The Business
Rates Time
Bomb
Many business occupiers are facing challenging
conditions in the current economic climate, with the
level of outgoings a major concern.
A major financial burden that increases every year and no longer mirrors rental values is business rates. The 2010 revaluation resulted in a large increase in rateable values as the antecedent valuation date (AVD) was April 2008 (just a few months from the peak of the market). Since then rental values have decreased in most areas, so the difference between open market rental values and rateable values has increased year on year. This gap is now large in many locations, particularly in the retail sector, causing increased hardship to occupiers. These problems have been magnified by above target inflation causing the uniform business rate (UBR) multiplier to increase at a fast rate, as it rises each year in line with RPI inflation. The government’s decision to defer the next revaluation by two years, with a valuation date of April 2015 rather than April 2013, will hit many occupiers hard and further erode occupiers’ profitability.
This bulletin examines and quantifies these problems and their ramifications. It also considers what could be done to make the rating system fairer and more equitable at the local level.
• Business rates are attractive to the government,
providing a major source of income (£21.6 billion in
2012/13 for England), equivalent to about half that
raised through corporation tax and about three
times that raised from Stamp Duty Land Tax.
• Irrespective of revaluations the amount of business
rate income received is guaranteed, with annual
increases linked to RPI inflation. Business rates
continue to grow disproportionately
to most other government revenue sources.
• With the increasing burden of business rates on
occupiers the government’s decision to postpone
the 2015 revaluation is hard to justify. It represents a
missed opportunity to ensure a fairer distribution of
the tax.
• The tax is increasingly inequitable because rateable
values are currently based on rental values at the 1st
April 2008 valuation date when the market was at its
peak. Over the following five years the weak state of
the economy and the subsequent fall in rental
values means that current rental values bear little
resemblance to current rateable values.
• GVA’s view is that the overall total market fall in rental
values is close to 15%–20%. This is in line with the
government’s own prediction that if a revaluation
were to go ahead in 2015 the Uniform Business Rate
would rise to 60p in the £. This would represent an
unprecedented level of rates as a % of rental value
and equates to a 72.5% increase in the uniform
business rate since its introduction at 34.8p back in
1990.
• The effect of major declines in rental values has not
benefitted many occupiers. The effect of upward
only rent reviews and rate bills increasing each year
in line with inflation has meant an increase in total
occupancy costs for many occupiers at a time
when income/turnover has fallen significantly.
• Given the reasons for a 2015 revaluation were so
compelling why did the government decide to
postpone it for two years? DCLG said the decision
will ‘avoid local firms and local shops facing
unexpected hikes in their business rate bills over the
next five years’.
• This simple statement ignores the reasons behind
why a revaluation is undertaken. Those businesses in
the worst affected markets would have experienced
falls, not increases, in their rates. GVA questions
whether the decision was in fact Treasury, not DCLG,
led because it delays the government having to
introduce a transitional relief scheme, which would
phase in larger revaluation increases in liability, part
funded by phasing in revaluation decreases in
liability. But in practice the scheme is actually front
end loaded and costs the government £1 billion in
the first two years of its operation (as evidenced
from the 2005 and 2010 revaluations).
• GVA recognises that the government is very unlikely
to change its decision to delay the 2015 revaluation.
GVA therefore urges it to use the £1 billion to help
businesses that need this assistance the most. There
are a number of potential ways in which these
savings can be returned to occupiers:
• An inflationary freeze in business rates for the
2015/16 and 2016/17 rate years
• Targeted help to businesses in the locations and
sectors in England that have suffered so much
through the revaluation deferment.
• I ncrease empty rates relief to pre April 2008 levels
for a two year period.
• In the longer term other solutions should be
considered:
• Make the appeal procedure easier and quicker
• Ensure a more level playing field between online
retailers and bricks and mortar retailers. GVA
proposes having more town centre retail enterprise
zones to attract occupiers and stimulate growth in
town centres.
• Ensure that rating revaluations occur more
frequently, ie. every three years.
