residential researCH

TAXING HIGH VALUE HOMESAN ANALYSIS OF PROPOSALS FOR A MANSION TAX, SEPTEMBER 2013

an analYsis OF PrOPOsals FOr a MansiOn taX sePteMber 2013

ASSESSING THE prOpOSALFour years after first being proposed, details of a possible mansion tax remain surrounded by uncertainty. Liam Bailey, Knight Frank’s Global Head of residential research, says it is time to cut through the guesswork and provide some clarity on its likely impact.

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The Liberal Democrats have proposed the introduction of a mansion tax on properties worth £2m+. The tax would apply to the portion of residential value over £2m, at a rate of 1% annually.

The proposal is supported by Labour, and both parties have stated their objective for the tax to raise between £1.7bn and £2bn annually.

Based on an investigation into official data our conclusion is that the mansion tax, as currently proposed, will raise approximately £1.3bn annually, before exemptions.

In order to raise the targeted revenue the value threshold for the tax would need to be reduced from £2m to either £1.5m (to raise £1.7bn) or £1.25m (to raise £2bn), and potentially even lower once exemptions and the cost of collection are allowed for.

Reducing the threshold from £2m to £1.25m would more than double the number of properties affected from 55,000 to 140,000.

The tax would be levied overwhelmingly on London and the South East of England, with 86.4% of all £2m+ properties located in those two regions.

Heritage properties would be targeted, with 16% of all £2m+ properties being listed buildings compared to less than 2% of all sub-£2m properties.

With a £2m threshold nearly one in ten properties defined as “mansions” would be one and two bedroom flats.

If the £2m threshold were adopted and not increased in line with house price inflation, over the next 25 years a total of 775,500 properties would be dragged into the mansion tax net, including all properties with a current value of £540,000 or more. This means that some first time buyers buying through the government’s help to buy scheme (upper limit £600,000) would be paying a mansion tax before they finished their mortgage term.

KEy FAcTS

The idea of introducing a new annual tax on high value property was first discussed in September 2009 by the Liberal Democrats. Their initial proposal was for a 0.5% annual levy on all residential property value over a threshold of £1m. It was estimated the tax would apply to around 240,000 properties, and would raise around £1bn each year. 1

In November 2009 this initial proposal was amended, so that a 1% levy would apply to the portion of a property value over £2m, which was estimated to apply to around 70,000 properties. This proposal was formalised in the 2010 Liberal Democrat Manifesto, with an estimate that it would raise around £1.71bn in tax annually. 2

In February 2012 the Labour Party announced their support for an annual 1% levy on properties worth £2m and above. The Labour Party’s objective of raising £2bn annually from the tax was confirmed in the House of Commons debate in July 2013.3

We therefore have two current proposals, one from the Liberal Democrats and one from Labour, which would tax residential property values above £2m, with the aim of raising between £1.7bn and £2bn annually.

How much will the mansion tax raise? At first glance there is a fairly straightforward calculation to make in assessing the annual tax take from the mansion tax. Count all £2m+ properties in the UK, establish their average value, and calculate 1% of their combined value above the £2m threshold. After deducting costs and exempt properties you have your result.

In reality, however, every part of this calculation is problematic.

Step 1: How many £2m+ residential properties are there in the UK? Our own calculations point to there being around 50,000 £2m+ properties in the UK. However, since the mansion tax was first mooted, figures of between 35,000 and 74,000 have variously been put forward by interested parties.

Helpfully, we now have the official estimate. David Gauke MP confirmed in the House of Commons that “our assessment…is that there are 55,000 properties worth more than £2m in the country. We have the finest minds in the Treasury working on this… ”. 4

This same estimate was confirmed in response to a series of questions raised by Lord Oakeshott of Seagrove Bay during House of Lord’s Questions on 25 July 2013. 5

We made enquiries of HM Treasury to review the details of their calculation. While we were not permitted access to review the research, for the purposes of this note we have assumed the Treasury’s assessment to be accurate and we have adopted 55,000 as the total number of £2m+ properties in the UK.

Step 2: What is the average value of a £2m+ property?There are two official sources which can provide an estimate of the average value of the 55,000 £2m+ properties.

