The Property Speculator » Capital Gains Tax

5 Taxes on Property you can’t Avoid, Part 2

This article is the 2nd Part of looking at property taxes.

3. Capital Gains Tax

This is not a tax on the amount received from a transaction. It is a tax on the increase in value of the asset accumulated over the term of ownership.

Capital Gains Tax (CGT) is not payable on a company’s trading profit. It is payable on any sum that arises from the sale or release of an asset. A company must pay CGT in the same way as an individual must.

In relation to property trading, the HMRC website states the following:

If you’re a sole trader or a partner in a partnership and your trade is in property, you’ll pay Income Tax rather than Capital Gains Tax on any profits you make when you sell or otherwise dispose of property. This may include a one-off purchase and sale of a property. You usually have to pay any Income Tax due by completing a Self Assessment tax return.

It’s different if the property trading business is carried on by a limited company – in which you may be a director or shareholder – any profits on properties disposed of form part of the total profits of the company on which it pays Corporation Tax.

This means that if you are a property trader, you’re only likely to have to pay CGT if you sell associated equipment, rather than the actual property.

Entrepreneur’s Relief might be available to property traders and partners in a property trading business to reduce CGT liability. The HMRC website explains how entrepreneur’s relief works:

You can make claims for Entrepreneurs’ Relief on more than one occasion as long as the total qualifying gains in all your claims doesn’t exceed the lifetime limit.

For 2010-11 to 22 June 2010 Entrepreneurs’ Relief reduces the amount of gains liable to Capital Gains Tax by four-ninths on all qualifying gains up to the maximum lifetime limit. From 23 June 2010 the four-ninths reduction no longer applies – instead all qualifying gains up to the maximum lifetime limit made are taxable at 10 per cent.

Entrepreneur’s relief does not apply to companies though.

Business Asset Rollover Relief might be available if business assets (such as property) are sold and any profit reinvested into a new, similar asset. This is not an outright reduction as such (like Entrepreneurs relief is), it is a postponement or (as the title suggests) a ‘rollover’ of the CGT liability.

To be eligible, the assets (old and new) must be used for business purposes. The new asset must also be purchased between 1 year before and 3 years after the old one is disposed of.

It is possible to claim business asset rollover relief for partial reinvestment of capital gains, rather than the whole amount.

4. Inheritance Tax

The intention of Inheritance Tax (IHT) is to tax the person who either gifts an asset within 7 years of their death or ‘lifetime gifts’. In the event of death it (obviously) has to be the recipient who pays IHT.

Lifetime Transfers are when a party gifts an asset (the most common is a property) to a second party when the first party (the donor) is still alive. If the donor survives 7 years from the date of transfer, then the transfer is known as a Potentially Exempt Transfer (PET), and no IHT is payable.

If the donor does die within 7 years of transfer, then IHT will be payable from the date of transfer. Tapering relief might be available if the donor survives the 7 year point from the date of transfer. No tapering relief is allowed if the donor does not survive the 7 years; the transfer is regarded as a Chargeable Lifetime Transfer (CLT) and IHT is payable on the full estate value.

Transfers on Death are only payable on estates valued at £325,000 or more (for tax year 2011-2012). The estate value adopted is the one at the ‘instant before death’. Values in excess of the current threshold are charged at the current rate (40% for 2011-2012).

Therefore for example, if an estate is valued at £400,000 then the value over the threshold (£75,000 in this case) is charged at 40%. This works out to be £30,000.

Any IHT already paid within the preceding 7 years can be used to offset the liability and reduce the sum payable.

5. SDLT

This is paid in the event of a substantial property interest transfer, such as purchase (SDLT is paid by the purchaser) or a long-leasehold occupancy (in which case, SDLT is paid by the Leaseholder).

SDLT is not tapered. This means that if the value is over any of the thresholds, the whole value is taxed, not just the amount that is over the threshold.

So, if a property is bought for £126,000; the amount of SDLT (at current rates) payable is £1,260.00 (1% of £126,000). Likewise, if the property is bought for £124,000, then no SDLT is payable.

This situation results in an accumulation of property values at just below the threshold values. For example, there are many properties for sale at around £249,950. There really aren’t many at £255,000.

For the tax year 2011-2012, the current SDLT rates are:

For properties up to £125,000, the rate is zero. No SDLT is payable.
For properties from £125,000 to £250,000; the standard rate is 1% of the property value, and for first-time buyers, it is zero.
For properties from £250,000 to £500,000; the rates for standard and first-time buyers is 3% of the property value.
For properties from £500,000 to £1m, the rates are 4%.
For properties over £1m, the rate is 5%.

