The Property Speculator

Property and VAT

Having at least an understanding of tax and how it relates to a property development is valuable knowledge. Obviously the larger the project(s) the more likely tax will feature strongly in your plans.

Contrary to what many protestors in London feel, I think there’s nothing noble in paying more tax than you absolutely have to. Therefore, it’s good to learn.

© Copyright Sebastian Ballard and licensed for reuse under this Creative Commons Licence

At the moment, VAT is not fully recoverable on a conversion from a commercial property to a residential one. This means that costs in the form of labour and materials will be subject to VAT at the rate of 5% on this particular type of conversion. If you are buying the materials yourself, you will be charged the normal rate of VAT at the point of sale and will only be able to claim it back once the build is complete and it qualifies with the criteria set by HMRC. If the project is a new build, some aspects might be zero-rated for VAT. If you are the person purchasing materials or procuring labour, you will again be charged the full rate of VAT at the point of purchase or invoice. This however can be claimed back from HMRC under the ‘DIY House Builders & Converters VAT Refund Scheme’ or if you are VAT registered, all incurred costs would offset your annual VAT liability.

Quoting information available on the HMRC website, the following table briefly shows the rate of VAT that should be paid on particular construction work:

Construction Work	Rate of VAT
Construction of new qualifying dwellings & communal residential buildings	0%
Conversion of a non-residential dwelling into a qualifying dwelling for a housing association	0%
Conversion of a non-residential building into a qualifying dwelling (other than for a housing association)	5%
Renovation or alteration of empty residential dwelling	5%
Approved alterations to a listed dwelling	0%
Alterations to suit the condition of people with disabilities	0%
Installation of energy saving materials and grant funded heating system measures.	5%
Development of a residential caravan park	0%
Home improvements on domestic properties on the Isle of Man	5%

To qualify as a ‘qualifying dwelling’, the following conditions have to be met:

If it is built from scratch, any pre-existing building is demolished to ground level.
No more than a single facade (or double in the case of corner sites) of an original building is used if that is a condition or requirement of planning or listed building consent.
If a new building is constructed that shares an existing wall of a neighbouring property, no internal access must exist between them.
If an existing building is extended and this creates an additional dwelling/dwellings. This does not include dwellings that are attached to business premises and cannot be disposed of separately. The additional dwelling must also be wholly within the enlargement or extension to be zero-rated.
An Annexe to an existing building is constructed. This does not include ‘granny annexes’ or enclosed separate swimming pools.
The building is one of several constructed at the same time on the same site. This must be used together with the other buildings for a ‘relevant residential purpose’.

Services provided by professionals such as Architects, Surveyors, Project Managers and Supervisors are always standard-rated for VAT. Plant equipment, scaffolding hire, security fencing and mobile offices cannot be zero-rated and will attract the full rate of VAT (although the service of erecting and dismantling scaffolding will be zero-rated if associated with zero-rated work).

Sometimes only part of a building might qualify for zero-rating, such as a mixed-use development. In this case, the work that is carried out on the qualifying portion of the development can be zero-rated. This is called apportionment.

When selling or granting a leasehold interest in a zero-rated building, it is usually only the first transfer that does not attract VAT. On mixed-qualifying developments this can be apportioned appropriately. All subsequent transfers will be subject to VAT but this can offset the VAT bill of the party purchasing the interest.

Usually, a property that has previously been lived in cannot be zero-rated and will attract a VAT rate of 5%. However if you can prove that the property has not been lived in for at least 10 years, then it will be zero-rated for VAT incurred in renovation/alteration work to make it habitable as a residential dwelling. In order to prove the building has not been lived in for a minimum of 10 years, records from the local authority in reference to council tax or electoral roll can be used, alternatively a letter from a local authority Empty Property Officer can provide sufficient evidence to render the other forms of proof unnecessary.

In the renovation or alteration of empty residential property, most VAT will be charged at a reduced rate (currently 5%). To qualify as ‘empty’, the property must have been unlived in for at least 2 years prior to commencing the renovation work (this ignores ant occupancy by squatters or a property guardian). If the property is inhabited during the renovation works, it still qualifies at the reduced rate provided there is a clear period of 2 years immediately prior to commencement of work. The occupants can move in on the day after work begins.

Be aware that if you take advantage of a zero-rating on VAT, the building must stay in the specific residential use it was designed and built for. If not, a taxable charge will apply. This charge decreases the longer the building stays in its original use; after 10 complete years no taxable charge will apply.

