Estates, whether urban or rural, need to be on the front foot if they are to prosper in today's challenging economy and survive the ever-increasing welter of legislation. Should they sell up, borrow or diversify? Do they represent acres of opportunity or could they become dangerous millstones? And what are the ground rules that will help a family estate to make a positive net contribution?
For many years, the landed estate has perhaps been viewed as the oldest and earliest family business. Traditionally, large tracts of land with associated buildings, the main Hall or house, farm buildings and let cottages, were in one family's ownership, run by the estate's factor or agent, and passed from eldest son to eldest son from generation to generation.
Those of us familiar with Downton Abbey will immediately recognise the type of client and manner of dealings. Lord Grantham being the head of the family but seemingly the bulk of the work and decisions taken by his agent, whilst Lord G entertained lavishly, dealing with 'matters on the ground' via his London lawyer. He was, however, a kind and considerate owner and perhaps failed to see that the Estate could no longer stand on its own two feet, propped up by the investments in his US wife's marriage settlement. The running of the Estate needed a shake up and kindness in some ways had to move over for business-like actions and profitability. Even they, in the post-First World War era with the country ravaged by loss of men and poverty, knew that for Downton to survive it needed a shake up, and had to work its assets harder, but within the confines of the responsibilities the family felt it owed to society, the locals and, importantly, its tenants and staff.
This theme has been reflected in many other 'real' landed estates that are now run far more as businesses, rather than just the recipients of rents from subservient tenant farmers.
Cashflow is everything. Many estates have historically been viewed as asset rich and cash poor. Nowadays every effort is made, if necessary and in some cases to the discomfort of the owners, to find sources of revenue that are sustainable, to reign in expenses and focus on overall return. The assets concerned must be worked hard: each must play its part. Annual budgets, projected out to five or 10 years, and often with longer cash flow models are now commonly adopted.
In many cases, the Hall or family home is now opened to the public, whereas in the past (and indeed still the case in some of the richest estates) this was vigorously resisted. Nowadays, families will accept some level of public access: whether this be to host weddings with the backdrop of the rolling hills and countryside unadulterated by housing developments, power lines, and sprawling city back drops; to view the family's art collections; to host the odd festival, flower event or car rally; or simply to explore the perfectly maintained and manicured gardens. The landed estate has had to accept that even the 'big house' may have to pay its way. In some cases this does not necessarily generate a significant revenue stream of itself but, in the case of a property of significant heritage and cultural importance, Inheritance Tax at 40% can be saved by claiming conditional exemption on the house or its contents or art, such that public access for a number of days be permitted.
Exploiting planning opportunities is now considered de rigeur, particularly for land on the periphery of the Estate. The loss of a couple of fields on the edge of a nearby village can generate significant profits, if the local planning policy permits a 50 or 100 house development. Structuring such a transaction so that land is owned in the correct entity is essential to protect from tax, as well as potentially earmarking the cash receipts for other purposes - be that to reinvest in the Estate or to set aside as a nest egg for school fees or an approaching tax charge, or for family expenditure.
Many estates have carefully audited their property portfolios. Aside from the main house, smaller properties are now exploited in a far more business-like way. See side panel for an example of a large-scale project on the Graythwaite Estate in the Lake District. Even smaller, redundant buildings can play their part: over the last generation we have seen a significant number of barn conversions, turning run-down old buildings into profitable ventures for the owners, whether as residential properties or business units. Successful farm shops or similar ventures have been set up in such former barns, whether run by the family or, more commonly, third parties.
Lakes and rivers are converted into fish farms; gravel and sand extracted where possible. Forestry is also big business, with estates selling forward to take advantage of the relatively high prices for timber. Properties have been done up, with loans where necessary, so as to command better rents and, by default, better quality tenants. In some cases, old Rent Act tenants have been encouraged to move, if appropriate alternative accommodation is available.
For the farms themselves and over the passage of time, many of the old-style Agricultural Holdings Act tenancies have been replaced by new tenants on the more IHT efficient Farm Business Tenancy. It is a testament to the owner/agent who maintains a workable relationship with his existing tenants that many are now agreeable to seeing their AHA tenancies re-granted, such that rights of succession and other favourable elements of the AHA tenancy are preserved, but as a tenancy granted after 1995 it now commands the 100% IHT rate for agricultural property. All of that achieves a more commercial operating system, as well as securing tax advantages.
