Nama,Residual valuations and taxation

The Irish Property Bubble (2006) NAMAwatch (Pt. I)
1

13.5% Vat and 9% stamp duty got us into trouble and by scrapping them it could get us a long way out of it. Maybe the commission on taxation will give us some joined up thinking on this .

Let us assume the banks lent at 70% of net value ( including rolled up interest) - the developer putting in 15% of anticipated value and profits projected at 15% of anticipated sales. If flats were to be sold at 340.5k ( 300k x 1.135) each then the person buying the flat would be paying a total of 371,145 including stamp . The bank would have lent 300k x 70% is 210k.

Let us assume that stamp duty and Vat are abolished - the initial flat can be sold to the prospective purchaser at 210k i.e. 56.5% of his original expected cost to get the bank out. I wont bother with the calcs but there is a multiplier effect when you apply the reductions to undeveloped land.

If 210k is the market value the alternative is that the flat eventually gets sold for 170k plus 13.5% vat plus 1.09 stamp and the government in whatever roundabout way loans the 40K to the bank.

Why dont they

  1. nationalise the banks
  2. then repossess the land
  3. then scrap the associated taxes
  4. then sell the land
  5. then sell the banks
  6. then reintroduce the taxes.
2

NAMA already has the power in the draft legislation to not pay any taxes, so I believe this is indeed the plan to make a paper profit, or at least break-even on the existing and soon to be completed stock. It does raise a couple of tricky issues, though. Never mind the current levels of VAT, never mind the peak levels of VAT, the level of VAT revenue to the state goin’ forward will be depressed. This means that the budget deficit will remain large and be either made up by raising other taxes or reducing spending.

The result is that we are seeing another taxpayer transfer to NAMA and another distortion in the property market. What developer, who remains having to pay taxes, will be able to compete with the NAMA developers?

3

Unbelievable and very unfair if NAMA can compete on that basis.

Its a tangled web they weave…

Residual valuations arent complicated but I suspect the whole gross/net thing gets the unwary confused. I have my suspicion that banks ( wrongly) allowed developers to borrow against projected gross property valuations (including VAT).

4

On page 115 of the Bill

And as NAMA Bill authorizes partnerships, joint development projects and development entities it looks like the Developers are trying for a tax free bail out.

And the insider deals on the securitized bank assets will be tax free also.

5

would it be an idea to have a thread that puts together a single comprehensive list of potential issues with each of the problem nama sections and email to all tds in advance of the dail debate? At least then they can’t claim not to have been informed.

6

Can I change my name to NAMA?

7

We are at cross purposes here …the taxes NAMA appear exempt from are taxes on “profits”. ( It would be circular anyway).

The Stamp and Value added taxes that need to be removed to increase underlying land and property values (and therefore bank exposures) are not profit taxes.

Bank Loans are now more than the assets are “worth”. Part of that “worth” is 13.5% VAT and 9% stamp duty collectable by the government. I think they have got so used to the fat that these taxes brought in that they are blind to fact that removing them ( for a while ) solves a huge part of the apparent need for NAMA.

8

Wrong.

Plus your knowledge of basic economics is the same as the people who created the mess.

9

There are also amendments to the VAT act, see schedule 2 section 8 (the last four pages):
finance.gov.ie/documents/pre … rftleg.pdf

My understanding of them is that NAMA does not have to charge VAT on sales it makes. This means that the builder has already claimed VAT on labour and materials in construction, but that these may now not be claimed in the sale. The unrealised gain of VAT in the building/sale of a development could no longer exist. But I am neither an accountant nor a legislator, so I may have totally the wrong end of these amendments!

10

I was not wrong based on info posted earlier but yoganmahew link throws a different light on things

Here is a land valuation for you without these taxes …

Sales incl stamp 3,706,000 3,706,000

Less stamp 306,000 -

Less VAT 400,000 -

Net Proceeds 3,000,000 3,706,000

Cost of Construction 1,500,000 1,500,000

Finance Charges 200,000 200,000

Developers Margin 450,000 556,000

Residual land value 850,000 1,450,000

Increase in land value 70%

Political dynamite but better than a ten year quango IMO.

Where is my knowledge of " basic economics " flawed jmc …it was one of my better subjects . Income tax is levied on
“profits” BTW.

Anyway to explain myself further ( and hopefully better) . There is bugger all revenue coming from property vat and stamp at present. Foregoing it will only have a marginal effect on current revenues. However scrapping these improves residual valuations of land and property. I think the 70% increase above is a reasonable estimate of the impact on valuation of pure residential development land. On completed residential property difference is 22.5%. If the banks have properly written down loans they can write back impairments on say 30bn of land revalued upwards by 70% = 21bn and 30Bn of completed sock by 22.5% = 6.75Bn . The banks balance sheets are improved by 27.75bn because they have been effectively been capitalised by the apparent future stamp and VAT not collected being written back into assets. I say apparent because the taxes can be reintroduced when market takes it.

There is a sequencing issue - and definite case for nationalisation of banks first. In any event I dont think the state should have to do anything beyond this …if this isnt enough to save the banks thy should be allowed to fail.

11

Nice catch. I was leaving Schedule 2 until I had finished with the body of the Act. You have to print up the original Act, all amending Acts and insert the new amendments and see what the new beast looks like.

Looks like going through Schedule 2 is going to be real fun…

All the tax related items in the bill seem to be focused on propping up the gross margins during all phases of the NAMA process so as to make the numbers seems less awful than they really are. How much would the tax advantages outlined in the Bill add to NAMA’s gross margin v a traditional commercial development company? 30% plus?

So an in-progress development bank asset currently (really) worth 25% of book valuation, with this 30% plus tax advantage boost, and developed to completion by a NAMA joint venture / subsidiary that sells on for a paper net 15% (tax free) profit and you are up to around 70% of current valuation. At least on paper.

