Tax incentives at the heart of European residential investment

Copyright: David Lawson 1996

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Dick Van den Boss is eager to find more property. He will build if he cannot find standing investments. Perhaps not such a surprising aim when markets are beginning to recover - except that he is looking for housing. Even more remarkable is that Van den Boss runs a major pension fund. The idea would send shivers through the average UK fund manager. Antipathy towards residential investment remains unshaken despite proposals to launch housing investment trusts (HITs) providing tax incentives. Yet in countries like Holland, institutions are the main source of rented homes.

Van den Boss's PGGM has Fl 700m(270m pounds) in this sector - only a fraction of its Fl 7.5bn property portfolio but the figures are less important than the fact that it exists at all. Other Dutch funds have much bigger holdings, he says. So is there something Britain could learn about the way private renting works across the Channel? If there is, few appear to be interested. A sweep through most of the top UK advisers reveals almost total ignorance about how other markets operate - even among those who specialise in international homes sales.

Gavin McCrone of Edinburgh University Business School is not surprised. 'No country seems to know about how other European markets work,' he says. 'It is a major barrier to learning from others' successes.' His study of European housing with Mark Stephens of Glasgow University last year gives a rare and comprehensive insight into the factors at work in leading countries and should be required reading for professionals. But it also reveals that the Continent is not the ideal some might believe the UK should pursue.

Firstly, private renting is declining right across the Continent and institutions are heavily active in only a handful of countries. In Spain, for instance, where rent controls are severe, only 5% of the private rented sector is owned by funds. In France, the sector has fallen from 33% to 20% since the 1960s and most landlords are single-person owners. Barry Attarzadeh of Chesterton says any appetite institutions have is blunted by low returns of 4-5% and a massive overhang of property in Paris, where values have crashed.

Even the Netherlands, which along with Germany has the most active big investors, still has only 17% of stock in private renting. That is partly because is has a huge social housing sector (36%), however. It is also almost twice that in the UK, despite a long history of rent controls. The lesson is that tax incentives can make a difference. Investors can write all interest off against taxes, producing an attractive niche sector for institutions. Rent controls have also been eased and rents allowed to rise faster than inflation. 'We are very happy with the way subsidies work and consider residential in exactly the same way as commercial,' says van den Boss. Total returns of 8-9% are good enough to make this competitive.

Germany is the prime target for those seeking answers to the UK problems, however, as more than 40% of housing is privately rented. This stems partly from the tendency to buy late in life and then move infrequently. Insurance companies fed that demand for decades, according to Harald Blumenauer, a director of one of the country's largest estate agencies. 'There was a social pressure to invest in such activities,' he says.

But residential is losing its gloss. 'Twenty years ago a fund might have 70% in apartments and the rest in commercial. Today this has reversed,' he says. That is partly a reaction to stricter rent controls but mainly because yields of 4-5% on residential pall beside 5-6% on commercial property. Private individuals have made up some of the slack on schemes of less than DM20m (8.7m pounds). 'They look for long-term stability rather than immediate returns,' he says. Companies have also rushed to claim tax rebates of up to 50% building condominiums in the former East Germany. McCrone points out that the main message to be learned not just from Germany but most leading European countries is that fiscal incentives can make a difference. Most allow depreciation to be set against taxes - a measure he would like introduced here to attract larger investors.

A study by Coopers & Lybrand showed average net UK yields around 6-9% for shorthold lets - just within the real return of 6-9% demanded by institutions. It suggested HIT tax incentives would help that overlap. McCrone looks to European experience of depreciation allowances, lifting of taxes on rents and some gains tax exemption to bridge the gap. Both agree that the big barrier may not be yield gaps, however, but a persistent disenchantment with a sector that has been the centre of political wrangles for decades. 'Germany's advantage has been that its housing policies are not constantly changed by politicians,' says McCrone.

[Housing Policy in Britain and Europe - Gavin McCrone and Mark Stephens - UCL Press. 14.95]