Unfortunately as from the 1^st March 2011, if the building is sold or it is leased to a party who does not intend to use it for its intended residential purpose a taxable charge will apply:

Number of complete years before sale or change in use:	VAT Charge (as a percentage of the total VAT that would have been payable).
0	100%
1	90%
2	80%
3	70%
4	60%
5	50%
6	40%
7	30%
8	20%
9	10%
10	0%

Subsequently, the zero-rating facility is only really suitable for constructor/investors to take advantage of. However professional developers are likely to be in a position to avail themselves of the reduced rate of 5%.

For further information on VAT on property, follow this link to the HMRC guidance notes.

Dec 29th, 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 Investment Market Research

I do not profess to be an expert on business, but one thing I certainly do know is that the vast majority of first-time business starters do not put their plans together the right way.

Many, many business start-ups have failed because the founders try to establish the business in this order:

Decide what they can produce.
Get the item/service to market.
Decide who they will sell it to.

The reason this approach fails so often is that they aren’t producing the item or service to any particular ‘market’. There is a good chance that whoever they attempt to sell to isn’t actually looking for the product anyway.

A far better approach to establishing a business is to:

Research a market or field to understand it and the people immersed within it.
Learn exactly what shortcomings are evident.
Source a solution to that ‘problem’.

A property venture that makes money for you (let’s face it, why else would you be considering it?) is a business in the conventional sense; and the second business model above is very appropriate as a base. It will prove to be an expensive mistake if you buy a development or investment property, get work carried out and then think about whom to sell it to. Countless TV property programmes quote the novice developer as wishing to appeal to ‘young professionals’. This is all very well if the property is the right type and in the right area, however it will not work for the centre of a university district (for example).

It is so important to be extremely fussy when looking for a potential property that fits your requirements. In the case of professional developers, many plots of land will be under careful scrutiny so that the precise one is eventually chosen that will produce his expected return. To apply the business model above is very appropriate because the property will be your ‘product’ taken to market.

All areas will have particular needs in respect of accommodation. They are also highly likely to have accommodation that just will not sell or let. The letting agent is the absolute best person you could speak to when considering the type of property that you are going to purchase as an investment. If you are intending to develop the property, then speak to an estate agent in a similar way. The agent will have access to potential clients that have pestered him for a property to rent or buy in a certain area (this could be narrowed down to a particular road). He will no doubt be on the phone to these people on a very regular basis to provide an update on availability. Therefore, if you do purchase the ‘perfect’ property that offers exactly what these purchasers or tenants want, you are almost guaranteed to sell or let and achieve a good price.

In contrast, the agent will also have an extremely good idea of the properties that just will not move. These are the ones that appear in the paper every week with gradually declining prices or rents. The agent will know exactly which property you should not buy.

The venture must be approached in exactly the right way if it is to succeed. Several geographical areas can be considered, with the intention of purchasing a property in one of them. However, the property type is very likely to differ considerably across the range of areas. Your considerations might look like these examples:

Area A could ‘carry’ more reasonably priced single-person’s accommodation. Therefore the purchase of a large house that stands a good chance of obtaining consent for conversion into flats would be a shrewd move.
Area B is more upmarket and fairly ‘suburban’. It would support more 2 bedroom, generously proportioned flats because the agent regularly receives serious enquiries after them. Therefore, it might be sensible to consider a newly-built block of three storeys with upmarket, well-sized flats.
Area C is completely suburban with quiet roads but close to 2 good schools. In this situation, a plot that could accommodate 2 or 3 new detached houses would be an excellent move.

This is to show that many property types can be considered. It really does depend on the area and what is vital, is a flexible approach. The venture is a business and the properties should not be regarded as a blank canvas to experiment with indulgent interior designs. The aim is to produce a finished property that will have people fighting to rent or buy; and yes, this is perfectly possible in the current market provided you have done your homework.

Sep 13th, 2010

What to look for in an Investment Property Lease

If you are searching for an investment property that does not require (much) work to be carried out, there is a good chance that you will find yourself evaluating a property that has a tenant already in occupation. Under The Land Registration Act 1925 and 2002, if you purchase the Freehold interest in a property, you are legally obliged to honour all existing leases and agreements. In law, the rights of the person(s) in occupation override that of even the freeholder’s.