Business rates are attractive to the government as they provide a major source of income (£21.6 billion in 2012/13), equivalent to about half that raised through corporation tax and about three times that raised from Stamp Duty Land Tax. Over the
ten years from 2001/02 to 2011/12 business rates income increased by 44% where as corporation tax income increased by 36.5%. Since 2007/08, the detachment between rates and other forms of taxation has become even clearer, marked by a rise of 25% to 2012/13 compared to falls of 12% in Corporation Tax and 31% for Stamp Duty Land Tax.
Business rates are also attractive to the government as they are very difficult to avoid paying and are almost guaranteed to increase each year by the increase in the size of the building stock and by the rate of RPI inflation.
The reasons that business rates are attractive to the government are the very reasons they are unattractive to occupiers as explained in the next section.
Rental value changes
nationally
Business rates are currently based on rental values that existed at April 2008 (very close to the market peak). The next valuation date should have been April 2013 but the government has postponed this for two years. This means that at the local level, regardless of how much rental values have changed since 2008, the amount of rates paid each year will be unaffected, and will in fact increase as the UBR is indexed to RPI inflation. This will be 3.2% based on RPI for September 2013.
There have been two main problems with the rating system over the last five years and these problems will be exacerbated by the decision to postpone the revaluation.
Firstly, the severity of the 2008/09 recession and the very weak upturn that followed has meant a large change in rental values which has varied greatly in different parts of the country as the economic effects of the recession and its aftermath have affected areas differently. So, relatively, some areas have suffered hugely but other areas have benefitted from rateable values remaining fixed at April 2008 levels.
Secondly, as most areas have seen rental values fall, and in some areas the fall has been very large, most areas have suffered because rateable values have remained fixed at April 2008 levels. Business output/turnover has suffered (leading to reductions in occupier demand and hence reductions in rental values) but rate payments haven’t reduced in line, they have actually increased as the UBR has increased in line with RPI inflation (by about 12% since April 2010).
The change in rental values is, therefore, very important. The last five years have seen unprecedented changes in rental values in many areas due to the severity of the recession and its aftermath. These changes are discussed below.
At the UK level All Property rental values have fallen by 9.3% between end March 2008 and end March 2013 (IPD Quarterly Index). Office rental values have fallen by 11.2%, retail rental values by 8.8% and industrial rental values by 7.7%.
But this data only covers the larger centres where institutional investors and major property companies invest (and contribute to the IPD database). Smaller/poor secondary/tertiary centres are generally not included. In these centres rental decline is likely to have been greater.
Income from rates
-40% -30% -20% -10% 0% 10% 20% 30% Council Tax Business Rates SDLT Corporation Tax Income Tax
Increase in tax receipts 2007/8 to 2012/13
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The IPD rental value data is an average of all property owned by institutional/major property company investors. Arguably the lowest quality properties are excluded and for the properties that are included there are very large differences between the rental growth for properties in the lowest yield quartile (‘prime’ properties) and in the highest yield quartile (‘secondary’ properties).
For example, in the retail sector ‘prime’ standard retail saw UK rental value growth over the last five years of +4.2% (IPD Quarterly Index) in contrast to ‘secondary’ standard retail which saw rental values decline by 25.3%. So poor quality town centres, many of which are not in the IPD database, have seen a large fall in rental values and even this figure masks huge differences at the local level as explained below.
Source: IPD, GVA
Rental value changes
sub nationally
All sectors
At the UK level, All Property rental values have fallen by over 9% over the last five years, but at the county/regional level there are some marked differences. London (6.4% decline), the South East and Eastern regions have seen below average declines, whereas the South West, West Midlands, North West, Yorkshire & Humber, Scotland and Wales have all seen above average declines, as the map illustrates. The greatest decline was in Wales, at 15%.
-30% -25% -20% -15% -10% -5% 0% 5% 10%
Retail Warehouses: High Yield (High Quartile) Retail Warehouses: Low Yield (Top Quartile) Shopping Centres: High Yield (High Quartile) Shopping Centres: Low Yield (Top Quartile) Standard Retails: High Yield (High Quartile) Standard Retails: Low Yield (Top Quartile)
Prime and secondary retail rental value range
March 2008 – March 2013
All property rental growth Q1 2008 - Q1 2013 -8% to -6% -10% to -8% -10% to -12% -14% to -12% -15% to -14%
County and regional five year all property
rental growth
Retail sector
Standard Retail property at the county/regional level saw rental growth vary from +8.6% in London to -23.2% in Wales (IPD Annual Local Markets data from end 2007 to end 2012), but there were large differences between central/inner London (+10.5%) and outer London (-10.5%). At the County level Cleveland was worst, with rental values falling 23.2%.
