Will residential become a mainstream investment class? Will the tax system ever be simplified? And will the UK still be a safe haven for investors? The BPF’s policy directors Ian Fletcher and Ion Fletcher share their thoughts on the big issues that will shape the future of the property world over the coming decades
Sustainability
Much of the road for sustainability policy over the next decade is already signposted. National and international commitments enshrined in acts of Parliament mean the industry will have to meet various targets for energy efficiency for new and existing buildings. Retrofitting in both commercial and residential buildings will be driven ?more by stick than carrot, with minimum energy performance standards potentially ratcheting up beyond ‘E’ (as measured by energy performance certificates) after 2018.
The industry’s efforts to deliver cutting-edge buildings will be helped by technological innovation, the valuation profession – who will reflect sustainability more and more in their valuation methods – and an increasingly knowledgeable occupier community who will ask for better performing buildings. However, as the performance of the buildings improves, it will lead to more attention on wider sustainability factors, such as the transport people use to get to buildings, whether they ?are employees or customers.
Buildings’ ‘in-use’ performance ?will become more prominent as the public takes a greater interest and standard methods of measurement become more common. Collaboration between occupiers and their landlords will be commonplace. Occupiers will find their energy costs continue to mount, and they will therefore have greater motivation to work with their landlords, particularly where energy consumption is high.
Both parties will have made far better provision for collaboration in their leases and associated documents.
To lose both our housing minister and shadow housing minister on ?the same day – as we unfortunately did in October’s cabinet and shadow cabinet reshuffles – only goes to underline the truth of the old adage ?that “a week is a long time in politics”.?So it is therefore with some trepidation ?that we gaze into our crystal balls ?to guess what might happen in the ?sector over the next 10 to 20 years.
And the task of divining the future?is made harder when you consider that ?we are blessed with an industry that seeks to shape its own destiny and, as ?it innovates, shapes the world around it. The following thoughts are therefore not so much predictions as possibilities about where the current trends in real estate, politics, finance and society may take us.
Housing investment
The nation has had to grapple with some profound housing issues. A housing crisis that has been two decades in the making will not be resolved in five or even 10 years, and the continuing mismatch between supply and demand?is likely to ensure that residential will remain attractive as an investment asset.
Demographics, however, dictate that the sector’s offer will become more diverse. We are already seeing pressure on the private rented sector to broaden its appeal so it is more “family friendly”. The sector will therefore invest more in houses and less in flats and longer-term tenancies will become more common.
From the perspective of the?investment world, residential will lose ?its alternative tag and become part of ?the mainstream property investment sector, with a far larger proportion ?of pension fund allocations.
Politicians are only starting to appreciate that a better range of housing options for those entering retirement helps free up the market overall. There?is therefore likely to be more emphasis on housing and planning policy on the range of options for older age groups. Huge questions also remain: what will happen to the housing wealth of the baby boomers and their children? Will it be passed down to their grandchildren ?or be spent making up for insufficient pension provision and care in old age?
But a nation that relies more on renting in old age will raise profound issues. People will need to generate more income to pay for rent in their old age, or the benefits system will have to take up the slack. Rather than owning, people may start to use housing more ?as a savings vehicle, and this may in?turn lead to the greater development ?of institutional and retail products?and perhaps even one of the sector’s unfulfilled challenges – residential REITs.
Housing policy is no longer just the preserve of London policymakers, but Cardiff, Edinburgh and Belfast as well. Looking to the future, innovation ?and diversification in the constituent countries of the UK will make a UK-wide investment strategy more difficult.
And what of the localism agenda? ?One can foresee that, frustrated by a ?lack of housing delivery, the pendulum will swing back from localism to centralism, and central government ?will introduce strong financial incentives and disincentives to ensure that local councils do not sit on development land.
Planning
The tension between a modern economy that needs better facilities if it is to remain competitive and a population ?with ‘not in my back yard’ tendencies,?will have to be resolved. Planning will therefore remain an issue on which politicians tinker, but fail to take the necessary steps over the next 10 years.
Looking to the longer-term, radical solutions will have to be found, which may include a series of ‘new towns’. The role ?of local councillors in plan-setting will be encouraged and elevated, but their role ?in planning decisions will diminish and ultimately be withdrawn, with planning officers making planning decisions.
Constant policy change in planning ?will be matched by changes in how value is extracted from the planning process. The Community Infrastructure Levy ?will labour on for at least the next seven years. Increasing evidence that it is harming delivery of new development will see its eventual demise, to be replaced by a simpler roof tax.
Commercial
The significant change in what the industry offers its tenants over the past ?20 years is perhaps not as well recognised by those outside our industry as it should be – from a world of privity of contract ?and 20-year plus leases to a world where shorter leases are predominant. The?pace of change for business tenants?will continue to dictate that the majority want flexibility. The next 20 years will ?see as much change in our industry’s landlord and tenant relationships as ?it has over the past two decades.
All-inclusive rents will become ?far more prevalent as tenants seek predictable business costs. As a result, landlords will compete even more on service standards and innovation. The leading ‘bricks and mortar’ landlords will also become some of the major providers of online solutions and virtual malls. ?At the smaller end of occupation, small businesses will find others ways of occupying property; for example, via co-operative arrangements. The ?1954 Act will continue to look dated ?and a future government will, finally,?find time in parliament to reform it.