These articles are merely designed to give an introduction to the basic taxes that are likely to be experienced when a novice developer or investor begins their venture (whether it is done through a limited company or privately). I highly recommend making sure you are aware of current taxation rates. This is very important when carrying out a property financial appraisal.

http://www.hmrc.gov.uk/businesses/

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May 4th, 2011

5 Taxes on Property you can’t Avoid, Part1

This article is intended to give you a basic understanding of the different taxes involved in property. You will certainly come into contact with most of these taxes, property transactions are unfortunately an excellent source of revenue for HMRC.

1. Income Tax

As the label suggests, this is simply a tax on income. Taxes are collected over a period of 12 months, this runs from 6th April one year, until the 5^th April the next. For the purposes of income tax, this year is known as the ‘year of assessment’ (for corporation tax it’s known as a ‘financial year’).

If the rules concerning tax are slightly ambiguous or deficient, it might give a taxpayer the opportunity to avoid tax. This is known as tax avoidance, and is legal. The alternative is to deliberately not follow the laws on tax, which is tax evasion, and is illegal.

All UK residents who are liable for income tax are given a tax-free allowance. The income minus this allowance is known as taxable income. It is on this taxable income that the current income tax rates are applied to, this arrives at the total income tax payable for that person. For the tax year 2011-2012 the personal allowance is £7,475.00, the basic rate is 20% and that is payable on all income up to £35,000. On income between £35,001 and £150,000 the rate is 40%. So to use an example, if a person is paid £45,000 per year, his tax will be calculated as follows:

The first £35,000 will be taxed at 20%, however from this the allowance of £7,475 is deducted to produce £27,525. This sum will be taxed at 20%.

The remaining £10,000 will be taxed at 40%.

20% of £27,525 is £5,505

40% of £10,000 is £4,000

£5,505 + £4,000 = £9505

Therefore on an income of £45,000 per annum, £9,505 will be payable in tax.

Note. The upper rate of income tax is 50%, payable on income exceeding £150,000. This wasn’t mentioned in the main body because it’s almost certain that if you fall into this bracket, you will have an excellent idea of the tax you will have to pay.

2. Corporation Tax

This is a tax charged on the net profit of companies resident in the UK. It is calculated in a similar way to income tax. The basic rate of corporation tax is 26%, but this is payable on net profits that exceed £300,000.

Corporation tax is calculated on all net profits arising over the period of a financial year. This means that all the company expenditure that it must pay throughout the tax year, is not included in the final taxable amount. This does not mean however that a company can purchase anything just to lower their tax liability. Some items are regarded as fixed assets; these are items that do not depreciate immediately, such as property, IT equipment and motor vehicles. Fixed assets value can contribute to the profit figure. Net profit means that all the company’s salaries, rent payments on premises and any tax already paid is subtracted from the profit figure. The remainder is charged at the corporation tax rate to produce the sum payable.

Although a company that operates in the ‘Property’ sector can use mortgage repayments to reduce corporation tax payable (as the debt is classed as a liability), there are limits on this. The UK uses rules known as International Accounting Standards (IAS); IAS 16 covers the accounting treatment of property, plant and equipment. In the case of property it stipulates the Revaluation Model, which means:

The asset is carried (between financial reporting periods) at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably. [IAS 16.31]

The Revaluation Model

Under the revaluation model, revaluations of the asset should be carried out regularly, so that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date. [IAS 16.31]

If an item is revalued, the entire class of assets to which that asset belongs should be revalued. [IAS 16.36]

If a revaluation results in an increase in value, it should be credited to other comprehensive income and accumulated in equity under the heading “revaluation surplus” unless it represents the reversal of a revaluation decrease of the same asset previously recognised as an expense, in which case it should be recognised as income. [IAS 16.39]

A decrease arising as a result of a revaluation should be recognised as an expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating to the same asset. [IAS 16.40]

When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained earnings should not be made through the income statement (that is, no “recycling” through profit or loss). [IAS 16.41]

What this means, is that property assets should be regularly revalued. If the value increases, this sum is placed into the accounts as ‘revaluation surplus’. This is because this increase is not trading profit and does not represent a tangible amount of money anyway. If the revaluation figure represents a decrease, it should be covered up to a certain point by that accumulated in the revaluation surplus account, once the deficit exceeds this, it is regarded as an expense, and therefore a liability.

