by Peter Champness
The 1957 Treaty of Rome included obligations to establish the freedom to trade without restriction and, in particular, the free movement of persons, services and capital. It is astonishing that, having been blatantly blocked for 30 years by national governments, the Single European Act which came into force on July 1 1987 should be seen as the instrument of change.
It is even more surprising, given the level of scepticism about the effectiveness of the EEC Commission and all its works, that it should have seized the imagination of businessmen throughout the community.
It is the latter which gives street credibility to the 286 technical proposals — most of which will have now been tabled by the commission. Perhaps Winston Churchill’s words in 1946 in Zurich of “building a kind of United States of Europe”, now adopted by Jacques Delors, president of the commission, will come to pass.
To what extent will a single property market emerge? What is involved and how can we benefit from this?
One of the problems about commenting on property markets is the dearth of solid statistical data. Indeed, taken as a whole, property markets are a classic case of an inefficient market. It is clear to anyone who has had involvement with the mainland European markets that, compared with the United Kingdom, the volume of transactions in all sectors is significantly lower. Bearing in mind the comparative economic performance of the various countries making up the European Community, this is perhaps surprising. There are, however, various reasons why this has occurred, and why, as in the equity and other financial markets, the United Kingdom boasts more sophisticated and active markets.
The reasons are not entirely straightforward, but to take a simplistic view, they include:
- a traditional pattern in continental Europe of owner-occupation of property, allied to strong banking links as being the chief source of long-term finance as against equity capital;
- a tenacious clinging to historic values in accounts meaning that directors are less aware of sleeping assets and the return on real capital values than their UK counterparts;
- lease structures that limit the investors’ participation in the growth of rental values;
- a market limited to a small number of major cities such as Paris, Frankfurt, Madrid and Milan; and
- tax structures that impede modern portfolio management techniques.
The UK is now a low-tax country, and particularly so where it comes to corporation tax and taxation arising on the transfer of property. The UK corporation tax rate at 35% is joint lowest with Spain: comparable figures for France and Germany are 42% and 56% respectively. In no community country are transfer taxes or stamp duty as low as in the UK, and in some countries such as France they are very high indeed. With real costs of transactions in France running at an additional 19% on cost, it is not surprising that the name of the game is long-term investment if property is held beyond the period when VAT applies. VAT is, of course, another complication with which the UK practitioner will have to learn to deal.
Thus one of the major factors ruling against Pan-European property investment, and the reason why there are relatively few Pan-European investors, is the complications and tax pitfalls that can arise. This is not to say that astute and well-advised investors cannot get round these problems and benefit from pricing inefficiencies compared with saturated domestic investment markets; merely that it is a disincentive towards geographical diversification.
It is clear, in particular, that high transfer costs on property acquisition do not encourage property trading either of single properties or portfolios, except to the extent by which property-owning companies can be acquired by acquisition of shares. With many acquisitions taking place via share purchases and sales, the favourable competitive position as an adviser and market-maker of the Continental banking institution vis-a-vis the chartered surveyor is enhanced.
Property investment markets, perhaps unsurprisingly, are not well understood in continental Europe, and certainly EEC economists have been slow to understand the benefits in terms of economic efficiency that derive from healthy and, as far as possible, perfect markets for property investment products.
For this reason, little thought has yet been given to the removal of fiscal barriers in respect of property investment, albeit that on the corporate investment front the requirement for free movement of capital is recognised by a recent directive.
The effects of the 1992 programme on property markets are therefore oblique, through changes in growth rates, corporate restructuring, accounting and financial regulations.
The authors of the EEC paper on the economics of 1992, referring to the removal of exchange controls, note that this will result in net gains by ensuring that investment takes place in those projects which have the highest returns irrespective of the country in which they are located. It is further noted that these movements will also increase the output and income of the community as a whole. The same would, of course, apply equally to property investment markets if the current fiscal barriers were removed!
The programme leading up to 1992 will lead to a change in the investment participants in property markets. The volume of business will be even more greatly increased should the fiscal restraints mentioned earlier be removed. As it is, we can expect so far as the United Kingdom is concerned a boost to investment markets from the further involvement of European funds, many of whom have in the past been unable, owing to exchange control or regulation concerning the home of investment funds, to invest in property outside their own countries.
