Valuations and potential LVT receipts

The Valuation Office Agency already have records of all commercial land and buildings for Business Rates purposes, so that requires minor tweaks only, in this section I will outline how residential land could/should be valued.

• The total tax base for UK residential land (skip to article)
• What do we mean by "land-only rental value" or "site premium"? (skip to article)
• Using recent selling prices as a guide to rental values (skip to article)
• Adapting the Council Tax system (skip to article)
• Valuations and banding generally (skip to article)
• Appeals (skip to article)
• Regular revaluations (skip to article)

1. Estimating the total tax base for UK residential land.

People are more familiar with selling prices than with rental values, so let's start with Savills' January 2015 summary to set the scene:

Their total number of units in England & Wales agrees to the total number of homes for which a Council Tax valuation exists.

We can then replace selling prices with average rents from Homelet's December 2014 survey, adjust those rents for the fact that rented homes are on average 10% smaller/cheaper than owner-occupied homes; add on 10% for Council Tax and multiply up again by the number of units, to give us the total rental value:

To arrive at the land-only rental value, all we have to do is deduct an estimated £4,000 for the annual running costs of each home (repairs, insurance, amortisation/cost of capital for bricks and mortar etc) and that's the land-only rental value of a nice round £200 billion:

We could at this stage simply say, as at January 2015, the current land-only rental value of £200 billion is 3.5% of the total value of all housing, so the land-only rental value of each home will be +/- 3.5% of its selling price, and, subject to a few caveats as explained below, this is surprisingly accurate.

Please note:

1. The headline figures for the three main house price indices (Nationwide, Halifax and HM Land Registry) of (currently £188,000; £189,000 and £177,000) are not simple mathematical averages, the first two are based on a historic hypothetical figure indexed up for price changes and HM Land Registry is based on the geometric mean rather than the simply mathematical average. To cut a long story short, their headline figures are much lower than the true average.

2. Savills' average value for England & Wales of £216,000 is one-sixth lower than a simple average of all prices paid in England & Wales reported by HM Land Registry in the calendar year 2014. If the average land-only rental value is 3.5% of Savills' lower figure then it is only 2.9% of the higher average price paid according to HM Land Registry.

2. "Land-only rental" value or "site premium".

In an ideal world, Land Value Tax is based on the land-only element of the rental value of each plot. The nay-sayers hit back by saying that if you have a plot of land with no building on it, its rental value will be negligible, which is why I refer to the "site premium". i.e. physically identical buildings (for example, a three-bed semi-detached house) in different parts of the UK will have different rental values. The extra rent commanded by the more expensive ones is down to the "location, location, location" and that is the "site premium" and the tax base for LVT.

Alternatively, we can establish the gross annual rental value and deduct an estimate of running costs, of say £4,000 for a semi-detached house with correspondingly smaller or larger amounts for smaller or larger homes.

(For simplicity let's initially assume that all UK residential plots are being put to their optimum permitted use i.e. that for which they have planning permission. This is probably true for 95% of all plots. The other 5% are plots with derelict buildings on them; plots with useable buildings on them which are unoccupied; and there are around half a million plots which have planning permission but which have not been developed yet. Of the 95% which are actually being used (which have buildings on them up to the current permitted limit), there are only a few per cent at the top end (small building, big plot) where it would be economically/commercially worthwhile replacing an existing building with some smaller houses or flats (with or without LVT). So for valuation purposes, the working assumption is that they will be taxed on their current, actual use.)

Here are five more or less identical three-bed semi-detached houses from the first, fourth, fifth and tenth deciles, with one from the top one per cent for luck (downloaded February 2013):

Once we've established the site premium for the first house, the rest is just subtraction. The difference in rental values relates purely to the "location, location, location"/the site premium.

3. Using recent selling prices as a guide to rental values.

HM Land Registry publish their price paid data for England and Wales free online, showing the full address and postcode and split into selling prices for flats, terraced houses, semi-detached and detached houses.

