The property investment space in the UK is shifting constantly. One factor that investors must keep front of mind is the impact of tax on their investment. It is often a complicated picture and requires expert oversight to ensure there aren’t any surprises further down the line.
Jason Dunlop, tax partner in the real estate team, S&W
Jason Dunlop, tax partner in the real estate team at S&W, talks to Property Week about the tax landscape for investors and developers.
What does the outlook for real estate investment look like in 2025 and beyond?
In recent years, investment into UK real estate has been stalled by the economic headwinds of interest rate rises, inflationary pressures in the fallout of Covid-19 and political uncertainty.
However, this year there have been signs of an improving investment market. Investors are back and deal volumes in certain asset classes are starting to rise as we see interest rates fall, inflation stabilise and a strong political mandate for the Labour government.
Further falls in the Bank of England base rate could trigger a wave of investment activity as investors move away from the bond markets, chasing stronger yields in real estate instead.
This year there have been signs of an improving investment market. Investors are back and deal volumes in certain asset classes are starting to rise
What are investors focused on when appraising new opportunities?
Investors are seizing opportunities with value-added strategies, usually involving some kind of repurposing or redevelopment. They are also increasingly interested in the environmental and social impact of their investments. For example, the commercial office market has been challenging in the wake of the pandemic as the demand for office space has dropped due to the trend towards hybrid working.
However, investment in prime office space with strong ESG credentials remains strong, with new best-in-class assets commanding a ‘green premium’ and demonstrating that, even in a tough market, high-quality, future-proof real estate will perform well.
What asset classes do you think will be the target for investment?
Those assets where the demand/supply imbalance is the greatest will remain strong, and they tend to lean towards operational real estate. We’re seeing a lot of activity across the living sectors and these are expected to continue to perform well given we have a chronic undersupply of affordable housing and investors are looking for ways to bridge that gap. This includes build-to-rent, co-living and social housing, but it also includes retirement housing, supported living and healthcare to cater for the needs of an ageing population.
Investors also recognise that well-managed real estate performs better so there’s a lot more investment being put into the operating platforms that typically sit alongside these asset classes, which increase the value of the investment and improve resilience.
Digital infrastructure is another growing area. Data storage and the growth of artificial intelligence are really driving that space.
What is your approach to advising your clients on their options for structuring investments?
Whenever we are structuring investments into real estate, we consider the profile of the investor, the nature of the underlying real estate and the business plan – all of which are key factors that can really influence our advice.
We typically prepare an options appraisal upfront and explore the high-level tax implications throughout the investment lifecycle, including corporate structure, acquisition, financing, development, operation, sale and profit repatriation. We’ll run through the advantages and disadvantages of the structures we think would be most suitable, taking into account the tax profile throughout the life of the investment. Once a preferred route has been determined, we can move forward to detailed structuring and implementation.
What are some of the key tax factors that influence structuring for UK real estate investment or development?
It’s important to get your structure right at the outset. This is the architecture for the investment, and if you get this right it will make everything much simpler. That said, tax can be complicated and changes regularly, so it’s important to review your strategy frequently.
Many real estate investments are funded by debt, and one thing we support our clients with is navigating the complex rules in UK tax legislation that govern the tax deductibility of financing costs – for example transfer pricing, corporate interest restriction and hybrid mismatches. We advise clients on the potential application of these rules and also if there are ways to manage or even mitigate their impact.
Investors are also usually very interested in the tax implications of a future sale of their investment. We will often look at different exit options, such as asset sales versus share sales, appraising the availability of certain reliefs or exemptions and the preferred profit repatriation strategy, to determine the most tax-efficient disposal option.
What are some of the most common or under-appreciated tax risks in corporate real estate mergers and acquisitions (M&A)?
We provide financial and tax due diligence in connection with corporate real estate M&A to help identify and mitigate deal-related risks.
A common one is tax attributable to latent gains. Purchasers acquiring shares in entities that own real estate should consider whether there is a gain on the underlying property and determine the tax attributable to that latent gain.
The buyer needs to be aware that any tax triggered on the future sale of the asset would be their liability. As a result, buyers often seek to adjust the purchase price for the shares to account for this. We recommend this issue is identified and dealt with upfront to avoid difficult price negotiations down the line.
As already mentioned, there are many rules that can restrict interest deductibility for tax purposes, and this is another frequent risk area arising from tax due diligence.
For example, tax deductions for related-party (such as shareholder) debt are restricted to the arm’s-length price – that is, both the quantum of the debt and the rate of interest that could be obtained in the open market. Often, target entities do not have sufficient evidence to support the tax deductions for related-party debt, which could expose historic tax liabilities that may require remedial action or protection via the sale and purchase agreement (SPA).
The Construction Industry Scheme (CIS) can also catch people out. If a company has carried out any significant development works, whether it’s a new build or a conversion, then they are potentially within the scope of the CIS. If they fall within those rules, they are under an obligation to report all those costs to HMRC and to potentially withhold tax on payments to subcontractors.
We regularly identify cases where the target entity has either failed to realise that they are within the scope of the CIS or not accurately verified the status of its subcontractors, and in some cases may have paid them gross without deduction of tax. Again, this may either require remedial action prior to acquisition or adequate protection via the SPA.
Tax risks arising from due diligence can be varied, complicated and financially significant to the overall prospects of the deal; but it may also uncover opportunities that can add value to an investment, such as unclaimed capital allowances on previous capital expenditure. So it is recommended advice is sought upfront to navigate risks and capitalise on opportunities.
About S&W
S&W is one of the fastest-growing top 10 UK accountancy and advisory firms. It works with businesses and individuals to navigate challenges, unlock potential and achieve the extraordinary.
Providing comprehensive financial and tax advisory services to investors and developers from across the real estate sector. In a complex and ever-changing regulatory environment, S&W industry specialists tailor solutions to simplify commercial decision-making throughout the investment lifecycle, from acquisition to exit. Pragmatic and sector-focused experience to help you realise your real estate ambitions.