THE 2002 Budget and property implications - Courtwell

Posted On Friday, 01 March 2002 03:01 Published by
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The 2002 budget contained only 2 direct impacts on the property sector in SA but contained several indirect positive implications for a sector that has lost much of its
The 2002 budget contained only two direct impacts on the property sector in South Africa but contained several indirect positive implications for a sector that has lost much of its lacklustre in the past eighteen to twenty-four months.

While the latest budget may cause some negative impact, astute property and asset managers will overcome these with relative ease.

(Some readers will say that, since property is fundamental to our lives, each change contained in the national budget will cause an effect of some kind, save to those who suffer through having no formal housing and place of employment. Limited space, however, requires that we address only those items that will affect property considerations materially.)

For ease of reference, we divide this guide into THREE sections, viz.:

Income adjustments -

Expenditure adjustments - and

Other macro-economic factors influencing fixed property at present -
as they affect the property sector.
Highlights include:
(a) Transfer duty reductions
(b) The impact of personal tax reductions on retail trade and turnover rental
(c) The impact on duty reductions on securitisation
(d) The impact on the property sector by recent movement in bond market

A. INCOME ADJUSTMENTS

1. THE ADJUSTMENTS IN TRANSFER DUTY
Transfer duty (an indirect tax paid on the transfer of fixed property) will change on 1 March, 2002 in respect of residential property transfers.

PORTION OF TOTAL PROPERTY VALUE OLD TAX RATE NEW TAX RATE SAVING*
Below R100k 1% (on portion below R60k)** 0% (on portion below R100k) R1 000
R100k – R300k 5% (on portion between R60k and R250 000k) 5% (on portion between R100k and R300k) R10 000
Above R300k 8% (on the portion above R300k) 8% (on portion above R300k) R16 000
TOTAL R27 000


*based on a transaction value of R500 000.
** unless exemptions applied, in which case the old rate was 0%.

Whereas the saving to purchasers will vary according to the cost of the property under sale, this reduction in tax will encourage movement in the residential property market.

This bodes well for residential housing prices and for property practitioners in the residential property market as more buyers will enter the market, improving demand.

Readers may be interested to know that the transfer of fixed properties between juristic persons still remains subject to one of three tax regimes, as follows:

(a) Where the seller is not a vat vendor, a transfer duty of 10% (a flat rate) applies;
(b) Where the seller is a vat vendor, providing certain other criteria apply, a vat rate of 14% applies (instead of transfer duty);
(c) Where the seller and purchaser are vat vendors, and the property is sold as a going concern, the transfer is zero rated. In this instance (and provided that the transaction complies with certain requirements) neither transfer duty or vat is payable.

2. THE ADJUSTMENTS IN PERSONAL TAX

The minister of finance estimates that an extra R15 billion in personal income will be foregone by the fiscus as a result of the reduction in personal income tax.

Of this amount, that which is not saved, will be invested in property or spent, both of which consumption alternatives will impact positively on the property sector.

Money directed towards property will benefit the construction sector initially and the secondary property market thereafter, adding further impact to the result of decreased transfer fees on residential properties.
The additional revenue in the hands of consumers will be encouraging to retailers which will benefit after shoppers have reduced their debt levels. The benefit to retail landlords, however, will be through the increased turnover rentals which they derive as a result of improved tenant turnovers.

Retail landlords should consider holding back the distribution of dividends in favour of retained earnings and investing additional revenue in building and nodal rejuvenation.

As South Africa continues to lag the international recession, those landlords that maintain their properties well and invest in tenant-attracting improvements will create wealth through having lower capitalisation rates applied to their properties.

Page 194 of the budget review (published by the treasury) indicates that dividend secondary tax income increased between 1999 and 2000 by 63% and by 27% between 2000 and 2001.

Property companies, inter alia, should consider the re-application of profits, where strategically prudent, towards portfolio and nodal improvement in the interests of wealth creation.

Some of the benefits may be offset by the reduction in employee benefit deductions from taxable income.

3. THE DUTY EXEMPTIONS IN RESPECT OF CERTAIN WARRANT REPURCHASES

Warrant issuers will now be exempt from Marketable Securities Tax and Uncertified Securities Tax during the repurchase of issued warrants.

Where the underlying asset comprises fixed property, warrant issues will improve in favour through this reduction in indirect taxation.

Securitisation has become a favoured means of portfolio enhancement within the property sector in the USA and UK where approximately 53% and 47%, respectively, of commercial property investment is securitised.

This method of portfolio enhancement (which contributes towards risk diversification and profit improvement) is beginning to gain momentum in South Africa. Warrant trades on the JSE now comprise 18.7% of share transactions and, of this, less than 4% of such trades are fixed property asset based.


4. THE REMOVAL OF STAMP DUTY ON MORTGAGE BOND CESSIONS

Bond holders will be induced around for improved bond rates following removal of this indirect tax. The bond registration costs will continue to impact negatively on the leverage which borrowers have in this regard.

5. THE INCREASE IN THE LEVEL OF DOMESTIC INTEREST AND DIVIDEND EXEMPTION

The exemption level on divided income increases to R6 000, creating a very small incentive for investment in the property sector. Never-the-less, portfolio managers should continue to encourage investment in the property sector, where such portfolios are soundly managed and yields show the propensity to exceed other asset-class returns AND a lower risk profile.

