George Osborne’s Budget back in March may be remembered for the tax on fizzy drinks to tackle Britain’s growing obesity crisis. But hidden in the fine print was a property boon for charity investors. Charity investors benefit from one important and unique advantage over other investors. They are exempt from Stamp Duty Land Tax on property purchases. In the March Budget, the Chancellor announced an additional 1% increase in tax for properties of more than £250,000, taking the rate from 4% to 5%.
For most investors, therefore, the “round trip” on costs, allowing for agents and solicitors fees, is around 8%. For charity investors, however, it is around 3%, providing not only a yield and return advantage but also conferring less liquidity constraint. This tax advantage is only useful if the prospects for property are positive. And, fortunately, they are, despite property’s recent outperformance.
Commercial property has been an attractive asset class for charity investors over the past five years. The sector has returned 10.4% a year over the rolling five years to May 2016. In contrast, bonds (5-15 year gilts) have returned 5.7% and equities 5.6% (FTSE All Share). Furthermore, this return has been achieved with less volatility and a constantly high income yield. For most of the last five years property returns have been driven by yield compression, giving rise to capital growth.
This trend ended last year, with income and rental growth now likely to be the drivers of return. The gap between property yields and the risk-free rate (normally taken as the gross redemption yield on 10-year gilts) remains at 350 basis points (5% property vs 1.5% gilts). This is higher than property’s historic norm of 250 basis points, meaning that property pricing could absorb an increasing gilt yield as and when the market normalises in the post QE environment. With inflation remaining low, however, and interest rate rise expectations pushed out possibly to mid to late 2017, property looks fairly priced and looks set to deliver an attractive nominal and real return of 6% to 6.5% a year. What could derail this outlook? Property’s biggest weakness is, arguably, its recent strong performance record.
During the upswing money flowed into the retail funds and managers have become more cautious at this point in the cycle. The post-Lehman period was one of property’s darkest periods and, with managers wishing to avoid a repeat of previous mistakes, they are holding large cash weightings in the event that retail investors turn negative on the sector. Property returns are ultimately correlated with movements in GDP. Even before the pre-EU referendum slowdown in the economy the PMI indicators were indicating slower growth. An economic shock, possibly precipitated by a Brexit vote, remains a risk too. For most charity investors with a medium to long-term time horizon for investing, however, property remains an attractive asset class. There is a defensive quality with income paid quarterly in advance and a very valuable tax advantage. Market dynamics are changing rapidly in an increasingly technologically-advanced world, meaning that good asset selection is key.
By James Thornton Chief Executive of Mayfair Capital Investment Management Limited and Fund Director for the Property Income Trust for Charities
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