Result. A story you can spin politically to show how brillant the whole NAMA idea was all along. See, NAMA did not loose the kind of money that the naysayers talked about. By international standards this was not a bad hair cut…yada…yada…yada…(…please ignore what is going on behind those curtains over there…)

All part of the gameplan.

12

Sorry if I was a bit snippy but you are not in the property development world of the last forty odd years, you are in NAMA land now. The rules of traditional cost and tax accounting dont apply in NAMA land.

NAMA is structured and designed to bury and obfuscate huge losses from banks, developers and others. It is designed to be a development company with many unusual and unique features so all back of the envelop calculations like one you used as an illustration (although it was completely valid for traditional deals) is for all intents and purposes irrelevant.

NAMA was designed to be that way.

13

Kudos goes to Maor Uisce…

I’m still not sure that I am reading the sections correctly, but it is the most cynical interpretation…

14

That VAT exemption now fills in the last piece of the tax cycle for NAMA. Its those exemptions for NAMA that are fundamental part of the plan to make the agency plausible and therefor politically palatable down the line.

Lets take a very simplified hypothetical situation

Big Developer has a property development project, 10M loan to buy the land, 10M loan to develop the project and the developer expects to make 25% on top. Final market price for complete project 25M. At least that was the original business plan. To simplify the scenario lets say he has the land and has the development loan but has not really started building yet. Problem is the land used to secure the first loan is now only worth 2.5M, and more importantly the probably best market price when the project is finished is only 60% of original estimate, say 15M. So if he continues to completion he loses 5M and if he just shuts up shop and liquidates he has just lost 7.5M.

So now NAMA Joint Ventures gets involved. The land is valued by NAMA at 6M and the loan on the land is adjusted accordingly (it was bought from the bank for 9M). As the development phase is tax free and the 10M loan was taken out based on historical non-tax free development costs and for arguments sake lets say the NAMA tax advantage is 30% then only 7M of the development loan (now from NAMA) will be used to develop the project. So of the original 20M borrowed from the banks only 13M has to be payed back to NAMA. Sell the finished development at 15M, pay back the 13M and you have still made a 2M profit. Not as big in absolute term as the original plan, but close enough in percentage terms because it is tax free courtesy of NAMA.

And that is how you turn a 5M/7.5M loss into a 2M profit at a cost of ‘only’ 3M loss (plus interest over the next 20 years) to the taxpayer. And if the profit is split 50/50 then the taxpayer ‘only’ loses 2M and NAMA is trumpeted as a great sucess because its projects are turning a profit.

Of course the fact that the only reason the project made a profit at all is because it did not pay the normal taxes is neither here nor there.

Now scale the above up to 90 billion…

15

One thing to remember in all this is that the VAT advantage will only exist for loans attaching to property inside the state. There is a huge exposure in the North for a start where this just wont work .

Anyway let me play with Jmc’s numbers a bit. We will ignore stamp duty bit for now. The land value is derived from the sales price .

When the land was first bought the numbers might have broken down like this …

If sales price is 25m then this consists of circa 22m plus 3m vat. Let us take a developers margin of circa 20% ( rounded to 4m) . The net available for construction,land and finance cost is 18m. We will say construction and finance costs are 8m leaving a residual land value of 10m. If the bank funded 85% the land loan would be 8.5m.

Then let us factor in the market collapse say 30% in end prices.

If sales price is now 17.5m then this consists of circa 15.5m plus 2m vat. Let us take a developers margin of circa 20% ( rounded to say 3m) . The net available for construction,land and finance cost is 12.5m. Lets say construction and finance costs are back a bit say now 7.5m - this leaves a residual land value of 5m. 50% of what we started with. The bank loan is now impaired by 8.5m - 5m = 3.5m. The original 8.5m loan is worth a maximum of 5m.

Now assuming NAMA doesnt " charge" vat the numbers become .

The sales are still 17.5m and this consists of circa 17.5m plus 0m vat. Let us also assume NAMA take a lower margin of say 1.5m in establishing a valuation . The net available for construction,land and finance cost is now 17m -1.5m = 16 m. Lets say construction and finance costs are back a bit say now 7.5m - this leaves a NAMA residual land value of 8.5m. the same as the original loan.

The issue for NAMA is whether it pays 5m for the loan (the real open market value) or the 8.5m that can de derived when a lower margin and vat exemption are built in.

There is potential for a huge transfer of value to bank shareholders.

16

I seem to remember that when the Government was lobbied to eliminate VAT on condoms the excuse it threw back was that it was prevented from doing so under EU rules.

Has the Government got permission to do this from the EU? If not then there must be grounds for a complaint to the EU.

If it has approval then this clearly gives NAMA an unfair advantage to any other person selling who must levy VAT and stamp duty, so surely there is grounds for another anti-competition challange a la HCL?

17

Our HCL protest seems to have been unheeded at EU level apart from one or two emails saying they had received our correspondance. 'Tis Bord Snip who eventually put the foot down about it.

I can’t help wondering why they have been so slow to get back to us… :angry:

Anyhow, rightly or wrongly, I wouldn’t put much faith in them given our last experience with them.

18

There is no VAT on UK new build housing so I dont think there is an EU tax harminisation issue. I think there is a anti competitive angle …but it appears only be smaller, prudent developers who are not potential beneficiaries of NAMA so there probably wont be much bleating from the sector.

It is stating the bleed obvious but the fairness of NAMA hinges on the assumptions used in establishing valuations of development land and property and therefore underlying loans. The devil will be in the detail but it will be derivative of :

Projected Gross Development Value
VAT etc
Building Costs
Finance Costs
Developers Margin ( the lower this is the more the over valuation of underlying assets - they could have fun with this )