Close companies (known as such because the shares are not available for widespread public purchase) that offer benefits and distributions to their members, must pay tax on these payments.

In Part 2, we’ll cover Capital Gains Tax (CGT), Inheritance Tax (IHT) and Stamp Duty Land Tax (SDLT).

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May 1st, 2011

An Introduction to UK Capital Gains Tax on Property

The present UK system of Capital Gains Tax (CGT) was introduced in 1965 by the Finance Act. The intention back then was simply to tax individuals on the realisation (liquidation) of assets. However, the secondary effect was a tax on the inflationary appreciation in value of these assets.

A definition of Capital Gains Tax could be:

‘A tax on chargeable gains when an individual disposes of assets’

Each UK resident has an allowance that enables him/her a certain amount of tax relief on CGT. Any amount over and above the allowance will be charged at the appropriate rate. The current rates can be found on the website of the HMRC on this link.

To be regarded as a UK resident:

A person must spend at least 6 months of a tax year in the UK or have a residence in the UK (whether it is used or not, or owned or not).
The person must have spent at least 3 years continually in the UK.
For a company to be considered resident in the UK, it must be incorporated in the UK or have its registered office and main correspondence address in the UK.

People and companies exempt from CGT are:

Local Authorities
Trade Unions
Non-residents, not having a business in the UK.
Registered Charities
Pension funds

The definition of ‘Disposal’ is (in the words of HMRC):

‘An asset is disposed of whenever its ownership changes or whenever the owner divests himself of his rights in or interests over that asset, for example by sale, exchange or gift’.

This includes the sale of a leasehold property interest, receiving substantial insurance money or gifts. However, it does not include death.

To calculate the amount of Capital Gains a taxpayer will be taxed upon, the following should be subtracted from the eventual amount received:

The cost of original acquisition.
Any expenditure made to improve the quality of the asset that has been disposed of. This has to be an ‘identifiable change’ in the asset value.
Any costs incurred by the owner in defending or establishing his right to ownership of the asset. For example, if someone has to incur legal costs to prove inherited ownership of a deceased relative’s property.

So to use an example, a person sells their second property that was bought 5 years ago. From the eventual sum the property sells for, the value at purchase, the amount spent on it to increase value and any legal costs incurred when the owner had to establish a boundary are subtracted. The remaining sum is the amount that will be taxed. Subsequently, it is the amount of gain that is taxed, not the value that is received.

Calculating the amount of CGT payable on the net gain, can be quite complicated. This is because there are 2 different rates of CGT, an individual allowance and Entrepreneurs relief to consider. However, I’ll do my best to explain using another example:

Amount subject to CGT – £50,000

Individual CGT exemption allowance – £10,100 (for tax year 2010-2011)

Subtotal liable for CGT – £39,900

Entrepreneurs Relief allows all gains that qualify* to be taxed at 10% (for June 2010 onwards). Therefore from the initial sum of £50,000, a CGT tax bill of £3,990.00 would be likely†.

Note * to qualify for Entrepreneurs relief, the capital must have come from the disposal of a business asset, not a personal one. There is also now (from April 2011) a lifetime limit of £10m.

Note † this figure is merely a guide. It should not be relied upon and professional advice should be sought.

An alternative relief to Entrepreneurs Relief is Business Asset Roll-Over Relief. This applies to capital income from the sale of a business asset such as a property, provided the capital is used to purchase another business property or certain type of asset. If it ‘leaves’ the company, it will be subject to CGT.

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Mar 31st, 2011

Capital Gains Tax on Property

The following post is NOT intended to be comprehensive financial guide, nor is it a definitive guide for calculating your tax liability on any income received from investments. This post is based upon tax avoidance, NOT tax evasion. For accurate advice regarding tax liabilities, I highly recommend you consult a Chartered Accountant or Tax Accountant and refer to the relevant website of the appropriate tax authority for the region you live in.

CGT or Capital Gains Tax is a very large consideration for potential property developers and investors. According to the website of HM Revenue & Customs:

Capital Gains Tax is a tax on the gain or profit you make when you sell, give away or otherwise dispose of something that you own, such as shares or property.

http://www.hmrc.gov.uk/cgt/intro/basics.htm

What this means, is that if you receive a lump sum from the sale of a property (for example) then you will be taxed on the difference between the amount you paid for it and the amount it is eventually sold for. Unfortunately there are very few ways to avoid this. Even if the property was gifted to you by a relative or left in a will, the calculation for CGT will still be based around the assessed market value of the property when you received it.