Real estate tax
The UK’s tax system has developed organically and anarchically over the course of the nation’s history, and as ?all good students of evolutionary theory know, evolving systems tend towards ever greater complexity and specialisation.
The amount of legislation dedicated ?to the UK’s taxes has increased year on year such that, by 2009, it was reported that the UK had the longest tax code in the world. So there is no doubt that the system is ripe for massive simplification.
Scholarly tomes have been written ?on the subject, most recently by ?Sir James Mirrlees in 2011. Let’s?imagine for a moment that the next government decides to adopt Mirrlees’s recommendations when it takes office ?in 2015. What would that mean for real estate? Well, the good news is that we could bid farewell to SDLT and business rates – two of the most despised taxes sitting on the books. The potentially ?less good news is that these would be replaced with some form of land value tax. LVT would subject each parcel of land in the UK to an annual charge dependent on its value, based on ?where it is and what is around it.
The supposed benefits of an LVT include the increased incentive to use land as productively as possible and ?the removal of the discrimination inherent in the business rates system whereby, for instance, agricultural land is not taxed whereas business premises are. From an economic perspective, taxing land is equivalent to taxing ?an economic rent and therefore does ?not discourage any desirable activity.
However, scratch beneath the surface and the challenges of implementing such a tax become apparent. So how can we transition from the current system to the new without causing massive disruption? How to apply the new tax to the UK’s complex landholding structure? The political challenges are more formidable still: the government likes inflation-linked business rate revenues as they ?are independent of the economic ?cycle, which is useful in a recession. ?In addition, the Treasury is nowhere ?near well enough resourced to carry ?out such a fundamental change.
Given the complexity of the undertaking, it’s unlikely that ?we’ll see any substantial reform ?of property taxation in the next 10 ?years (notwithstanding the Lib-Dems’ continuing support for an LVT). Instead, we will see more tweaking around the edges and government doing just enough to keep its loudest stakeholders happy. With a bit of luck (and some vigorous advocacy by the industry), that could mean more frequent business rate revaluations carried out by a beefed-up Valuation Office Agency with the capacity to quickly process the thousands of appeals it receives. Empty rates could finally be abolished as the government recognises their pernicious effect on investment in regional real estate.
Finally, and on a slightly different note, I am hopeful that the next 10 years will see the continued development of the REIT, PAIF and Tax Transparent Fund regimes. There will always be overseas interest in investing in UK real estate, and the more options we can give in terms of tax-efficient investment vehicles, the more likely we are ?to attract those investors.
Real estate capital
The past couple of years have seen ?the UK consolidate its status as a safe haven in troubled economic times, and a healthy chunk of the inward investment it has seen as a result has ended up woven into real estate. But what happens ?when the global economy picks up ?again? Won’t that investment all go pouring out again as risk-adjusted returns begin to look better elsewhere?
As optimists, our view is that the UK will continue to attract significant amounts of investment from all over the world due to the resilience of its economy (the healthiest demographic profile in Europe), its enduring political stability (the UK’s ‘revolution’ of 1688 was remarkably hassle-free) and its ongoing cultural and educational attractions (anyone for the theatre?). And let’s not forget the well-established property rights and relatively transparent and fair legal system.
While the UK’s commercial real estate sector has of late seen considerable investment from Far Eastern investors – individuals as well as institutions – this is expected to continue as those institutions become increasingly familiar with the UK and comfortable with investing here. Furthermore, many emerging markets are yet to see the large-scale formalisation of pension arrangements and development of insurance markets. As billions of people in Asia, Africa and Latin America begin to channel their savings into formal ?long-term arrangements, investment funds of truly epic proportions are likely to emerge. Funds which will need to invest that money somewhere safe and stable. Like the UK.
Real estate lending
As emerging markets’ insurance and pensions systems develop, so will their banking sectors, and those institutions are also likely to find the UK an ?attractive place to lend against commercial real estate. Just as the Japanese did in the 1980s, the Americans in the 1990s and the Germans and Icelanders in the 2000s.
Despite the entry of emerging market banks into the UK real estate finance market, the provision of commercial ?real estate debt finance is likely to ?be less bank-dominated than it has historically been. There seems to be a consensus that banks’ move away from commercial real estate lending following the crash is structural rather than cyclical, which should allow alternative sources, such as debt funds, insurers and CMBS, to play a bigger role in the market.
A more diversified lending market will not prevent future boom/bust cycles, but should prove more resilient come the next property crash and mitigate the shortage of debt finance that inevitably follows. In addition, banks’ reduced exposure to commercial real estate should mean they are better insulated from it – with obvious benefits for overall financial stability.
The challenge for the BPF will be to ensure that the regulatory environment remains conducive to attracting overseas investment and that emerging alternative sources of lending are not regulated out of existence before they’ve had the chance to establish themselves.
Retail
The pace of technological change will continue to have a dramatic impact on the retail sector, causing a further decline in the need for “bricks and mortar” stores, and causing some high streets to become unviable. The boom in multi-channel retailing also has implications for logistics property, which will continue to thrive as an asset class.
Investors will continue to focus on prime shopping centres and to think carefully about how they can future-proof their assets in the face of a rapidly changing, and diminishing, occupier market.
The traditional high street will undergo profound change, with retail cores shrinking and empty shops being converted to other uses. The archaic business rates system will continue to put pressure on companies whose business models require physical space, until parliament finally overcomes decades of political resistance to change and introduces a system of property taxes fit for the internet age.
