Business rates: land and real estate
From property value to public value
12 March 2018
Kevin Muldoon-Smith and Paul Greenhalgh urge property professionals to get involved in the discussion over how land and real-estate value can contribute to local authority funding
The value of land and property is becoming increasingly significant to local government finance – but the valuation of both, and methods of taxation, should be urgently reformed to help fund local services and support economic growth.
Until recently, local government funding was generally efficient, relatively equally distributed and controlled by central government; however, emphasis is now being placed on local autonomy, austerity and efficiency. Typically, it will be the responsibility of administrators from central government, who devise policy, and from local government, who implement it, to work out how welfare requirements are to be reconciled with what the Local Government Association (LGA) reports will be a 77% reduction in finance by 2020.
To a large degree, the property sector has not played a part in this new context for public-sector finance. This is a missed opportunity, however, given the growing interest in the value of land and property and its potential taxation as a panacea for devolved welfare, infrastructure and development requirements that are largely unfunded.
Property tax, land value capture, infrastructure premiums, local asset-backed vehicles, bond mechanisms, direct property investment and more efficient exploitation of council assets and local anchor institutions have all received fresh attention in recent years. However, the debate around these methods has largely been confined to public administration and economic geography. Consequently, although the government clearly wishes to exploit the inherent value in land and property, there is no clear rationale for doing so, and initial efforts have been beset by difficulty.
This situation is illustrated by one of the government’s flagship devolution policies, the Business Rate Retention Strategy (BRRS), introduced in 2013. Currently, BRRS allows councils to retain 50% of business rates. The intention is for local authorities to retain 75% of new business rates by 2020 and 100% BRRS after 2020; the latter is currently being piloted in several locations in England.
Empty property taxation is also rewarded more than thriving business centres
The BRRS only rewards business rate growth generated by new property development, with any growth from existing property stripped out. Empty property taxation is also rewarded more than thriving business centres, because the former is levied on the maximum business rate multiplier rather than the lower, small business rate. Moreover, buildings occupied by larger employers and businesses generate most tax while small businesses largely exist outside the business rate mechanism due to relief, the rateable value threshold for which now stands at £15,000.
The BRRS implicitly assumes that new property development can act as a proxy for economic development; however, this is not borne out in reality. Locations with buoyant rental levels that can attract new commercial development have an advantage over those where demand is low and viability is a challenge. Furthermore, certain locations with buoyant job prospects – for example the A19 corridor in Sunderland dominated by Nissan, or the so-called 'Golden Triangle' for logistics in the Midlands – are not accommodated by the BRRS. This is because industrial property, although space-hungry, does not translate into significant business rate income due to its lower rental value per unit area.
Constructing a better system
Current efforts to improve the BRRS mostly involve complex alterations to the underlying administrative system, such as redesigning the reset mechanism or modifying the proportion of local retention. However, changes to the technical fabric of public administration will not alter the underlying flaws in the BRRS. In order to improve the situation, a comprehensive debate is needed that covers property, finance and tax policies.
It was alarming that none of the major political parties mentioned BRRS in their manifestos for last year’s general election. Furthermore, the proposed legislation that would have underpinned 100% BRRS, the protracted Local Government Finance Bill, fell once the election had been called, and was not included in the government’s subsequent legislative programme outlined in the Queen’s Speech.
The recent silence in relation to the BRRS has certainly contributed to the uncertainty about how local areas will develop after 2020 when the 100% BRRS was due to come into force. However, this hiatus gives the commercial property sector some time to reflect on, and influence, ways that the BRRS could be improved, the better to support local welfare requirements and prompt clear local economic development and industrial growth.
An obvious area for attention is the singular focus on new development at the expense of new value in the existing built environment – a limited perspective that ignores the potential reward held in property stock. In response, the commercial property sector should seek to advise as to how a more comprehensive approach, combining the societal, environmental and economic value of all commercial real-estate stock, could be developed.
A significant change would be for the commercial property sector to lobby the government to reduce the rate of empty property taxation below the small business rate multiplier, which would give local authorities and landlords an incentive to promote small business growth rather than rewarding dormant potential. It remains the case that local authorities can potentially make more income from empty rates than business rates, and this became more pronounced when the government significantly increased the threshold for small business rate relief in 2016.
Another problematic but rewarding change would be to consider how the potential growth in value of existing commercial property may be better captured. Currently, any new property value created through strategic economic development initiatives such as improved design, individual placemaking, infrastructure or transport is lost. Meanwhile the added worth derived from improvements in building performance – which might be intended to deal with, for instance, issues including climate change, economic productivity and new ways of working – cannot be easily captured.
Growing over the gap
Business rate retention accounts for only 30% of local authority funding. However, it is unlikely that this policy and its wider stated aim of achieving incentive-based financing will disappear given the recent announcements from the LGA that local authorities would see a 77% reduction in central funding by 2020 and a potential £5.8bn funding gap. Councils’ reliance on local property tax will only increase as a proportion of total spend as they fight tooth and nail to remain solvent and provide a sustainable level of welfare services.
Chancellor Philip Hammond announced in the autumn budget that the City of London, the 32 boroughs and the London Mayor will be able to keep all their business rate growth from this year, even though the legislation for 100% business rate retention has been kicked into the long grass. The Chancellor also announced that the 5-yearly rating revaluation would be reduced to 3 years after the next revaluation in 2022. The following week, the government published its long-heralded national Industrial Strategy. All 3 initiatives have been mooted for some time; however, it is not clear how the announcements will work in practice, or what the final consequences will be.
The central challenge for those who are interested in new forms of local governance and finance based on land and property value is understanding how relatively rigid administrative systems can be adapted the better to exploit the value of land and property. This is why we began a new research project late last year at Northumbria University seeking to understand how proceeds from land and property and the expertise of the real-estate sector can better inform the funding of future local welfare needs in the UK.
There is a clear opportunity for the real-estate sector to bring its expertise to bear
Alongside an international comparison of land- and property-led public sector finance initiatives, we will as part of the project be canvassing the views of real-estate professionals on how the public and private sector can work together the better to exploit the value of land and property. The intention is to move beyond the negative view that prevails in the international press and academic community of the real-estate sector as an extractor of local value, towards a positive narrative of public-sector and real-estate market partnership.
There is a certain inevitability about the increased exploitation of real estate, in terms of land value and taxation, for the purposes of public welfare. How this unfolds, however, is still amenable to influence. There is a clear opportunity for the real-estate sector to bring its expertise to bear to have a positive influence on society, the wider economy and the environment – and thus counteracting the traditional criticism that it protects vested interests.
Dr Kevin Muldoon-Smith is Lecturer in Real Estate Economics and Property Development, Northumbria University. Dr Paul Greenhalgh MRICS is Associate Professor in Real Estate Economics, Northumbria University