Even if you were to ‘gift’ the property to another party, you might still be taxed because you would be disposing of it. The reason for this is that it makes it more difficult for people to avoid being taxed. There is no end of highly inventive ways to ‘hide’ transactions of money, carried out by far cleverer people than me. However, the person disposing of the property is being taxed on the ‘gain’, not the actual financial profit.

Even if the asset you dispose of is overseas, you will be liable for tax as soon as the money enters the UK, such as being paid into a bank account. Make no mistake, HM Revenue & Customs will leave no stone unturned if they have reason to believe you have attempted to evade CGT.

There are exemptions however. Your ‘principle and primary residence’ (your home) is exempt. Your car and any personal possessions worth less than £6000 will not be taxed either should you dispose of them.

The rate of CGT that must be paid will depend upon the amount of taxable personal income you earn. This is where the calculation gets a bit tricky because the taxable amount is charged at different rates and there is ‘Entrepreneurs Relief’ that you might qualify for.

For an idea of how much CGT you might be liable to, go to my Capital Gains Tax calculator. Enter the required information into the white boxes and ignore the information boxes (in grey) until your data has been entered.

Entrepreneur’s relief is an allowance that has conditions to satisfy before qualification can be established. For gains that qualify, a rate of 10% CGT is payable on them, instead of either 18% or 28%. There is currently a lifetime limit of £5 million for Entrepreneurs relief. The Government’s website Business Link gives the following explanation:

Entrepreneurs’ Relief allows individuals and some trustees to claim relief on qualifying gains, up to a maximum lifetime limit, made on the disposal of any of the following:

all or part of a business
the assets of a business after it has ceased
shares in a company

The relief applies for the years 2008-09 onwards.

Who qualifies?

The relief is available for you as an individual if you:

are in business, for example as a sole trader or as a partner in a trading business
hold shares in your personal trading company

The relief is also available for some trustees.

Entrepreneurs’ Relief is not available for companies.

Conditions that must be met

Depending on the type of disposal, certain qualifying conditions need to be met throughout a qualifying one year period.

For example you must have owned the business during a one year period that ends:

on the date your business was disposed of – if you are selling all or part of your business
on the date your business ceased – if your business has ceased

How the relief works

You can make claims for Entrepreneurs’ Relief on more than one occasion as long as the total qualifying gains in all your claims doesn’t exceed the lifetime limit.

For 2009-10 Entrepreneurs’ Relief reduces the amount of gains liable to Capital Gains Tax by four-ninths on all qualifying gains up to the maximum lifetime limit.

From 23 June 2010 the four-ninths reduction above no longer applies – instead all qualifying gains up to the maximum lifetime limit made are taxable at 10 per cent.

2009-10 example

Your business stopped trading and in July 09 you sell an asset of the trade, making a gain of £90,000.

Entrepreneurs’ Relief reduces the gain liable to Capital Gains Tax by four-ninths. Four-ninths of the £90,000 gain is £40,000 (£90,000 × 4/9 = £40,000).

You must work out the Capital Gains Tax due on the remaining gain of £50,000 (£90,000 − £40,000 = £50,000).

http://www.businesslink.gov.uk

If you run your property venture as a company, not as a private individual, there might be advantages if you are a higher rate taxpayer. This is because although your company will be liable for CGT when selling an asset, the net profit you make will be subject to Corporation tax rather than Income Tax. Corporation tax is currently charged at a lower rate (20% providing the profits do not exceed £300,000) than that of the upper rate of income tax (40%).

Further information on other aspects of property taxation visit this link.

Feb 6th, 2011

Investing in Ground Rents

It’s not easy to begin investing in property; there are very high costs involved which have the effect of barring many prospective investors from entering the market. In economic terms, this can be explained by the balancing of supply and demand. If supply remains constant, as demand increases, so does price.

This is not really of much interest to the person who is very keen to begin property investment but is having trouble finding the capital to invest. This is where ground rents can prove to be worthy of some consideration as an alternative. The term is used mainly in England, Wales, and Ireland. The USA has similarities to this system but differs on some points. In Scotland, the term ‘Ground Annual’ is used instead, this system in basically similar to the ground rent one as the interests can be assigned and sold fairly freely.