6. THE TAXATION OF TRUSTS AT 40%

Apart from special trusts and testamentary trusts, trusts (including property trusts) will now attract a tax rate of 40%.

Thus income in the hands of the trust is taxable at 40% and distributed income is taxed in the hands of the beneficiaries at their respective marginal rates.
This increase further impacts on the viability of trusts where the assets held for the benefit of the beneficiaries comprise fixed property.

One should note that the treasury projects an increase in income of R90 million as a result of this tax reform, which indicates the impact on trusts, including property trusts.

In addition, the retention of capital gains tax has to be factored into all property transfers, including those of trusts.

As a matter of interest, where trust property is transferred to a beneficiary of a trust, no transfer duty is payable if the trust is created in a written instrument by a natural person (an individual) for the benefit of a relative of the trust founder and where no consideration is paid.

7. THE EXTENSION OF SMALL BUSINESS ENTERPRISE TAX RELIEF

Businesses with a turnover threshold below R3 million will pay tax on the first R150 000 of taxable income at a rate of 15% and may continue to write off investment expenditure during the year of expenditure.

Property services companies within this category will benefit in this regard.

8. THE REMOVAL OF STAMP DUTY AND UST ON THE ISSUE OF DEBT INSTRUMENTS

This tax reform will benefit the bond market and marginally improve returns in this asset class. It is possible that investment expenditure will be diverted from property to bonds as a result thereof.

9. THE ACCELERATED DEPRECIATION FOR MANUFACTURING ASSETS

Improved tax reforms for the manufacturing sector will further enhance industrial property.

Industrial landlords are also reminded of the various tax incentives available to them through, inter alia, sections 11 and 13 of the Income Tax act, 1962.

10. THE INDIRECT TAX INCREASES IN RESPECT OF ALCOHOLIC BEVERAGES AND TOBACCO

It is important to remember that retailers of alcoholic beverages and tobacco products will have to elect whether to attract custom through absorbing the excise increases or pass such increases onto their clientele.

In both cases, retailers in this category will come under pressure to maintain their margins and this will impact on their ability to meet overheads.

B. EXPENDITURE ADJUSTMENTS

1. IMPROVEMENT IN CAPITAL EXPENDITURE

The increased allocations towards infrastructural improvement will positively affect the construction industry and property services sectors.
The R17 billion (projected to increase by 18% pa hereafter) contained in the budget are sufficiently substantial to invoke meaningful results for construction companies.

Property services companies provide important support structures during infrastructural development and they will welcome this shift towards the creation of a capital-based expenditure pattern.

Rural and urban-renewal programmes at municipal level will receive an increase in benefits of 28 percent, if the treasury is able to sustain its present allocation trend (in addition to the R3,3 billion allocation towards municipal infrastructural improvement).

Property services companies should, therefore, expanding their geographical influence as these allocations take effect.


2. THE ALLOCATION TOWARDS PUBLIC-PRIVATE PARTNERSHIPS

Public-private partnerships continue to receive the support of the central government with almost R1 billion being allocated in this regard.

Not all PPPs are property sector-related but those that are should use this opportunity to form entities that will complement the government’s transformation and skills transfer policies in this sector in anticipation of the projected increase in PPP allocation of R2,8 billion during 2003/4.



C. OTHER MACRO-ECONOMIC FACTORS INFLUENCING PROPERTY AT PRESENT

1. THE BOND MARKET

The improved liquidity the bond market and the introduction of the R194 (10.0%; maturity in 2007) will continue to apply pressure in the property market and developers will need to invoke a great deal of innovation to divert funding from the bond market.

However, this also positively influences the calculation of hurdle rates and discount rates during financing applications, as does the reduction in fragmentation of the (bond) yield curve.

(We do not wish to make extensive commentary on the calculation of net present values here but readers are invited to contact us for further information in this regard.)

2. NATIONAL GOVERNMENT BORROWING

Our diminishing debt burden and restructured debt management differentiates South Africa from many other developing countries. This factor should also be emphasised during our attraction of foreign investment.

3. SOUTH AFRICA’S CREDIT RATINGS

As South Africa’s credit rating amongst the three leading international credit rating agencies continues to improve, local asset managers should be encouraged to obtain mileage from this trend and invite more participation in our property sector.


4. SALE OF PUBLIC LAND

The sale of public land, whilst opening up opportunity for PPPs and the construction sector, is likely to have a downward pressure on land and property values and diminish returns.

Local authorities are only obliged to reduce the sale value below market where the purchaser will use the land for social purposes. In all other instances, state land will be sold at the prevailing rate.


5. INFLATIONARY PRESSURE

Tenants are unlikely to reduce their pressure on landlords as result of the short-term projections of an increase in the consumer pricing index.

Such reduced escalations will continue to keep internal rates of return down.

Investors would be well advised to perform discounted cash flow analyses at every opportunity instead of relying on the capitalisation valuation method as the effect of lower escalation rates takes it toll.

Our estimation of the real cost of borrowing at present is 7.6% as a result of the recent increase in interest rates. This creates little scope for real profit in a low inflationary environment.

Publisher: SAPOA
Source: Courtwell Consulting: Research Division.

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