At the Local level, Knightsbridge saw the strongest rental growth (+24.4%) and Middlesbrough the worst (-40.3%). But there was no clear north/south split - Stevenage, Thamesdown (Swindon) and Plymouth saw rental value declines of 30–37%. These falls in rental value are huge but they reflect a mixture of prime and secondary properties. It is clear that smaller poor secondary or tertiary shops/ town centres will have suffered even more.
Analysis of IPD’s data shows that nine local authority areas saw positive rental value growth over the last five years. 16 local authorities saw a decline less than the sector average and 72 saw a decline above the sector average. 42 local authorities saw rental value declines of more than 20% and nine saw declines of more than 30%. The retail sector’s problems have been reinforced by:
• the severe recession and its aftermath, where wage increases have been very weak and more than offset by inflation, meaning negative income growth in real terms,
• online retailing which has syphoned off retail sales from physical shops (but doesn’t pay rates except on low value warehouses) and • increased rateable values in the last revaluation, resulting from
strong rental growth over the previous five year upturn. This has meant stepped rate increases each year from 2010 due to the transitional adjustment.
As a result much of the retail sector has seen annual increases in rates payable due to the effects of transitional adjustment and annual increases in UBR, at a time when rental values have declined strongly, reflecting weak occupier demand and declining turnover. Business rates in some cases are more than the rent for the property. The rental value in one Arcadia Group store is reported (Financial Times, 3 July 2013) as having fallen from £500,000 pa in 2008 to £125,000 pa in 2013, whilst rates payable were £227,000 (but subject to inflation linked increases). The Arcadia Group pays about £150m pa in rates which would fall by £30–£40m pa if rates were calculated off up-to-date rental values (FT, 3 July 2013).
9.3% 34.0% 25.8% 21.6% 5.2% 4.1% 10%+ 0% to 10% 0% to -10% -10% to -20% -20% to -30% -30% to -40%
Retail rental value changes Dec 2007 – Dec 2012:
Local authorities by growth band
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Office and Industrial sectors
Office rental value growth at the regional level shows a less varied picture than for retail. Most areas, including central London (despite the recent buoyant market), have seen an overall fall in rental values. A few areas have seen a small increase, but most have seen a decrease. The four worst areas were all in the south – Bracknell, Camberley, Swindon and Bromley with falls of up to 30%. Analysis of IPD’s data shows that four local authority areas saw positive rental value growth over the last five years. 27 local authorities saw a decline less than the sector average and 23 saw a decline above the sector average. Five local authorities saw rental value decline of 20% or more.
Industrial rental value growth at the regional, county or local authority area has varied less than for the other sectors, but most areas have seen a fall in rental values over the last five years. At the regional level there is a rough north/south split but it is not very marked, with London rental values falling 4.6% and Wales, North West, Yorkshire & Humberside and the North East rental values falling by 9.9–11.6%. Scotland, due to strong growth in Aberdeen (+23.8%), saw only a marginal overall decline of 0.5%. At the local level a number of areas saw single figure rental value growth and at the other end of the scale, Leicester, Bracknell and Bolton saw rental value falls of 21–24.1%.
Analysis of IPD’s data shows that 17 local authority areas saw positive rental value growth (marginal in most cases) over the last five years. 48 local authorities saw a decline less than the sector average, but 85 saw a decline above the sector average. 39 local authorities saw rental value declines of 10–15% and 14 saw declines of 15–25%.
Effects on occupiers
The above analysis is summarised in the chart below, which contrasts the rise in the UBR during the current cycle with the fall in rental values in different sectors.
Source: IPD, GVA
The effect of such major declines in rental values is causing severe problems to occupiers. The effect of upward only rent reviews, rate bills increasing each year in line with inflation and in some cases the effect of transitional adjustment resulting from the increase in rental values between the last two rating revaluations, has meant an increase in total occupancy costs.