In a number of cases, we have seen the tenants themselves looking at diversification and this can require some diplomacy in dealings. The landowner may not wish much non-agricultural use, as that will impact his APR and, possibly, on his lifetime planning if the CGT hold-over relief afforded to gifted agricultural land was denied or restricted. However, he appreciates that the tenant may be struggling, with falling revenues following two wet harvests, increasing costs of employment and input costs, reduced subsidies and fearing the impact of CAP Reform, and thus practically the owner may allow diversification. It may be that, adopting his more corporate approach, a new structure is adopted, such as adding some properties to a company structure, to enable diversification at the tenant level without a risk to the tax reliefs for the landowner.
Borrowing is in many cases now encouraged, initially reluctantly, but over the years it has proved that sensible application of borrowed funds generates greater return in the long run. As general principles, borrowing should be modest in loan to value when looking at the total value of the estate, but can improve cash flow provided there are clear ways for repayment, such as self-amortising loans.
The recent changes to IHT relating to debts taken out by Estates or businesses to be used for reinvestment within the Estate were not welcome news to the landed estate and business community. Under these, HMRC was seeking to disapply the IHT deductions that were afforded when a property that does not attract IHT relief (eg the main home) is used as security for borrowings that are then used on other projects, whether be to enhance or repair farmland, let cottages, or to inject funds into one of the businesses. However, after some lobbying, we have more clarity when such loans will still secure IHT advantages and it is critical that Estates are alive to the issue as the correct paperwork with the Bank will be critical when the IHT is levied.
Other estates are aware that the tax incentives of holiday lets are being constantly withdrawn by HMRC, firstly the income tax reliefs, and now - following thePawsoncase - the potential restriction of IHT relief for all but the most actively run holiday cottage businesses.
However, equally, the more diverse estate, and run as a commercial business rather than a number of separate assets, has more chance of being viewed by HMRC as a business. This was following theFarmerand, then more recently,Balfourcases, in which the Courts held that an Estate, when all of its components were taken together, is a business running all of its various operations - some more profitable than others. Such a business can thus secure relief from IHT. As a result it is all the more critical that the assets are worked together, and appropriate accounting and minutes will be essential in debating the tax relief with HMRC when the time comes.
The bulk of the estates in trust now face the added burden of a charge to IHT of up to 6% every 10 years. Whilst generating an extra 0.6% of return every year may appear a reasonably achievable challenge, without a business plan, profits once received can simply be ploughed back into the estate (or, worse, seen as the owner as an unexpected windfall and suddenly earmarked for a personal expenditure). It is critical that sufficient cash be available on that 10 year anniversary to meet the IHT, and estates must plan for that accordingly.
Estates have become more corporate, often now being run by a 'board', of which the patriarch is now perhaps the MD or Chairman, with a qualified business person as the CEO. He (or increasingly she) may be a surveyor or agent, or indeed in some cases ex-City accountant or other businessman, now takes the helm in terms of strategy.
Rather than all assets being owned outright, trusts, partnerships and corporate structures are interleaved to take advantage of tax breaks and to limit liability where an operation carries any risk - in just the same way a trading house in the City or a trading business incorporated to secure such protection.
It is also essential that the business plan identify which assets are playing their part. There may be obvious reasons that an under-performer is retained - for example, the family home provides accommodation for the owner yet generates little return in most cases; ditto for the art collection. The owner needs to be ruthless, and commercial, in deciding which assets are key holds, and thus identify others to prop those up, financially. A sound, strategic business plan is critical.
Reinvestment is crucial and without this estates will flounder and die. Critical mass is also important, as without a spread of investments and appropriate diversification a family can be too dependent on the vagaries of just one type of venture. A 10 year minimum plan is essential, but it should not be totally reliant on the estate itself - ideally at least 10% of the value of the estate should be in an investment fund, whether held as investments or in properties earmarked for sale. Every estate needs its rainy day fund and short-term access to cash to retain overall flexibility.
Not all ventures work and Estates have been quicker to recognise that; fail fast is a new motto. It is better to try, but not all ventures will success, for whatever reason - economy, location, weather, public sentiments. The modern estate needs to acknowledge that one of the new ventures will prove to be the estate's cash cow in years to come, but it needs to identify which will, and importantly which will not, and take action fast.
Ultimately, in the same way as a business needs a back up plan, asset management and a proactive approach is the only way to survive. Urban estates perhaps provide more opportunities for income returns and higher yields than rural estates, if only because in part sentiment contributes so much more to the latter. Whereas an estate with an urban asset class can take decisions more ruthlessly and with less sentimental attachment, the rural estate cares more about retaining certain properties and, above all else, preserving the family's home.
This article was written by Fiona Graham and originally appeared in the October 2013 edition of Private Client Adviser.