I downloaded price paid data for the year 2014; deleted the ones without a postcode leaving 850,000 actual transactions; applied the magic of pivot tables; calculated the average selling price of a standard three-bed semi-detached house (as reduced by one-sixth to use Savills' lower average price) in each of 2,288 postcode districts (there are about 10,000 homes in each postcode district); ranked them in ascending order and typed in the average rent from (adjusted as mentioned above) for each 20th district up to those with average selling prices £750,000 (things get a bit hit and miss after that); and ended up with the following chart:

The co-efficient of correlation is 0.87, which is high enough for these purposes. 0.0 = no correlation, 1.0 = perfect correlation. Whether the outliers are just outliers or whether some of the underlying data is inaccurate is unknown, but this will do to illustrate the principle.

We can then deduct the annual running costs (see above) from the gross rental values to arrive at the land-only rental value/site premium and express it as a percentage of selling prices. This suggests that there are very few areas where the site premium is less than 3.5%, and these are probably due to patchy data more than anything else:

Using the last twelve months' data gives us 300 to 400 sales in each postcode district, or 100 sales in each smaller postcode sector. Obviously, there is a trade-off between using selling prices for the last twelve months and for longer periods. If you use longer periods, then you have a bigger sample size but if prices have changed a lot, then the older prices themselves will be less indicative.

4. Adapting the Council Tax system.

To get the ball rolling, we could adapt the Council Tax system (this is the system in England. The systems in Wales, Scotland and Northern Ireland are slightly different), which in essence is as follows:

Step 1: Banding - homes were valued in 1991 (homes built since then are given a hypothetical 1991 value) and put into bands A (less than £40,000) up to H (over £320,000).

Step 2: Working out required receipts. Each council works out what it wants/needs to spend and subtracts its central government grants to give a balancing figure to be collected in Council Tax.

Step 3: Apportioning required receipts between homes in that council area. Band A homes pay one-third as much as Band H homes in the same council area. Band D council tax varies widely across the country - between £700 (Westminster, which gets most of its income from parking charges) and £1,800 (parts of Dorset).
Using the same approach, all we have to bear in mind is:

a) There is no need to value each individual home; this is expensive and leads to too many arguments; further, Land Value Tax is based on the site premium element of each plot-with-planning and completely ignores whether an individual home is well-maintained/has an extension/loft conversion or whether it is dilapidated/derelict. Each 'home' is unique and special; shapes drawn on a map are not.

b) It is only relative and not absolute values which matter. For example, if you are in a room with a dozen people all milling around and you have to guess how tall each one is in feet and inches, you'd struggle, but getting them to line up tallest on the left, shortest on the right is easy enough. If you are then told that somebody in the middle of the row is 5'6" tall, you can easily guess how tall the others are. So you have to start in the middle and work outwards!

c) We can easily establish the site-only rental value of a bellwether 3-bed semi-detached house in a typical residential area - see examples in 2. above - and we can just express all other homes relative to that.

The adapted Council Tax system (a close approximation of Land Value Tax)

Step 1a: Banding. All homes are put into bands depending on size and type. This is fairly objective and should be done consistently across the whole country. A typical three-bed semi with off-street parking, our bellwether home, goes into Band D wherever it is in the country. For example:

Band A* - Studio flats (* with automatic single-person's discount)
Band A - One-bedroom flats
Band B - Two-bedroom flats; small terraced houses
Band C - Three-bedroom flats; medium sized terraced houses; small semi-detached houses
Band D - Large terraced houses; typical three-bed semi-detached houses
Band E - Large semi-detached houses; small detached houses
Band F - Typical detached houses
Band G - Large detached houses
Band H - Very large detached houses

Step 1b: working out the site premium of a Band D home in each area. The site premium for homes in each band in each area is established, using rental values and selling prices as inputs, and the results smoothed between bands in each area to establish a robust figure for the site premium of a Band D home (typical three-bed semi with off-street parking) in each area. The site premium of homes in other bands in the same area is deemed to be the appropriate Council Tax fraction (see Step 3). All site premiums across the country are then added together to establish the 'tax base'. At present, this is at least £200 billion a year.