Additionally, the very substantial trade account surplus for Japan — $96bn in 1987 — will ensure that they continue to be major overseas investors. Hitherto, a very large part of such investment has gone to the United States of America into US Government Bonds, other forms of equity investment and of course property. This surplus is likely to continue for the foreseeable future, and it is likely that the apparent imbalance in overseas investment in terms of geographical location current in many Japanese investment portfolios will be altered by an increased preference for investing in the United States of Europe. For historic reasons, the first impact of such investment is taking place in the United Kingdom.
We have seen the beginnings of an increased international involvement with the London market by US investors and developers, and it is unlikely that US funds will long ignore the European market, in particular if the dollar strengthens.
UK and other European investors are already becoming active in continental Europe, both in the traditional markets of Germany, Holland, Belgium and France, but also in relatively new markets such as Spain and Italy.
A European property market which, as it opens up, presents more opportunities through underlying growth and, with the removal of barriers, slowly approximates more to a perfect market model, will also, unless the EEC seeks in Sir Nicholas Goodison’s words to “develop the European financial markets behind a ringed fence”, be seen increasingly in an international investment context. Risk analysis is likely to become more sophisticated, and comparisons will become international, at least for Grade A investments with triple A covenants that can be traded globally. This will, inter alia, require special skills from practitioners, and may in practice be open only to those with strong international presence in which the banks with their extensive branch networks may achieve a dominant role.
Overall, European property investment markets will be the subject of an inflow of new money from Pan-European, US and Japanese investors. This will enhance present trends and accelerate the recent fall in yields apparent in Paris, Madrid and Brussels. Increasing pressure will build up to resolve the present tax problems which hinder the development of a volume property investment business in continental Europe.
So far as the continental European banks are concerned, with their wide financial holdings including involvement with development companies in their own countries, they are likely to seize the increased opportunity of involvement with property investment and development and the high margins available from property funding. They may even adopt UK methods of property finance in their own countries where they have the advantage of effective sales networks. Thus competition in property finance will also develop on a Pan-European basis with new forms of creative property funding resulting from an interaction between Continental bankers and those in London.
Thus there will be many challenges and opportunities in the era of new property investment markets of the years to 1992, in respect of growth from the underlying increase in business activity, from increased competition in the property finance market, the expansion of property unit trusts, securitisation and unitisation of property schemes, as well as an entry of new players in UK and Continental markets with differing priorities and business methods.
Against this background, what will be the future performance of the UK property investment markets?
- The UK property investment market is at a high point, although certain sectors and geographical areas do not fully reflect growth prospects owing to normal leads and lags in institutional property investment perceptions.
- Other factors than 1992 will influence markets, including the Channel tunnel project and the rating revaluation and national non-domestic rating multiplier in 1990. The former, though giving further impetus to the economy in the South East and property values there, will also act as a drain in terms of warehousing towards the Pas de Calais region. One of many effects of the rating revaluation and the national multiplier may be a slowdown in the rate of growth of prime and secondary retail rents, particularly in the South East of England.
- The UK property investment market will be sustained by the various effects of the 1992 programme. There may be overheating in certain market sectors regarded as prime by overseas investors. The main thrust of new investment in Europe will go to the UK. Generally, volumes will increase and potential for property trading will emerge strongly as markets adapt.
So far as specific directives and proposals are concerned, the community has adopted legislation for liberalising capital movements between member states, most of whom have until July 1990 to implement it.
In the company law field two essential directives are under discussion: the directive on cross-border mergers of public liability companies and for the control of concentrations between undertakings.
As regards financial services, there are proposals on the harmonisation of essential standards in banking for prudential supervision and for the protection of investors, depositors and consumers, including the draft second banking co-ordination directive based on the concept of a single banking licence issued by the home country and valid throughout the community. Proposals as regards the insurance sector include the adoption of the second draft directive on life insurance. The adoption of the non-life services directive was the most important event for insurance for the first half of 1988.
As regards securities markets, the council adopted a directive on the mutual recognition of prospectuses in 1987 and agreed a proposal for a directive on the investment policies of certain UCITs (Units in Collective Investment Trusts). Proposals have already been made on the information to be disclosed when companies offer their securities to the public, and on investment services. The degree to which a single “passport” to operate will apply is still open to discussion. Other outstanding matters include a proposal for a directive on takeovers and other general bids, and insider trading.