A Ground Rent is the freehold interest (which is the outright ownership) on a parcel of land where a second party (the Leaseholder) owns a long-leasehold interest. The Leaseholder will be the owner of any building on the land and subsequently will be the recipient of any associated rents generated by the building through a tenancy agreement. He will pay the ground rent on a regular basis to the freeholder for the continued use of the land. A Ground Rent can be on both Residential and Commercial property. As the term suggests, it is rent payable for the use of the ground. The Freeholder will not be the owner of the building that is situated on the land.

Ground Rents are valued in a similar way to most other investment properties. They will have a lease in place of between 21 and 999 years. A period of 99 years is fairly common. When the lease interest is approaching expiry, the Ground Rent value will tend to increase because when a new lease begins, the ground rent might be set at a higher rate (due to inflation) making it more desirable to potential purchasers. The leaseholder is also very likely to have to pay the freeholder a premium to extend or renew the lease. Any likelihood of the leaseholder defaulting on the ground rent payment will have the opposite effect though, so a purchaser will be looking for what is known as a ‘strong covenant’ (meaning the leaseholder is unlikely to default on the payment). If the leasehold interest is not due to expire within the next 150 years, the ground rent value will be quite low in comparison to agreements with less than this to run.

A Ground Rent can be purchased at a property auction (Savills and Cushman & Wakefield in particular, often auction ground rent investments). In common with other property auction lots, a guide price is provided prior to auction. The value of the ground rent investment is likely to be around 10-20 times the value of the annual rent paid. This would be an initial yield of around 5%-10%. So for example if the annual rent payable to the freeholder is £350, then a guide price of £7,000 might be set. This would provide a yield of 5% (yield is calculated by expressing the annual rent as a percentage of the capital value). Often, an investor has the opportunity to purchase a set of ground rent investments, for example on an apartment block with many units. The leaseholder will be obliged to pay ground rents to the freeholder for each individual apartment.

As with almost all investments, a return of between 5% and 10% is typical. Purchasing a Ground Rent investment will not make you rich overnight and is not likely to provide a rate of return that is greater than most other investments. What it will do however is provide a method of property investment that allows the investor to purchase property interests in far smaller ‘units’ than a whole house or flat. A ground rent can also provide an excellent way of diversifying an existing portfolio.

A ground rent can provide a very secure investment. If the leaseholder defaults on the rent, the freeholder has the right to take possession of the land and any buildings upon it (depending upon the agreement terms). However, investors usually simply want a passive rent income, not the hassle of trying to get a new occupant for the property.

Ground rents are not without their shortcomings though. One of the major attractions of property investment is that the freeholder has a tangible investment, the value of which can be increased through improvement. A ground rent does not allow this as it amounts to an interest in property that cannot really be physically observed. Improvement to the ground itself is not particularly possible; the building belongs to the leaseholder so what can the ground rent holder do to increase the value? Nothing really.

Another shortcoming of Ground Rent investment is the scale of administration involved when running a substantial portfolio. The work involved in rent collection and any legal obligations that the freeholder might be obliged to carry out can seem disproportionate to the amount of annual rent collected making ground rents one of the most illiquid investments imaginable. Property investment companies that specialise in ground rents will have rent collection and billing as automated as possible for the purpose of improving cost-effectiveness.

Jan 9th, 2011

Property Tax

When considering the best approach for your venture into property investment, it is important to differentiate between different ways of structuring the finance. This will help prevent you paying more tax than you need to. It must be stressed that evading your tax liability is a criminal offence; and if HMRC/IRS suspect that you have attempted to do this, you can expect a thorough investigation that might continue for up to several years.

That said, these agencies are actually very approachable and have a cooperative attitude. This is simply so that taxpayers do not pay more tax than they are required to. It makes good business sense to me.

In the UK and the US, tax is payable on a company’s NET profit. This means that all the company expenditure that it must pay throughout the tax year, are not included in the final taxable amount. This does not mean however that a company can purchase anything just to lower their tax liability. Some items are regarded as Fixed Assets (these are normally items that do not depreciate immediately, items such as IT equipment or motor vehicles).

In the UK, if a private individual has a supplementary income or is self-employed, they must compile a self-assessment tax form. This works in a fairly similar way, in that net profit is taxed and most expenditure is not.

The reason these basic principles have been explained, is because investment property provides an income that will contribute towards your taxable amount. No one wants to pay more tax than they should, and your individual circumstances will affect how you structure your property financial gearing.