First, HM Revenue & Customs produces an annual summary of residential property transactions by price band. The most recent data for 2012 reveals that there were 3,280 sales of £2m+ properties, with a total value of £16.75bn. The average value of last year’s transactions was therefore £5.1m. 6

Second, the Land Registry publishes its own data on residential property transactions.

1 http://www.ft.com/cms/s/0/22cb5388-a6b4-11de-bd14-00144feabdc0.html#axzz2bl5Xntq8 2 Liberal Democrat Manifesto 2010 3 Hansard 1 July 2013, Columns 648-650 4 Hansard 1 July 2013, Column 650

an analYsis OF PrOPOsals FOr a MansiOn taX sePteMber 2013

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FIGUrE 1 Mansion tax thresholds and potential gross tax take, split by value band

£2M tHresHOld £1.5M tHresHOld £1.25M tHresHOld Properties Gross tax take Properties Gross tax take Properties Gross tax take (£) (£) (£)

Sub-£2m - - 44,500 86,750,000 84,500 224,160,000

£2m-£3m 24,200 98,450,000 24,200 219,450,000 24,200 279,950,000

£3m-£4m 11,000 155,920,000 11,000 210,920,000 11,000 238,420,000

£4m-£5m 7,150 171,700,000 7,150 207,450,000 7,150 225,320,000

£5m-£10m 8,800 393,890,000 8,800 437,890,000 8,800 459,890,000

£10m+ 3,850 477,750,000 3,850 497,000,000 3,850 506,630,000

All 55,000 1,297,710,000 99,500 1,659,460,000 139,500 1,934,370,000

source: Knight Frank residential research

and used by charities or social housing providers, farmhouses and some properties used by businesses to house employees. More significantly the list of exemptions includes properties rented to third parties.

Removing exempt properties will obviously reduce the number of chargeable properties and the associated tax take, potentially significantly. Without a final list of exemptions it is an impossible task to assess the significance of this issue.

Step 4: Estimating the annual receipts from a mansion tax In figure 1 we have set out our conclusions on the annual revenue generated from a mansion tax, taking into account the assumptions made above. Our conclusion is that the proposed threshold and tax rate would deliver a gross annual receipt of £1.3bn, 24% below the Liberal Democrat estimate of £1.7bn and 35% below Labour’s £2bn estimate. This represents an average annual payment of £23,595 per property.

As noted above, our estimate excludes the impact of exemptions and the cost of collection, which could have a significant negative impact on revenue.

There are two further issues which will have an impact on the final tax take; the behaviour of owners and purchasers.

How would owners react to the tax? Would they look to split properties into multiple smaller units? The temptation for a cash poor owner of a £4m property to create two £2m units would be fairly strong. As we note below

We have assessed their Price Paid Dataset for all £2m+ properties for the 12 months to June 2013. These 1,661 transactions have a mean value of £3.6m.

There are several reasons for the differences in both average prices and sample size.

The Land Registry’s Price Paid Dataset generally under-reports the number of high value residential sales. One key reason for this relates to the fact that a sizable portion of high priced houses often come with a large area of land, and this land element means the sale is not included in the strict definition of the residential Price Paid Dataset.

These missing sales provide at least one explanation for the difference in average value between the HRMC and Land Registry average values. In most cases landed properties will have the value of the house, land and associated property treated as a linked transaction and will therefore be included in the above HMRC figures as an aggregate of residential and “non-residential” values.

The Land Registry information removes these transactions and reports a more accurate net “residential” value. This factor points towards the Land Registry’s lower average value figure as being more appropriate for the purposes of our calculation.

Before we conclude on this point it is worth noting that there is also a tendency for high value sales in London to be missing from the Land Registry’s Price Paid Dataset. For this reason we have reviewed both datasets together with additional market sources and have concluded on a figure of £4.4m as the average value for a £2m+ property in the UK, and have adopted this figure in this paper.

Step 3: How many properties will be exempted? Details of potential exemptions to the tax do not appear to have been worked up by either Labour or the Liberal Democrats. However we did get an insight into Labour thinking from Chris Leslie MP, who confirmed in the House of Commons that the list of exceptions to the recently introduced Annual Tax on Enveloped Dwellings (ATED) “…may well serve as a guide as to how a mansion tax could work in future”. 7

The exemptions for the ATED are fairly wide ranging and include those properties owned

however, changes to the behaviour of owners could have further unforeseen consequences for overall tax take.

