The Organisation for Economic Co-operation and Development (OECD) recently introduced a very interesting recommendation which has caught the attention of real estate investors in the UK and worldwide. In connection with the organisations Base Erosion and Profit Shifting (BEPS) initiative it is looking to reduce the number of tax breaks used by international companies and international investors. So what impact could this have on the worldwide real estate market?
Tax deductions
The OECD has recommended a restriction on the tax deductibility of interest charged on capital borrowed. The idea is to reduce the deductibility factor to between 10% and 30% of earnings which could have a dramatic impact upon property investment calculations. While this will not impact domestic investors it will impact those who rely heavily upon borrowed funds to finance large real estate investments and the current tax-deductible benefits which are available today.
When you bear in mind that some of the larger property investments around the world cost hundreds of millions if not billions of pounds then a tweak in factors which can be deducted against profits can make a massive difference. In simple terms this move, if adopted by the UK government, will effectively increase the cost of borrowing because less of the interest paid will be tax deductible.
Many experts believe that the OECD is using a hammer to crack a nut and while there have been issues regarding tax evasion and tax avoidance, is this really the answer?
Will this reduce investment in real estate?
Simple fact is that if the cost of finance is increased by a reduced tax deduction on interest charges then we will see reduced investment in real estate around the world. Large corporations have their own targets, they maximise the tax breaks available and these are factored into their calculations. The suggestion that some public infrastructure projects could be exempt from these proposed changes could make infrastructure investment more attractive potentially at the expense of real estate?
One of the other issues which many people have failed to mention so far is whether indeed all governments adopt this proposed change by the OECD. Can you imagine a situation where the likes of the UK and other prominent real estate markets adopt the OECD recommendation yet other countries fail to do so? This could have the effect of funnelling new channels of real estate investment to countries which do not adopt the proposed changes.
Are Real Estate Investment Trusts the answer?
Real Estate Investment Trusts (REITs) are big business in the world of real estate and some experts believe they could benefit from the proposed changes by the OECD. However, it may take some time to clarify the situation with regards to REITs as these vehicles themselves, openly tradable, are created in such a way as to be as tax efficient as possible. They have grown in popularity over the last decade and with individuals and small investors taking a greater interest in worldwide real estate they are perhaps the easiest and most cost-effective means of creating exposure to specific markets around the world. The fact they are readily tradable is also a very positive factor.