If you regularly pay income tax at the higher rate, it makes sense to run your property venture as a limited company. This is because any profit/income that is collected on an annual basis will be liable to corporation tax which is charged at a much lower rate than the higher personal tax rate. Starting a limited company is very straightforward and will cost somewhere around £80-£100. This method however, will be subject to a bit of administration. You will be required to submit a Company Return (specifying shareholders and capital) and a Corporation tax return every year. These obligations are not difficult to carry out but you will probably be subject to a fine if you miss due-by dates.

The interest payments on an investment property mortgage qualify as company expenditure; this means that they serve to reduce the company annual profit, and therefore the amount of tax payable. Many professional property investors structure their mortgage to only pay-off the interest on a month-to-month basis. Obviously the only way you will ever clear the balance of this mortgage is by finding the capital from another source, or to sell the property and pay it off. This method works fine if it is only ever the capital value of the property you are interested in. As we’ve been reminded in the last few years, property values can fall as well as increase but a capital loss is not particularly likely if you hold it for 20-30 years. The property is then sold; the mortgage paid off, tax paid and the remainder is yours (or the company’s). If you have a repayment mortgage that pays off the capital as well as the interest, the monthly payments will be more expensive but there will eventually be a time where the property is mortgage free. At this point, the rent payments then count as all-profit. This makes the books look much healthier but remember you pay tax on the net profit. So if the property is completely mortgage free, you will be paying the maximum amount of tax.

Another point to make regarding companies is that if you are the director of a property investment company, you cannot take money out of the company without paying income tax on it. Your private financial matters are entirely separate from the company’s. Your property company can pay you a salary, but this is taxable like all personal income.

If you currently pay income tax at the lower rate, it might be better to run your venture on a personal level. When selling, if the property is not your ‘primary and principle residence’, you will be subject to paying Capital Gains Tax. This is calculated at a certain rate (currently 18%) on the NET gain of the asset. This means that if you purchased a property in December 2000 for £80,000 and you sold it in December 2010 for £120,000 your net gain would be £40,000; you would be liable to pay around 18% of £40,000. The actual calculation is slightly more involved than this though, as individuals have an annual exempt amount will can also be factored in (this is currently £10,100). For information on Capital Gains Tax and relief, follow this link to the HMRC website.

You might be covered by ‘Entrepreneurs Relief’. There are certain criteria that must be met, but it applies to the disposal of business assets if you are a sole-trader or are a partner in a trading business. There is a lifetime limit currently, of £2 million. This should be investigated fully if you believe you fit the criteria. For information on Entrepreneurs Relief, refer to the HMRC website by following this link.

Oct 25th, 2010

Becoming a Property Developer or Investor

Many people dream about becoming a full-time property developer or investor but simply don’t know where to start.

The first step is to decide which approach suits you and your circumstances. Do you want to be a developer or an investor?

A Developer looks for a suitable property that is in need of work (to a lesser or greater degree). This can be purchased at auction, through an estate agent in the conventional way or quite often the owner is approached and a deal is struck. The work is carried out over a period of between 6-18 months and the property is put back on the market, hopefully to be sold at a healthy profit. Being a developer offers the shortest route to making money through property as you have the best opportunity to increase the value.
An Investor will sometimes buy a property with a tenant already in place. To be purely an investor in property (as opposed to an investor/developer) would mean that the property is purchased with no intention of carrying out any works, just getting an occupant in as quickly as possible so that an investment return in the form of rent is provided. This situation is unusual as most landlords understand that some work is likely to be needed before occupation. This approach is more passive than being a developer. Be aware though, it is unlikely that you will see much financial return in the form of profit for several years. Most landlords only make enough to cover the mortgage, management fees and tax. The benefit comes in the years ahead when the capital value of the property has increased considerably. Using this method is likely to take 10 years or more to see a significant increase in your investment.

The next step is to realistically look at your finances. Obviously buying property is never cheap, and it is probable that you will require a mortgage. At the time of writing, the majority of mortgage providers ask that you provide a deposit of around 20%-25% of the purchase price (or the total development price if your plans are more ambitious). You will also need to cover fees at the point of purchase (estate agent and solicitor with added VAT) and Stamp Duty. Once the property has been purchased, if it is a development project there will be a period where the work is being carried out and you have to meet mortgage repayments. This should be factored in. If it is an investment property, then rent voids must be allowed for (when no tenant is occupying it and subsequently no rent is being collected). Management costs must also be considered, such as garden maintenance, decoration and general property upkeep.