Will purchasers reduce their bids for £2m+ property and would prices fall? They might do, and if they did it would cause a substantial problem for the taxman. While a fall in value would be considered irritating for home owners, the structure of the tax means that a fall of say 5% in average £2m+ property values would have a disproportionate impact on tax revenue reducing the tax take by 9%.

Step 5: conclusion – how do you raise £1.7bn or £2bn annually from a mansion tax?It is clear from our investigation of official data that a £2m threshold is too high to deliver a tax take of £1.7bn, let alone £2bn. In table 1 we provide an analysis which points towards a threshold of £1.5m in order to reach the Liberal Democrats £1.7bn target, and £1.25m to reach Labour’s £2bn target.

The main issues informing the above assessment include the estimate of the number of £2m+ properties and their average value. If either turn out to be too low, then obviously tax take would rise. But note that we have set out a gross position. Even if the gross tax take were to exceed £1.3bn, the impact of exemptions, valuation shifts, changes to owner behaviour and the cost of collection and valuation would be need to be accounted for and would contribute to a lower net tax take.

5 Hansard 25 July 2013, Column WA240 6 http://www.hmrc.gov.uk/statistics/transactions/annual-transactions.pdf, Table 3 7 Hansard, 1 July 2013, Column 673

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AN ANALYSIS OF PROPOSALS FOR A MANSION TAX SePTeMbeR 2013

What do mansions look like, and where do you find them? As Stephen Williams MP notes on the opposite page, there are parts of the UK where a £2m property could be fairly described as a mansion. However in many areas, especially those where most £2m properties are located, they can be anything but. In the following graphic we confirm the distribution of £2m+ properties, by size, type and location.

Forecasts for £2m+ properties in 10 and 25 years time assume no indexation in the £2m threshold (see figure 6 for full analysis).

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AN ANALYSIS OF PROPOSALS FOR A MANSION TAX SePTeMbeR 2013

“ The mansion tax, as the name suggests, is a tax on mansions. If a farmhouse was of mansion proportions and was valued at more than £2m, it would fall within the scope of a mansion tax.” Stephen Williams MP 8

Parliamentary ConstituenCy

reGion £2m+ ProPerties

% oF all uK £2m+ ProPerties

Kensington london 7,675 14.0%Chelsea and Fulham london 5,824 10.6%Cities of london & Westminster london 5,329 9.7%Westminster north london 2,870 5.2%Hampstead and Kilburn london 2,671 4.9%esher and Walton south east 2,277 4.1%richmond Park london 1,786 3.2%Wimbledon london 1,700 3.1%Finchley and Golders Green london 1,622 2.9%Holborn and St. Pancras london 1,594 2.9%Runnymede and Weybridge south east 1,053 1.9%Putney london 953 1.7%Beaconsfield south east 702 1.3%Hornsey and Wood Green london 647 1.2%Hammersmith london 589 1.1%Tooting london 571 1.0%Windsor south east 569 1.0%Battersea london 567 1.0%Poole south West 541 1.0%sevenoaks south east 484 0.9%Hitchin and Harpenden East of England 446 0.8%Chesham and amersham south east 446 0.8%Islington South and Finsbury london 390 0.7%Oxford West and Abingdon south east 380 0.7%Brentford and isleworth london 361 0.7%twickenham london 354 0.6%Reigate south east 351 0.6%Hertsmere East of England 350 0.6%Chipping Barnet london 335 0.6%altrincham and sale West north West 332 0.6%

loCal autHority reGion £2m+ ProPerties

% oF all uK £2m+ ProPerties

Kensington and Chelsea london 11,955 21.7%City of Westminster london 8,119 14.8%Camden london 3,973 7.2%Elmbridge south east 2,746 5.0%Hammersmith and Fulham london 2,103 3.8%Wandsworth london 2,078 3.8%Barnet london 2,073 3.8%richmond upon thames london 1,839 3.3%merton london 1,696 3.1%Haringey london 646 1.2%Windsor and maidenhead south east 625 1.1%south Bucks south east 597 1.1%runnymede south east 578 1.1%Poole south West 540 1.0%sevenoaks south east 502 0.9%Islington london 495 0.9%St. Albans East of England 482 0.9%Chiltern south east 445 0.8%Kingston upon Thames london 429 0.8%Guildford south east 426 0.8%southwark london 396 0.7%Hounslow london 361 0.7%Reigate and Banstead south east 350 0.6%Hertsmere East of England 349 0.6%Brent london 340 0.6%trafford north West 332 0.6%Waverley south east 331 0.6%Ealing london 315 0.6%oxford south east 312 0.6%lambeth london 297 0.5%

