In order to tax land values, the value of the land has first to be assessed. In any system of Land Value Taxation (LVT), the way in which land values are assessed will be of critical importance to taxpayer and Government alike. From the taxpayer’s point of view, the method of valuation should be logical, transparently clear and fair. From the Government’s point of view, the tax base should be stable and the revenue from it predictable.
In this paper, we consider the key principles in valuing for the purposes of Land Value Taxation.
The value of land can be expressed in two ways – what it would fetch if sold, i.e., its capital (market) value, and what it would rent for, i.e., its annual rental value. For the reasons explained in this paper, it is important that LVT be levied on the annual rental value and not on the capital or market value.
At first sight, this seems odd, even perverse. Apart from farmland, bare land is rarely, if ever, rented. There is little or no evidence of land rents. On the other hand, building land is constantly being bought and sold and it is not difficult to find good objective evidence for capital values. The problem with capital values, however, is that they are subject to the vagaries and vicissitudes of market sentiment and can fluctuate considerably. The yield of LVT based on capital values is likely to vary considerably. This lack of stability and predictability in the market makes the capital value basis unsatisfactory from the Government’s point of view. It is also unsatisfactory from the taxpayer’s point of view, as the tax he has to pay may well fluctuate from year to year.
If rents are fairly stable and land values reflect rental values, why should land values be unstable? One obvious reason is interest rates. Land prices are very sensitive to interest rate movements given that most land transactions are financed by borrowing. It is not just actual interest rate movements which are relevant here, but the expectation of interest rate changes. Land prices are also subject to speculative surges. When these over-reach themselves, land prices can fall dramatically. It would be inappropriate to import this frothy overlay into the LVT valuation base. It would be a serious error, therefore, to base LVT on capital values. Annual rental values alone can meet the necessary requirements for stability and fairness.
If bare land (other than farmland) is hardly, if ever, rented, how can land rental values be assessed with confidence? If annual rental values cannot be assessed with confidence, how can they meet the criteria of fairness and transparency?
Although land is hardly ever rented on its own, it is constantly rented with a building on it. The rent of a property, i.e., land and building, therefore has two components – the rent of the land and the rent of the building. In this country there is an efficient market in the rental of all categories of land and buildings, i.e., commercial, retail, industrial and residential. The annual rent for all these types of property can be assessed with confidence. The question then is: does there exist a sound technique for assessing how much of the rent is attributable to the building and how much is attributable to the land? It is argued here that there exists a proven and acceptable technique for doing just this.
By way of illustration, take the case of a newly built three-bedroomed house with garden in a suburban South Eastern location. Its sale value is £300,000. The house cost £150,000 to build including the builder’s normal development profit. It follows that the balance of £150,000 – half of the total - must be attributable to the site. If the rent is £1,000 a month, i.e., £12,000 per annum, it is fair and reasonable to impute half of this to the land. The annual rent for LVT purposes would therefore be £6,000, i.e., half of £12,000.
The relationship of land to buildings – 50:50 in the above example – will vary across the country and even within a particular locality. In the North, for example, the land element in property values will tend to be lower. In very depressed areas it could even be close to zero. By the same token, in particular areas of the South East, e.g., Central London, land values may well account for considerably more than 50% of property value, perhaps even as much as 80% or more.
Most properties are not new and many in fact are very old. As any home owner knows to his cost, a building deteriorates with time and requires increasing maintenance. This should be taken into account on a depreciated replacement cost basis in allocating the property value between land and buildings. Admittedly, working out the depreciated replacement cost of a property requires skill and experience but this task is well within the competence of surveyors and valuers. Done as a matter of routine in an LVT environment, the technique would be refined and standardised across the country, thus ensuring consistency and fairness.
The land rent thus assessed would properly be described as an imputed or attributed rent. This technique of imputing a land rent from the property rent would account for the vast majority of land value assessments whether it concerned industrial, commercial, retail or residential land. There would nevertheless be instances where this technique would not be applicable or where it would require modification. Obvious areas where special arrangements will be needed include parkland and open spaces, churches, schools and hospitals. It would be out of place in a paper of this general nature to detail these special arrangements.
In view of the above, the way in which property (i.e., land and buildings) rents are assessed is clearly of prime importance. What is sought is the open market rent (i.e. the annual amount that it is reasonable to suppose the property in question would rent for if advertised in the normal way). This is a task which is carried out all the time by chartered surveyors and estate agents across the country. The process takes into account the age and condition of the property, its location and suitability for its purpose. The annual rental is then assessed by reference to the rental being paid on comparable properties, taking into account differences between the subject property and the comparable properties.
In coming to an assessment of the annual rent, the valuer would naturally have to take into account all relevant factors (i.e. factors which affect the rent including location and planning permission, actual or potential). This would be a matter of professional judgement on the part of the valuer. It would be a mistake to hem the valuer in by specifying relevant or non-relevant factors. There would be one exception to this rule. In assessing the market rent for the property, it should be assumed that the tenant has the right to renew the lease (at the then market rent) indefinitely.
It would be vital for the credibility – and, hence, acceptability – of any LVT scheme for there to be regular and frequent periodic valuations. Valuations under the current rating system are done every five years. As LVT would be a far more significant impost than local rates, valuations would have to be updated at least every three years. The aim should be to achieve even greater frequency.
Land rental value assessments would be subject to appeal by the taxpayer. In the case of an appeal the valuer would have to justify the rental assessment and show the evidence of market rents on which the value has been based. Annual rents that cannot be justified by reference to market evidence cannot stand.
As with any new tax there are bound to be circumstances not envisaged by the initial legislation. This will no doubt be the case with LVT. However, as regards valuation, the generation schema set out in this paper should provide a feasible framework.
Copyright (c) Coalition for Economic Justice, November 2010
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