The proposed directive on the mutual recognition of higher education diplomas, which it is expected will be adopted this year and be effective from 1991, will provide a mechanism for an appropriately qualified national from one European country to acquire the professional title of another country.
Much work has been done by the various Pan-European organisations both to identify the professions of the land in Europe and also to seek and compare their levels of attainment in each area of work. Sadly, for historical reasons the chartered surveyor, other than the chartered land surveyor, has no counterpart in Europe, and work he would normally undertake is carried out by a variety of professions, be they lawyers, accountants, management consultants, bankers, architects, engineers, brokers or others.
As regards the UK, this gives rise to difficulty, and the likelihood that a mechanism will have to be developed in order to offer training to foreign nationals who seek the RICS qualifications.
It should be noted that there are currently very few restrictions on practice by foreign nationals in the United Kingdom; in essence, anyone can put up his plate and practise as a surveyor. In other European countries there is a greater degree of control of activities, although members of the RICS Continental Group practising in Europe have not found such restrictions as do exist to be of practical significance as regards the carrying-out of their work.
As the profession develops, with new areas of work opening up in relation to financial services and related matters, community proposals will bring both new regulations and increased competition.
There will in my view be two main impacts on the surveying profession — directly via specific directives, and indirectly through corporate restructuring and increased growth of European economies. At the same time, there will be increased competition from Continental organisations, in particular from the banks, accountants, management consultants and others, and their ability to provide a comprehensive service covering property and other matters should not be underestimated. It will be for us to show that we can add value and be creative in our approach to all aspects of the property industry.
My particular interest has been in asset valuations for balance-sheet and other corporate purposes. This is likely to increase enormously, particularly in the period of rationalisation, while European companies develop through acquisition, merger and organic growth.
The essential skills of those involved in commercial and industrial agency will be much in demand. At the same time, professional advice will be required more and more throughout Europe, as harmonisation is finally achieved as regards company law, the presentation of prospectuses for public issue of shares, unitisation, securitisation and the presentation of balance-sheets for various types of companies.
A question put to me by the commission in respect of asset valuations was: “Who can do the work if it is made a requirement and would it not be prohibitively costly?” In respect of the first part of the question, there is no doubt that UK valuers can do it and are the best placed in Europe to benefit from the growth in such work. As regards the second the use of new technology and UK experience will ensure competitive pricing!
The directive on the mutual recognition of higher education diplomas provides for a period of training where someone needs to top up his own training in respect of aspects not covered by the education and practical experience gained in his own country. This will provide a challenge to the profession and the RICS, which will be designated as the “competent authority” for the surveying profession in the UK.
This matter also raises with it the whole question of the role of the institution in an expanded “home” market. Hitherto, the institution has quite properly considered itself to be a home-based operation, despite extensive international involvement. Henceforth, considerable thought will have to be given to the new role of the institution and whether a more Pan-European approach will be necessary, both in the interests of the European property business and of the furtherance of professional standards and the benefits that they bring to the efficient operation of property markets.
Both the RICS and the International Committee are aware of the risks and opportunities, and are monitoring closely all that takes place in Europe and endeavouring to identify where action needs to be taken. In respect of the latter, the prime role played by institution members in both the European Group of Valuers of Fixed Assets and the European Committee of Construction Economists provides a sounding-board and enables the institution, via Pan-European bodies, to represent the views of surveyors albeit that members of those organisations from other European countries must be persuaded first of their validity.
How are we as individuals and practices to face the challenge of 1992? If we take a clear-sighted view of the opportunities available there can be no doubt that we must, or should have already, taken a clear decision as to whether we can stand on the by-lines and continue as boutiques in a UK market, or whether we are able to take a Pan-European stance, either by developing our own offices, acquiring Continental businesses or by building up business affiliations to enable us to operate effectively on the European stage. This may well involve an expansion of our practices and a further scrutiny of the structure under which we seek to operate, be it partnership or by incorporation.
To conclude, if, as I envisage, this will lead to certain firms expanding rapidly, the only practical means of expansion may well be via a public flotation, and one wonders who will be next in line for such a flotation and whether their prospectus contains a strategy for “1992 — towards a single European property market”.