8 Hansard, 17 apr 2013, Column 349

Source: Knight Frank Residential Research

Source: Knight Frank Residential Research

TAXING ISSUESThe debate around the mansion tax over the past four years often seems to have generated more heat than light. This is unfortunate, as the proposal raises key practical questions which are in need of an analytical approach. The following briefing has been designed to fill the knowledge gap.

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Why a mansion tax? There is a view in some political circles that owners of expensive houses have been underpaying their fair share of taxes. As Nick Clegg said in a radio interview in February this year “the underlying issue which could not be ducked was that properties worth tens of millions of pounds were paying the same council tax as ordinary family homes”. 9

so why not reform council tax?If a tax is thought to be flawed it might be better to fix it rather than create a new tax. However, one argument in favour of the mansion tax is that a reform of the council tax is too complex and too expensive. This seems surprising, bearing in mind the Welsh Assembly completed the same exercise in 2005 by adding a new council tax “band I” for higher value property owners in Wales. A detailed reading of recent commentary suggests that the real problem with a reform of council tax is that increased revenue will flow to local government, whereas proponents of the mansion tax are looking to raise revenue centrally.

Wouldn’t a local tax be better? The fact that higher-valued properties are so concentrated in London and the South East of England (86.4% of all £2m+ properties) points to a strong argument for a local solution. Local authorities in these areas have made the point that it is precisely these regions where housing affordability is most stretched where additional council tax revenue could

potentially be directed at affordable or intermediary housing investment.

The fact that London in particular will be the main target for the tax, with five local authorities (Kensington & Chelsea, Westminster, Camden, Hammersmith & Fulham and Wandsworth) contributing well over half of all potential proceeds, highlights the growing trend for Londoners to contribute more in tax than is returned in local spending, an issue raised by the London Finance Commission. 10

Will a mansion tax be extended? Our calculations earlier in this report, point to the real threat of the mansion tax threshold being lowered substantially in order to meet stated revenue targets.

Even if the threshold is not lowered, there is another route for the extension of the tax. Bearing in mind the proposed threshold has remained at £2m since 2009 (since when the UK has seen close to 10% price growth) it seems a fair assumption that the threshold would not be raised in line with future house price inflation.

Over the past 10 years house prices have risen by 69%. Assuming a similar rate of growth in the future, all houses worth more than £1,185,000 today would be paying a mansion tax 10 years from now, meaning that the number of homes covered would nearly triple from 55,000 to 157,300. As figure 6 illustrates, over the next 25 years, the same time frame as a new mortgage term, the total number of properties covered by the mansion tax would rise to 775,500 – being all properties currently valued at or above £540,000. Once you understand this process you begin to see the tax’s political appeal.

“ Without indexation, all houses currently worth more than £539,000 would be paying a mansion tax 25 years from now, meaning that rather than covering 55,000 properties, the tax would extend to cover around 775,500 properties by 2038.”

an analYsis OF PrOPOsals FOr a MansiOn taX sePteMber 2013

9 http://www.bbc.co.uk/news/uk-politics-21523314 10 http://www.london.gov.uk/sites/default/files/Raising%20the%20capital_0.pdf

On the face of it this is a neat solution. However, depending on the structure of the provision it could create a significant increase in overall tax charge. Assuming an interest rate of 5%, you only need to defer payment 20 years and the final tax charge would be 65% higher than for those able to pay annually.

is the mansion tax fair? Rather than adding more words to the thousands already written on the fairness or otherwise of a mansion tax, we thought we would end by considering the “lifetime” tax position for a purchaser who is fortunate enough to be able to buy a £3m family home from earned income.

