Any Opposition ?
Cherie Blair QC has launched a judicial review arguing that the policy discriminates against individual buy-to-let investors by denying them the same rights as other business owners. This disparity breaches article 1 of the European Convention on Human Rights. In another reference to European law, it is being argued that by favouring corporate landlords the tax “distorts competition” and constitutes a form of aid which should not be granted “unless it has been approved in advance by the European Commission.”
Why is property is such a popular investment class?
The property market literally goes back to feudal times when leaders and prominent figures in society were measured by the land they owned and the homes which they lived in. Even though we have seen various investment trends and investment tools come and go over the years, with property a particular asset class which seems to ebb and flow in popularity, the property market has always been at the top of the investment ladder.
When you consider that property market investors as a whole lost trillions of pounds in the crash of 2009, with many having been pushed towards financial oblivion, can these excessive boom and bust cycles continue forever?
Since the end of WW2 we have seen excessive booms in property markets around the world and while there have been difficult periods when the price of property has fallen in different areas of the world, the vast majority have rebounded fairly quickly. However, this recent recession/depression which has engulfed the worldwide economy is something different and something which has literally left many more people financially distraught as they had invested in the ‘property bandwagon’. governments and Central banks are reacting.
More and more emphasis has been placed upon governments around the world to bail people out of this ongoing situation with more and more properties coming under government control in various areas of the world. While direct government ownership of property has not yet materialised in the UK, we have seen the tax payer take over a large chunk of the UK mortgage market, effectively meaning the government is in control of the UK property market and mortgage finance.
However, social housing has also risen to the top of the investment ladder as more and more people find themselves in a position of being homed by local authorities. Indeed, Sadiq Khan as newly elected mayor of London, outlined his plans for the capital, saying: “The key thing for me is to tackle the housing crisis.”
Large numbers of the UK population are also reconsidering their position and whether they should take the significant risk of buying a home in the future and adopt the more European rental model.
Will investors return in great numbers?
Whichever way you look at the macro economic position, there is no doubt that the massive numbers of investors in the property market literally “lost their shirts” in the 2009 crash. However, investors in the buy-to-let sector have returned with a vengeance at pre-crash levels and the Bank of England hope these recent changes will simply cool activity in the sector, stopping anymore risk building up with the intention of the tax changes cooling the market without need for macro-prudential intervention.
The key phrase being ‘cool activity’ not ‘halt activity’.
It is no coincidence that the substantial property boom which has dominated the world wide investment market for the last 20 years has coincided with a tightening of regulations in other investment markets. When you also take into account the ability to obtain substantial finance at affordable prices in the mortgage market, even for so-called sub-prime lenders, in hindsight we had the ingredients for a very popular and substantial investment market, but one with the potential to overheat.
At the moment governments such as those in the UK, the US, Europe and the Far East are making loud noises suggesting that mortgage finance in the future will not be as easy to obtain as it has been in the past. A change in the regulatory environment will coincide with a number of legal rules to be introduced, which could substantially reduce the amount of investment capital available to the worldwide mortgage market. Stricter Underwriting assessing affordability and stress testing of inevitable increases in future base rate.
As we all know, reduced demand in any investment market will reduce liquidity and potentially reduce the investment returns of the future.
The regulatory environment & mortgage liquidity
This is the big question on the lips of many investors around the world, the potential for governments to fulfil their threat to reduce mortgage liquidity and tighten the regulatory environment around the world. There is no doubt that whatever level of reduced finance, there will be an impact on the market but will this be a short-term, medium-term, long-term or permanent change in the property investment market? That is the key question for the property investor – short term turbulence should not influence long term investment rationale and indeed recent changes are considered by some as an ‘opportunity’.
So what will happen ?
The truth is that property has been, and will remain, the main investment market around the world. However, there may be some short-term issues with buy-to-let mortgage finance if we see a reduction in liquidity and an increase in the regulatory environment, which could hit many property investors in the short term. Despite this, however, according to the Council of Mortgage Lenders, only around one-third of privately rented properties are currently financed by a buy-to-let loan. The rest are owned outright, or are funded by a commercial mortgage, alternative commercial funders or through institutional investment. It is estimated that c.18% of all mortgage lending is buy-to-let mortgages.
Property investment however, is for the long term and should be viewed as such. Property investors will also re-structure arrangements to ensure maximum tax efficiency for their investments, with an inevitable increase in the use of Companies despite the potential double taxation issues.
While the likes of gold, pensions, stock markets and other investment markets will remain available to investors, it is worth remembering that investments such as pensions and stock markets already have a substantial exposure to the property sector. Whichever way you look at it, property is set to remain the main investment asset around the world for many years to come and the fact there are likely to be so many more opportunities created as a result of recent changes as some landlords pulling out of the market.
Despite attempts by the government and Bank of England to try and gain some control of the property investment market, this is a market which has been around for centuries, seen recessions, depressions and wars and still remains the main investment market of choice. In reality each and every economy around the world already has a significantly high exposure to the property market and if this was taken away, or reduced substantially, we would see a significant reduction in overall wealth around the globe.
As Mark Twain once said, “Buy land… they’re not making it anymore!”