by Richard Johnson
Much has been written recently about the current uncertain state of the property investment and development markets. The enterprise zone investment market has, since the early 1980s, provided a unique tax-efficient manner in which corporate and personal incomes can be sheltered. Have EZs been as badly affected as the rest of the property market and what opportunities exist for the next few tax years?
This article is based on recent studies carried out by St Quintin Property Finance which scrutinised the amount of investment activity that took place in the enterprise zone markets during the 1989-90 and 1990-91 tax years. As will be seen, several interesting results were drawn.
The background
Before the results of the study are examined in detail it is useful to review the rationale of investment in enterprise zones. They were created following the Local Government, Planning and Land Act, 1980 to encourage investment and thereby development — leading to job creation — in some of the more deprived areas of the country.
Twenty-eight zones have been designated: 10, which are known as “first-round” zones, were designated in the autumn of 1981 and 16 more were designated between 1982 and 1986. More recently, Inverclyde, to the south-west of Glasgow, and Sunderland have been designated during the past two years. There are no published plans to designate any further zones.
The zones are spread throughout the country. The individual areas selected were those where the Government felt that the particular combination of taxation and other benefits would most help the local and regional economies. The sites chosen were, on the whole, those where traditional industries had declined, or been closed, such as Corby and Dudley. The zones, therefore, are not always single blocks of land in urban areas, as in London Docklands, Dudley or Middlesbrough, but are located on several separate sites, as in north-west Kent, or bordering a “greenfield” environment, as in Wellingborough.
Each zone has a designation life of 10 years. Consequently, those designated in 1981 are drawing to an end, whether or not all the available land has been utilised. The rate at which the land has been used varies markedly between the zones. In Wellingborough, for example, the zone does not expire until 1993, but the last piece of land which is likely to become available has recently been sold.
The benefits
The most important single benefit which accrues to the purchaser of a new, unused commercial development in the enterprise zones is that companies and individuals are able to set off expenditure on buildings (but not the value attributable to the land element) against their tax liabilities. In crude terms this has the effect of “grossing up” the yield on an investment by the marginal rate of income or corporation tax paid — for example by 40% and 35%, less an adjustment for the land value, which is typically between 5% and 15%.
Developers, on the other hand, have been as attracted to the zones by the investment sales opportunities as much as by the relaxation of planning regulations. This has, however, meant that some quite remarkable individual schemes have been constructed — Dudley and the Newcastle/Gateshead conurbation have seen the construction of two of the larger shopping schemes in Europe.
It is highly debatable whether such schemes would have been approved in the absence of the relaxed planning regimes of the zones. Instead of the usual statutory planning procedures, individual planning schemes were adopted for each zone. Any scheme which falls within the very broad parameters of the scheme is deemed to have planning permission.
Past activity
Whether the enterprise zone experiment has been a success depends largely on individual views. Certainly, they have been very successful in attracting investors who sought to utilise what is one of the few remaining ways (apart from the Business Expansion Schemes) in which a tax-payer can invest in a tax-efficient manner.
Over the past few years the investment market could be categorised into three elements:
(1) Private individuals with medium or large incomes who sought to use their “top slice” of tax more efficiently. These investors have sought the opportunities offered by either the enterprise zone trusts (such as the Laser Trust which is provided by financial intermediaries Johnson Fry) or by the purchase of small industrial units, often with substantial leasebacks, such as those developed by Pilkington Properties. Their only real alternative was the formation of small syndicates, or investment clubs, to pool resources and purchase an individual property.
(2) The corporate sector over past years has not been as active as many advisers expected. The rapid rental growth which has characterised the property world of the 1980s has greatly benefited those companies — frequently property companies — which purchased enterprise zone investments in the value range £500,000 to £5m.
(3) The investors purchasing the larger individual properties have been the enterprise zone trusts. Their purchasing power has grown considerably, especially over the past three years, as they provide a relatively straightforward way for individuals to invest in these tax-efficient regimes.
The tax year 1989-90
For the first time in the history of the Industrial Building Allowance and enterprise zone market, supply considerably exceeded demand for investments. St Quintin calculated that property with a total value of £745m was available, of which only £250m was sold.
The great majority of these investments were available in London Docklands, and the Salford and Trafford Park zones in Manchester.
Actual take-up can be broken down as follows: approximately £250m was available in Manchester, of which 40% was sold; of the £300m available in London only 23% was sold; across the remainder of the zones 40% of the £200m of investments available was sold.
The lessons
The size of the 1990 market was much larger than in previous years and, although it is difficult to verify, it is estimated that no more than £300m had been available in any previous year — the majority of which was always sold.
It must be remembered that the figures of available investments are boosted by approximately £100m of schemes which had not commenced at the tax-year end. Nevertheless, the actual increase in the amount of “tax product” available was substantial.
The investors, 1989-90
Two types of investor dominated the market in 1989-90. The enterprise zone trusts purchased approximately £135m of property, representing about one-fifth of the total available but, more significantly perhaps, 50% of the total value of properties sold.
The majority of the trust purchases were in London and Manchester: 30% in the Isle of Dogs and 50% in Manchester.
Private individuals purchased in the order of £75m of buildings, mainly in small parcels of less than £1m. In some cases syndicates formed by, for example, the large firms of chartered accountants were able to purchase buildings of sizes up to approximately £4m.
The most significant change, however, was the fact that the property companies had all but withdrawn from the market. In previous years they had accounted for properties up to about £100m and had been one of the more steadfast supporters of the enterprise zone market.
It appears that the joint impact of high interest rates and the general decrease in the overall level of corporate profits forecast for the sector spurred this retreat from the enterprise zones, an effect compounded by some remarkable bargains available elsewhere in the investment markets. High interest rates, in particular, have greatly affected the ability of such companies to highly gear their enterprise zone purchases — a privilege they had enjoyed in previous years. This phenomenon is now being seen throughout the UK property sectors. Unless interest rates fall in the next few months this is likely to remain the single most important factor.
The investors, 1990-91
Initial analysis undertaken shows that the enterprise zone trusts continued to dominate the market.
The trusts purchased approximately £150m of property during this period. This figure represents around 75% of the total value of properties sold.
The majority of the trust purchases were once again in London and Manchester, although large purchases were also made in Clydebank and Dundee.
As in the previous year, there was very little activity from the corporate sector. The recent reductions in interest rates did not appear to have a dramatic effect in encouraging purchases by them.
Private individuals purchased a lesser amount of buildings than in 1989-90 and higher yields and greater income security were sought in nearly all cases.
The future
The period until the end of March is the most active time in the enterprise zone market, with investors seeking to shelter their taxable earnings which, in most cases, will by then have been established.
We expect 1991-92 to offer investors a lesser range of investment opportunities but at as high a yield as has ever been available in the enterprise zone market. Whereas in previous years there has been fierce competition in the closing days of the fiscal year, the current market will include excellent opportunities through the year in areas of enormous growth potential, often in major conurbations such as London Docklands, Manchester, Clydebank and Newcastle.
Developers must react to the changing climate by providing property investment products carefully designed for the requirements of investors. Those that are able to do so with yields that compete with other forms of investment will be greeted by success.