The terms⃰ of any lease in place on the property will affect its value to some degree (for example, a poor ‘quality’ tenant in place for the next 15 years does not represent an ideal situation and subsequently will be less desirable than a good quality tenant that renews a lease regularly). The main aspects of any tenancy agreements are:

Parties involved. All tenants and the Landlords name or company will be stated on the tenancy agreement.
Lease term. This is the period of time the tenant is permitted to occupy the property. This period may be either reduced, extended or become ‘open ended’ by agreement with the landlord. What commonly happens in residential tenancies is that the initial term is set at 6 months. The tenant may then continue in occupation (with the landlord’s approval) for an indefinite period of time, paying rent on a monthly basis. This is what is known as a ‘periodic tenancy’. The frequency of rent payments then becomes the period of notice for either party to bring the agreement to an end. For example if the rent is paid monthly, then the landlord or tenant can give a months’ notice to bring the occupancy to an end.
Rent Payable. This is the sum of money charged regularly by the landlord so that the tenant is permitted to remain in occupation. The rent is set initially as the tenancy agreement is created. Residential tenancies are usually paid monthly in advance; commercial ones are usually quarterly in advance.
Deposit payable (if any). This will be stated in both words and numbers.
Rent review. This is a clause in the tenancy agreement that allows the landlord to increase the rent payable so that it reflects continually changing rent values. It is very common in commercial tenancies but less common in residential ones. After the initial rent level is set at the beginning of the lease term, it might be reviewed at 3 yearly intervals (for example) to increase in line with the general level of economic inflation. Sometimes these reviews (most commonly commercial) are ‘upwards only’; meaning that the new rent level will be the lowest value of either the existing rent level, or a sum agreed by both parties as being an accurate reflection of current rates. In the event of disagreement of this level, the tenancy agreement will prescribe a method of establishing a new rent by a third party.
Break Clause. In place on commercial properties. This is a clause that allows either the tenant or the landlord to bring the agreement to a premature end. This is very often subject to around 6 months notice. Landlords sometimes charge a premium to compensate them for the risk of a subsequent rent void when the tenant moves out. This has mixed opinions amongst property professionals, some regard it as justified, and others see it as completely unnecessary.
Security of Tenure. This is a legal term that means the landlord cannot simply evict the tenant. It is now almost extinct in residential tenancies. Only agreements entered into before the 15th January 1989 are protected (known as Rent-Act tenancies), and provide the tenant with security of tenure. This has the result of substantially reducing the property value to around 50% of that in vacant possession. However, that is not to say that tenants under more recently drawn up contracts can be evicted on a whim. Far from it. You cannot evict a tenant without a Court Possession order. If a tenancy agreement has been in place, it cannot be substantially changed even if it is renewed. Any new agreement must be on similar terms. All residential tenancies granted after the 28^th February 1997 are ‘Assured Shorthold Tenancies’. This still provides the tenant with security of tenure, but the landlord will be granted a possession order on certain grounds after the initial term of the lease has passed and it has become a periodic tenancy. The specific grounds for possession are listed in the Housing Act 1988.

Commercial tenants are automatically given the protection of security of tenure under the Landlord and Tenant Act 1954 (known as the ’54 Act). This means that tenants can only be evicted under particular circumstances (such as the landlord wishing to occupy the property or develop it). The parties involved can specifically opt out of this act if it suits their circumstances. This is known as an ‘exclusive’ agreement, as opposed to an ‘inclusive’ one. This act can have quite an effect on the value of the tenancy, for an inclusive agreement puts the tenant in a strong position and an exclusive one does the same for the landlord.

When taking on ownership of an investment property with tenant(s) already in place, great care should be exercised in establishing which tenants actually should be in occupation. Once the conveyance process is completed, anyone in occupation of the property (whether they pay rent or not) is automatically granted rights to remain there. If you later find out that individuals should not be in occupation, court action might be required if they will not co operate and move out.

In all leases, there are ‘implied’ covenants adopted. These are:

The Tenant:

To pay rent as agreed.
To pay utility bills as required including connection fees.
To vacate the property upon lease expiry
To keep the property in good condition and not to commit ‘waste’ (which is where the tenant allows the property to fall into substantial disrepair through neglect)
Not to make any alterations to the property other than with the express, written permission of the landlord.
To allow the landlord (or representatives) access to the property (normally subject to 24 hrs notice) for the purpose of maintenance or inspection.
A requirement to report any damage to the property to the landlord to enable him to repair it or make an insurance claim.
Not to change the locks on the property with express permission.
To allow viewings of the property for prospective tenants within 2 months of term expiry.

The Landlord:

To keep the property in acceptable, habitable condition for the tenant.
To allow the tenant ‘comfortable enjoyment’ of the property.
To insure and keep insured the property against the usual fire and other risks.
To return any rent paid to the tenant for any period the property is not inhabitable.
To cover any outgoings that the tenant does not pay.

The landlord has the right to enter the property if the rent remains unpaid for 14 days or more; or if the tenant breaches his covenants or enters bankruptcy proceedings.

⃰Note. In property law, the word ‘Term’ (singular) refers to the length of time of the lease; whereas the word ‘Terms’ means the conditions contained in the lease agreement that the tenancy is based upon.

Sep 5th, 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