This in turn has reduced occupier demand and caused a further decline in rental values for secondary property in particular, compounding the problem for occupiers, but also for investors. Investors have the additional problem of vacant property – very high in many secondary locations, where they have no income but have to pay rates, which increase annually, based on rateable values which bear no relation to current rental values.
-50% -40% -30% -20% -10% 0% 10% 20% 30%
Plus deferment 5yr growth
Lowest local market standard retail rental values Secondary Shopping Centres rental values Office rental values All property rental values Retail rental values Industrial rental values Uniform Business Rate
Five year change in UBR and rental values
UBR = five years from 1st April 2010
Rental value growth = five years from AVD 1st April 2008
1.9% 7.4% 40.7% 42.6% 5.6% 1.9% 10%+ 0% to 10% 0% to -10% -10% to -20% -20% to -30% -30% to -40%
Office rental value changes Dec 2007 – Dec 2012:
Local authorities by growth band
Clearly many occupiers, and some
investors, are currently suffering from
paying rates which increase every year
as the UBR increases in line with RPI
inflation. At the same time the rateable
value on which their annual rates bill is
calculated has remained fixed despite
the rental value having fallen
significantly, and in many cases quite
dramatically.
For these occupiers the rating revaluation could not come soon enough. Had the valuation date been 2013, when it was due to occur, this would have meant that from 2015 annual rates bills would have fallen noticeably. However, transitional adjustment would have phased these lower rates bills over five years and so the huge problems many occupiers currently face would still continue for many more years.
Delaying the rating revaluation by two years means, in effect, that there will be no ‘correction’ to the problems currently faced for another four years and even then transitional adjustment will mean further delay. This delay could be a serious, possibly fatal, blow to many occupiers, particularly retailers in depressed town centres. These retailers are already suffering from reduced turnover as a result of the recession and the loss of sales to online retailers. Nationally online retail spending doubled its share of total retail sales over the four year period, 2008-2012.
In weak towns badly affected by the recession, the situation has been much worse, hence the severe decline in rental values. But unless new leases have been granted, or break clauses exercised, rent payments will not have fallen and the rates bill will have increased each year. Declining income and rising costs have led to bankruptcies and very high levels of vacancies in many towns (in many cases 50–100% above the national average vacancy rate which itself is historically high). The deferment of the rating valuation is, therefore, a major blow.
Deferring the rating revaluation for
two years – effects on occupiers
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Given the reasons for a 2015 revaluation
were so compelling why did the
government decide to postpone it for
two years? DCLG said the decision will
‘avoid local firms and local shops facing
unexpected hikes in their business rate
bills over the next five years’.
This simple statement ignores the reasons behind why a revaluation is undertaken. Those businesses in worst affected markets would have experienced falls not increases in their rates. Also where there have been increases in rate bills from revaluations the transitional adjustment scheme means that increased rates have been subject to phasing since 1990.
GVA has reviewed the costs to government of a revaluation to identify any other reasons for the postponement. We believe that the real reason for deferring the revaluation was Exchequer led, rather than the reason given by DCLG above.
Ratepayers who experience the most extreme increases in rates from the revaluation have their increases phased in through a transitional adjustment scheme, with the increase phased in at a fixed percentage each year. To help fund the scheme those rate payers who face a decrease in rates liability have their decrease phased in. The higher or lower the rates liability resulting from the revaluation, the greater the impact and the longer the transitional adjustment scheme runs.
However, this comes at a cost to government. Although they try to ensure the scheme is revenue neutral over the whole revaluation cycle, it is not. In particular, the first two years of any new revaluation are a real burden to government.
After the 2005 revaluation the net cost of the scheme in England for 2005/06 and 2006/07 was £1.1 billion. Following the more recent 2010 revaluation the net cost of the scheme in England for 2010/11 and 2011/12 was £980 million, according to the Treasury website. By delaying the revaluation for two years, the government will defer this transitional adjustment net expenditure of about £1 billion until after the 2015 election. This substantial saving (albeit only temporary) appears to be the real reason for the revaluation delay.
Despite protest and lobbying across many fronts the government is now very unlikely to reverse its decision to delay the 2015 revaluation. The estimated £1 billion in savings through not having to operate a transitional adjustment scheme from 2015 should, therefore, be used to help businesses that need this assistance the most.