Income tax and NI paid on £2,660,000 the £3,000,000 of net income required to buy the property

Stamp duty paid on the £210,000 purchase (7% on £3,000,000)

Annual mansion tax for 35 years £350,000 (1% on £1,000,000)

Inheritance tax on sale £1,070,000 proceeds (40% on £2,675,000)

Total tax take on lifetime £4,290,000 ownership of £3,000,000 property

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We mentioned earlier that some owners might be persuaded to divide properties into smaller units to reduce their liability. There is a potentially larger group of owners who might decide to put their home improvements on hold. If an extension, a conservatory, a swimming pool or a garden makeover risks adding significant value to a property – it would also add to the owner’s mansion tax liability.

Calculating the impact of deferred improvements on lost income taxes, VAT payments and more broadly weaker economic activity from reduced demand for builders, architects, pool installation and maintenance companies, garden supply firms etc – would be a challenge but would be necessary to give a true “net” position on the total tax take.

What to do with “cash-poor but equity-rich owners”? The unusual nature of the proposed mansion tax means that there is no transaction revenue or income stream to tax. This creates a problem for people with low incomes who own valuable properties. Not wanting to promote forced evictions, the Liberal Democrat response has been to suggest that older owners would be able to roll-up the annual tax, which would then be paid from their estate when they die. 11

Will the UK’s built heritage suffer? High value properties are disproportionally likely to be listed by English Heritage, suggesting that they are more likely to form part of the UK’s built heritage. Figure 5 confirms that, while at most around 1% to 2% of sub-£2m residential properties in the UK are listed, the figure rises rapidly to more than 31% of all £10m+ properties. Overall 16% of £2m+ properties are listed.

The imposition of an average annual tax charge of £23,595 sits awkwardly with the obligation for owners of listed buildings to maintain and protect their properties for future generations to enjoy. Exempting all listed buildings would reduce the potential tax take by nearly a quarter to around £0.98bn.

Will the economy and tax revenues suffer from a lack of home improvements?

FIGUrE 6 When does your home become a “mansion”? the impact of “fiscal drag” on the number of properties affected by a mansion tax

Number of years Cumulative house Current value of Number of properties following the introduction price growth* properties caught by a caught by a static of the mansion tax static £2m threshold £2m threshold

Introduction year 0% £2,000,000 55,000

5 years 30% £1,540,000 95,200

10 years 69% £1,185,000 157,300

15 years 120% £910,000 240,900

20 years 185% £700,000 419,200

25 years 271% £540,000 775,500 source: Knight Frank residential research, Land registry, HMrc, Nationwide

source: Knight Frank residential research, English Heritage

All £

2m+

£10m

+

£5m

-£10

m

£2m

-£5m

Sub

£2m

15.5%

31.4%

24.5%

0%

5%

10%

15%

20%

25%

30%

35%

1.9%

12.1%

FIGUrE 5 Listed buildings by price band % of all residential properties listed Grade ii or above

an analYsis OF PrOPOsals FOr a MansiOn taX sePteMber 2013

11 http://www.independent.co.uk/news/uk/politics/nick-clegg-suggests-retirees-could-defer-mansion-tax-payments-8503896.html

*Assuming the same level of future growth as seen over the past 25 years.

For the latest news, views and analysison the world of prime property, visit

KnightFrankblog.com/global-briefing

GLOBAL BRIEFING

ResiDentiaL ReseaRchLiam Bailey Global Head of Residential Research t +44 20 7861 5133 liam.bailey@knightfrank.com

PRESS OFFICEJohn Williams Head of PR t +44 20 7861 1738 john.williams@knightfrank.com

Knight Frank Residential Research provides strategic advice, consultancy services and forecasting to a wide range of clients worldwide including developers, investors, funding organisations, corporate institutions and the public sector. All our clients recognise the need for expert independent advice customised to their specific needs.

© Knight Frank LLP 2013

This report is published for general information only and not to be relied upon in any way. Although high standards have been used in the preparation of the information, analysis, views and projections presented in this report, no responsibility or liability whatsoever can be accepted by Knight Frank LLP for any loss or damage resultant from any use of, reliance on or reference to the contents of this document. As a general report, this material does not necessarily represent the view of Knight Frank LLP in relation to particular properties or projects. Reproduction of this report in whole or in part is not allowed without prior written approval of Knight Frank LLP to the form and content within which it appears. Knight Frank LLP is a limited liability partnership registered in England with registered number OC305934. Our registered office is 55 Baker Street, London, W1U 8AN, where you may look at a list of members’ names.

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