In common with a conventional mortgage, lenders will want to know what other borrowing you have, such as credit cards and loans. Mortgage providers are very keen to minimise risk and they will feel that if you are committed to other lenders, your ability to meet the mortgage repayments will be compromised. Also remember that mortgage interest rates can fluctuate a great deal, this will have a substantial influence on the monthly repayments.

Many property investors opt for an interest-only mortgage. This obviously means that the capital must be repaid at the end of the mortgage term and the only way to do this (realistically) is to sell the property. The difference between the selling price and the amount of the original mortgage is the profit. This is a bit of a gamble, as it’s impossible to accurately predict what the property will eventually sell for.

The deposit required to proceed with the purchase should be carefully considered. This might sound strange, as it’s clear that the higher the proportion of deposit compared to the amount to be borrowed will result in more profit and lower risk. While this is largely true, it’s not quite that simple. There is an optimum level of equity (money that is not borrowed) that will result in the best return and the most advantages:

The level of equity is high; if the venture is being run as a limited company, then tax will be payable on any profit gained. It’s also not good business sense to put so much equity into a single investment. For example if £100,000 of equity is available, it would be better to place £50,000 of equity into each of 2 properties rather than all of the equity into a single property. For more information on the tax aspects of running a property venture as a limited company, visit this link.

The level of equity is low; this situation leaves you very exposed to risk in the form of interest rate fluctuations (and subsequent high repayments) and rent voids. It could be argued that this aspect contributed to the credit crisis because borrowers left themselves far too narrow a financial margin.

The next step is to consider the market you wish to appeal to. On the property-related TV shows, the developers always seem to concentrate on the ‘young professionals’. This market in itself could be sub-divided into several smaller categories. However, do not overlook the other markets such as students, retired people and ‘downsizers’. It is important to consider the market before purchasing the property; it is always easier to provide a product for an established demand, rather than developing the product (the property) and then wondering who is likely to use it. Always do your homework, for example if there is a strong student population but a shortage of accommodation……it’s fairly obvious which type of property you should provide.

Get to know your target market intimately, do they own cars or use bicycles or public transport? This will affect where it is best to buy the property and if you need to provide a garage. Alternatively, you might be able to convert an attached garage to increase the floor area of a large house; thereby providing another student flat. If your target market is downsizers, will they need a large garden? Or a lot of storage space?

Information on an area’s demographics is available from the Office for National Statistics (www.statistics.gov.uk). Although it tends not to provide very detailed data, it is a good starting point. The other way to get to know what is in demand in your chosen area is to speak to letting and estate agents. They will have an excellent idea of what is always being enquired after but supply is scarce.

One last thing for now, it is highly recommended that you look for a property close to where you already live. You have a much better feel for values and know whether a property is priced too high. It is also far easier if you have to attend site regularly to deal with builders, Architects or Project Managers.

Aug 17th, 2010

Questions to ask your Conveyance Solicitor

The conveyance procedure can be a bit of a mystery to many property purchasers. A good solicitor will talk you through the conveyance process and provide fairly regular updates as the different stages are reached. A bad solicitor might not bother to keep you informed (he/she might simply be too busy) and not return your calls. Subsequently purchasers feel helpless and frustrated and this adds to the sense of being ‘kept in the dark’. Don’t underestimate the amount of stress generated when this happens.

Property conveyance can be defined as:

“The legal transfer of an interest in property”

This process can vary a great deal in the time it takes to complete and might range from a couple of weeks to several months, although the average time taken is 10-12 weeks. This depends upon the efficiency of all parties involved and the size and difficulty of the task (there might be complex legal issues that need to be resolved before continuation, or financial issues such as mortgage complications).

The two milestones involved in conveyance are Exchange of Contracts, and Completion. In England and Wales, at the point of exchange of contracts, the seller’s Solicitor should have done the following:

Received a copy of the title deeds
Obtained Land Registry office copies relating to the property being sold
Prepared the draft contract
Negotiated a completion date (which is included in the contract) and been in regular contact with the other party’s Solicitor to answer questions.
Carried out a ‘search’ which establishes if the property is connected to mains services, if any covenants run with the land and if there is any aspect of the purchase that his client (you) should know about.

Once the finalised contract has been drawn up, signed by the seller and exchanged with the other party’s solicitor, this is the point of contract exchange. Both parties are now legally bound to proceed with the transaction.

The second phase of conveyance ends at the point of completion. The solicitor must:

Request a redemption figure from the seller’s mortgage provider
Swap copies of the transfer deed with the other party’s Solicitor (respectively signed by seller and purchaser)
Finally, pay himself, the estate agent and send any outstanding amounts from the sale to the appropriate recipient.