Step 2: Working out required receipts. The total revenue to collected nationally will be based on how much is need to replace all the other taxes that will be scrapped/reduced. The total will increase every year as other taxes are scrapped/reduced and merged into LVT. This amount will be pooled and redistributed to local councils on a per capita basis (plus/minus a myriad of adjustments for other economic and political factors of no relevance here). Total required receipts are compared with the 'tax base', i.e. the total of all site premiums of all homes from Step 1a. to set the tax rate. So if required receipts are £100 bn and the total site premium is £200 bn, the tax rate is 50%.

Step 3: Apportioning required receipts between homes. The required rate from Step 2 is applied to Band D homes in each area, and the tax on homes in the other bands in the same area will then simply be the appropriate Council Tax fraction, as at present:

Band A* - 4.5/9
Band A - 6/9
Band B - 7/9
Band C - 8/9
Band D - 9/9
Band E - 11/9
Band F - 13/9
Band G - 15/9
Band H - 18/9

Going by average relative selling prices from HM Land Registry's sold prices and typical rents in a few thousand sample areas, the banding and apportionment exercises will be a good reflection of the site premium of each individual home on a consistent basis across the country.

So, for example, if required revenues from Step 2 were £200 billion a year (enough to replace existing property taxes and VAT, and significantly reduce National Insurance contributions) the rate would be 100% of current site premiums (rental values will go up if other taxes are reduced, so the future rate will be a lot less than 100%) …
- in the very cheapest areas, Band D tax (typical three-bed semi) will be £900 a year; Band A tax (studio flat) £450; and Band H tax for very large detached homes/plots £1,800.
- in median areas, Band D will be £6,000; Band A tax £3,000; Band H tax £12,000.
- in top decile areas (mainly London), Band D tax will be £14,000; Band A tax £7,000; and Band H tax £28,000. As shown above, it costs £20,000 a year to rent a three-bed semi in a top decile area (incl. current Council Tax); the maintenance and deprecation costs of such a home are a lot less than £6,000, and a tax bill of £14,000 a year is a fair reflection of the site premium.

Having done the exercise, you then compare the tax bill on individual homes with their actual market rents and rental values implied by selling prices, i.e. how much people are with small deposits have to pay in annual mortgage payments plus Council Tax, and shuffle homes at the edges of each band up and down accordingly to get a reasonably satisfactory result - as John Maynard Keynes said, "It is better to be roughly right than precisely wrong".

5. Valuations and banding generally

There are of course different ways of calculating the site premium:
- taking rental values and deducting an amount to cover the "bricks and mortar" cost;
- working out an overall average rental value per square yard in each area and multiplying that by plot sizes;
- if a street is a jumble of wildly different type buildings, simply working on the basis of plot widths;
- using recent selling prices as a proxy for rental values;
- we can do individual per home/plot valuations or use average figures for each category of home/plot;
- having a sophisticated system of valuing homes/plots in terms of 'units' or a rough and ready one;
- we can choose smaller or larger valuation areas;
- we can restrict ourselves to more recent data or include older data;
- we can adopt a points-based system, for example one point for every 50 sq yards of land occupied (so a flat in a high rise block gets half as many points as a similar flat in a low-rise building); one point for each habitable room or off-street parking space; adding an extra two points for homes facing a park; adding two points for homes within 500 yards of the nearest station and deducting two points for those more than a mile away.

... each with their advantages and disadvantages, so there is no point pretending that any method gives us some scientifically verifiable figure accurate to three or four decimal places, so it makes sense to put homes into Bands (like Council Tax bands) and all homes/plots in the same Band in the same valuation area pay the same LVT.