Deferring the rating revaluation for two
years – benefits to the government
The major concerns by occupiers need
to be addressed and the system made
more equitable. The government in fact
has made things worse by postponing
the rating revaluation by two years and
introducing the business rates retention
scheme.
The main aim of the business rates retention scheme, in the government’s view, is to make the system more equitable between local authorities, rather than trying to make it more equitable between occupiers.
The changes mean that local authorities will now be able to keep half of any future increase in business rates, resulting from new development, to invest locally. In fact the increase is not just from new development but from any change that increases the amount of business rates. There is, therefore, an incentive to target existing commercial occupiers where:
• There is a perception of undervaluation, and the Valuation Office is encouraged to review values.
• Create an industry to fine comb commercial property assessments for missed building alterations etc (inaccuracies may be longstanding and not reflected in business budgets). The Business Rates Retention scheme favours wealthier councils where there is plentiful new development, to the detriment of poorer councils where little new development occurs. This scheme does nothing to address the problems faced by occupiers in weaker towns where rates bills have kept on increasing, whilst business turnover falls, occupier demand reduces and rental values fall. In fact it will quite likely make problems worse.
A further problem for many local authorities will be caused by the office (B1a use) to residential change of use now permitted if the building is vacant and the change is undertaken over the next three years. This will potentially reduce the business rates payable in an area and will complicate the redistribution formula between local authorities, penalising those where business rates have fallen. The retail to residential change of use proposals, if confirmed after the consultation period ends, will also reinforce the loss of business rates at the local level in some areas. This suggests a lack of joined up thinking by the government.
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A number of changes could be made
to the current system to improve the
situation for business occupiers, either
temporarily or permanently.
• Change the annual indexation of UBR to CPI inflation rather than RPI inflation. The RPI measurement of inflation has been widely supplanted by the CPI measurement of inflation by the government for payments (as it is usually a lower figure). The use of CPI inflation indexation would in most years mean lower annual increases in the UBR, but the increases would only be slightly lower and it would still mean annual increases would always occur (unless inflation went negative). This would only be a marginal change and more fundamental changes are needed.
• Use the deferred transitional adjustment to cap the annual increases to the UBR to limit the amount of annual increases or ensure an inflationary freeze in business rates for the 2015/16 and 2016/17 rate years.
• Ease the rates burden to businesses in the locations and sectors in England that have suffered so much from the revaluation being deferred for two years. This means some form of targeted relief at the local level or by say exempting very small businesses from paying rates until a revaluation occurs or perhaps introducing lower rates for businesses that take vacant premises.
• Increase empty rates relief to pre April 2008 levels for a two year period.
• Make the appeal procedure easier and quicker where there have been large falls in rental values and large increases in vacancies, i.e. where a major change in underlying market conditions can be shown to have occurred. The Valuation Office Agency (VOA) are currently being obstructive to handling this difficult issue, taking a defensive rather than a helpful stance. • Ensure a more level playing field between online retailers (which
have no physical shops and so only pay business rates on their warehouse premises, reflecting industrial rather than retail values) with bricks and mortar retailers. GVA suggest a positive solution creating more town centre retail enterprise zones, which offer state aid relief up to a maximum of £55,000 to help attract new occupiers and stimulate growth in town centres. • Ensure that revaluations occur more frequently (i.e every three
years). This would also reduce the scale of transitional relief, with any savings to the government concentrated on reducing the Uniform Business Rate in England.
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For further information please contact: David Jones London 020 7911 2389 david.jones@gva.co.uk Leigh Richardson South West and Wales 0117 988 5318 leigh.richardson@gva.co.uk Graham Knight Midlands 0121 609 8806 graham.knight@gva.co.uk Duncan Harkness North West 0161 956 4128 duncan.harkness@gva.co.uk Paul Manning North East 0113 280 8013 paul.manning@gva.vo.uk Gordon Martin Scotland 0131 469 6046 gordon.martin@gva.co.uk Dan Francis Research 020 7911 2363 daniel.francis@gva.co.uk James Kingdom Research 020 7911 2273 james.kingdom@gva.co.uk