In Scotland, the transaction become legally binding at a much earlier point. In common with contract law, if the initial offer is accepted it becomes legally binding. This means that the survey is carried out before the initial offer is made. This system seems to have more advantages than the English system.

Solicitors carry out many, many conveyances. Unfortunately this sometimes means that they communicate with their clients using too much legal terminology. Many purchasers are never in a position where they understand fully what is going on throughout the whole process. A good solicitor should speak to you as an equal, and explain properly what he will be doing for you (after all, you will be paying him to do a job), what he requires from you (such as building work warrantees and proof of any planning consent granted) and how long the process is likely to take (although this can only be a very rough estimate).

Having worked on the ‘other side’ as a property professional, I would like to take a moment to defend solicitors. As mentioned above, property solicitors carry out a great many conveyances. Some go according to plan, many do not. Some legal issues can be extremely complex, especially when it comes to involving other parties such as planning authorities or other solicitors in ‘the chain’, this takes time. Most solicitors’ workloads are heavy; it is easy to forget that other clients also need updates on the progress of their conveyance. The solicitor might not have any update to report back to you. Remember, in some cases phone calls and letters will end up costing you extra. That said, there is no excuse for poor service.

By all means when looking to appoint a solicitor, use the internet. However, do not overlook word-of-mouth either. If a solicitor has done a good job for one person, the chances are he’ll do just as good a job for you. If you do use the internet, a good place to start is The Law Society (www.lawsociety.org.uk). There are many adverts on the internet advertising very cheap conveyance; this means that you don’t have to settle for sub-standard service just because you don’t intend to pay a fortune. There are also many websites that provide the facility to read reviews of solicitors.

Once you have found a solicitor that you feel will provide a good service, you should formally appoint him. This means that you should send a letter to the practice (or more likely these days it will be an email, this is perfectly acceptable) stating that you wish to appoint him/her to carry out the conveyance on your behalf. At this point, there will (should) be questions that you need answers to:

How much will Solicitors’ fees be?

It’s definitely a good idea to look for a fixed price arrangement. For the actual conveyance part, you will be charged somewhere from around £250 to £400 (plus VAT). In addition to this you will be charged for the Land Registry Fees, Search Charges and Transfer Fees. All in, a total fee of £600-£700 (plus VAT) is likely. There are so many services advertised on the internet for around £100 + VAT. It’s less likely that you will receive a good quality service for this amount. Also be aware that any service carried out by the solicitor that is above and beyond the service agreed to, is almost certain to be charged extra.

What type of survey should I opt for?

It is highly recommended that you obtain a survey on the property you want to purchase. Your lender will already require a valuation survey which is only to establish that the property value is in line with what you intend to pay and the amount you are borrowing. A Homebuyers Survey is the next step up and the most frequent option for property buyers. It covers the general condition and standard of maintenance of the property and any recommended actions that should be carried out. The most detailed report is a Building Survey. This is a comprehensive study of all aspects of the building. It will include the property condition, any defects found, the cost of remedial actions, environmental information (such as the likelihood of flooding) and the results of tests for woodworm, damp and dry rot. Clearly it is the purchaser’s decision which survey is carried out. The more detailed the study, the more expensive it will be. A full Building Survey is likely to cost in excess of £400. Also, if the intention is to completely ‘gut’ the property to a bare shell, is it worth a full building survey?

Do I need to be concerned over SDLT?

Stamp Duty Land Tax (SDLT) is (currently) payable on all property purchases over £125,000. Between £125,000 and £250,000, 1% of the property value is currently payable as SDLT. For first time buyers in this band, the SDLT rate is still zero. If the purchase price of the property is between £250,000 and £500,000, then 3% of the purchase price will be payable. And if the purchase price is above £500,000 the SDLT rate is 4% of the purchase price. The form can be filled out by your solicitor; but be warned, they are highly likely to charge extra for this (probably around £60-£100). More information on SDLT is available from the HM Revenue & Customs website (www.hmrc.gov.uk/sdlt/index.htm).

Is there anything I need to pay up-front for?

It is likely that the solicitor will ask you to pay up-front for the search fees, as this is sometimes done at the beginning of the conveyance.

If a deposit is payable, this will be asked for just prior to the stage of contract exchange. There are very strict guidelines governing what solicitors can do with this money once it’s in their possession. If any interest is payable on it during the period, it’s illegal for the solicitor to retain it.

Aug 14th, 2010