Simply using the Council Tax bands, with a ratio of 4-to-1 between the largest and smallest homes/plots in each area probably does not capture the full range within an area, but as Band D tax will vary widely across the country, it will capture most of the regional differences which is more important. It also has the advantage of simplicity.

Narrower bands are 'fairer' but valuations will need to be more exact, and there are different ways of establishing values. With just eight bands, a few homes at the very bottom end will end up being 'overtaxed' by a few £100 a year and a few at the very top end will be 'under taxed' by a few £1,000 a year, but those are acceptable losses - worst case, the tax would act like a very progressive poll tax.

6. Appeals.

Yes, we have to accept that there will be a flurry of appeals against the initial assessments/Banding.

a) If we use the concept of relative values/banding as explained above, the valuation authority can be relatively relaxed about allowing appeals during the initial assessment stage; if half of people appeal and half of those get their home/plot shifted down a band, then the number of units of housing goes down, but the tax rate can be nudged up to keep total revenues constant.

b) Banding reduces the number of appeals, even if the result is a bit arbitrary in some cases. If each individual home is given a precise £ value, then it is always worth putting in an appeal. With banding, the appellant will have to show that the rules have not been applied consistently (i.e. there was a mathematical mistake) and/or that the home/plot in question is in fact much smaller than assumed, or suffers from some particular factor, i.e. is next to an electricity sub-station etc, which means that it should be in a lower band

c) Only those who own a home at the time of the original valuation/Banding will be allowed to appeal within the next 12 months. Future purchasers will be deemed to have accepted that the banding is correct at the time they buy a home; even if the tax is objectively 'too high', that will be reflected in a lower purchase price so they have already got their money back. The tax on other homes might turn out to have been assessed 'too low', which is a one-off windfall gain for the current owner.

d) As with Council Tax, there will be appeals against the band a home has been put into. In borderline cases, homes should be put into the lower band. With the new system there might also be appeals  saying that the site premium of a Band D home in that area is not as high as the official figure. So administratively, it is good to have the official assessments on the low side - it doesn't really matter, because if the total assessed value goes down, the tax rate (which is set by a statutory formula and so cannot be appealed) will simply go up and total receipts will remain as planned.

7. Revaluations.

According to Communities Secretary Eric Pickles' estimate, doing a revaluation for Council Tax would cost £280 million, i.e. about £10 per home. It might cost a few hundred pounds if there is an appeal (which is less than people pay to have an accountant prepare their Self-Assessment tax return prepared year in, year out).

Putting homes into Bands will be much cheaper, it can be done as a paper exercise from Council Tax and HM Land Registry records, with a quick 'drive by' as a check, like the original Council Tax valuations. From moneysavingexpert:

Once upon a time, way back in 1991, in time for the launch of its new council tax system, the Government needed every property in the land to be put in a valuation band. But time was short, and the job large, so the people in charge asked estate agents and others to help.

Yet even with all the estate agents' help, they didn't have time to get the detailed information together, so they set about doing it quick by pairing up and driving down countless streets, allocating each property a band with just a glance. They became known as “second gear valuations” as they never even stopped their cars, never mind got out of them.

Further, the initial valuations/Banding is a one-off cost.

- The main thing is that future increases in rental value are captured. Valuers can reassess rental values (or implied rental values) each year and adjust Band D tax in each area accordingly; the tax in all other bands in the same area will move up or down automatically, checking always that the answer looks 'about right' for the upper and lower Bands. So keeping the tax base up to date is a very minor issue and will cost pennies per year per home/plot

- If we significantly reduce taxes on earned income (by £200 billion), disposable incomes of tenants and first-time buyers increases and a lot of that increase will flow through into higher rental values. So even if a few of the initial assessments are a bit high, after a couple of years, even those will objectively be on the low side and things will quieten down.

- If more tax is collected from land values and less is collected from output, wages and profits, then selling prices will change. They might go up (because of boost to economy), they might go down (a tax on land depresses its selling price), the two effects might cancel out, this is irrelevant in the long run.