Despite Brexit the commercial property market is holding up well. But new regulations could deter investors.
For lawyers in the commercial property sector, there is plenty going on at the moment. On the transactional side, the market has stayed strong despite predictions that the sky would fall in over Brexit. In the disputes arena, two separate legislative changes – concerning the rights of telecoms providers to set up equipment on private land, and new rules on the energy efficiency of buildings – look set to add grist to the litigation mill.
The commercial property market is essentially made up of three main components: office, industrial and retail. Of these three, retail is the sickly one, with insolvencies hitting the headlines on an all too frequent basis. The industrial market, on the other hand, is in prime health, with a lack of available premises pushing up prices and leading to very low vacancy rates.
What about the office sector? The picture is a little more mixed. Richard Clark, head of the real estate group at Burges Salmon, says: ‘The projected slowdown post-Brexit in terms of office takeup in London has not materialised; the market has been remarkably resilient. But there is a trend for reduction in the office footprint, which is linked to the move towards flexible working (see box, p15), and the huge takeup of office space by people like [communal office space provider] WeWork, which is now rippling out to the regional markets.’
Claire Nelson, real estate partner at City firm Wedlake Bell, says: ‘We saw a Brexit effect quite early on. In the quarter before the [June 2016] Brexit vote, people were slightly nervous, but no one thought [a Yes vote] would ever happen. Then we had a dip. People then got over their nervousness, and 2016 was actually OK, but in 2017, when the Brexit talks started, the market dropped off again.’
She continues: ‘We’re still seeing quite a lot of foreign investment, from China for example. But the English investors are holding off. We’re now seeing regular investors being outbid by foreign investors that will pay over the odds to get into the market.
‘Brexit has had an effect, and it will continue to have an effect until it is settled. But once we have certainty, the market will settle down. People don’t like uncertainty.’
The strong flow of foreign investment into the UK property market is partly down to tax advantages. At the moment, the UK capital gains tax (CGT) regime actually favours investors from beyond these shores – but that is about to change. From April 2019 CGT is being extended to all non-resident ownership disposals of UK real estate, putting foreign investors on an equal footing to their UK rivals.
Warren Gordon, chair of the Law Society’s Property Section and real estate professional support lawyer at CMS, says: ‘This is a concern to people in the property industry, because you don’t want to deter legitimate foreign investors. But my impression is that the market is still extremely strong at the moment.’
Even without the CGT benefits, the UK property market still offers a high return on investment. It seems unlikely that the tax changes will do much to dull the appetite of foreign investors for UK property, particularly while sterling remains weak.
‘The change only brings us into line with our European competitor market,’ Clark remarks, ‘so I don’t think it will have a dramatic effect.’
In a bid to avoid missing its carbon reduction targets, at the start of this month the government brought in new rules relating to the energy efficiency of buildings, with the commercial property sector likely to be significantly affected. A new legal standard for minimum energy efficiency now applies to rented commercial buildings.
Just like fridge-freezers and televisions, all commercial buildings are given an energy performance certificate (EPC) rating, which ranges from A to G. From this month, landlords must not renew existing tenancies or grant new ones if the building has a rating of F or G – the lowest scores. Then, from 1 April 2023, even if the lease has not reached renewal landlords must not continue to let any buildings with an F or G rating.
With an estimated 18% of commercial properties currently holding an F or G rating, the new rules are likely to have a big impact. The penalty for failure to comply runs to a maximum of £150,000, with responsibility for policing the rules lying with local authorities. ‘The local authority gets to keep the money, so it may be more incentivised to take action,’ Gordon says.
James Sutherland, a partner in the real estate disputes team at Burges Salmon, says that at the top end of the market, large landlords have been aware of the need to improve energy efficiency for a while and are ready for the new rules. ‘The problem is more at the middle or lower end, where you have got a cohort of landlords who are not aware,’ he says. ‘Often the work needed is minimal; changing the lighting or changing a boiler, for instance. But in some cases it will be much more wide-ranging.’
While these stringent new energy efficiency rules might be unpopular with landlords, for wily tenants – or their lawyers – they offer an opportunity. Tenants with a break clause coming up in properties with an energy rating that falls below the required threshold will find themselves in a good position to push for a rent reduction, because if they press the button on their break clause, the landlord will suddenly find themselves with an unlettable property. Likewise, tenants who reach the end of their lease may bring the energy rules into any dilapidation dispute with their landlord, arguing that they cannot be required to make repairs to a part of the building that the landlord is now under a duty to upgrade.
‘There are hidden consequences which may emerge at a strategic level in the way in which tenants interact with their landlord,’ Clark says. ‘There could be some high-level strategic play.’
In this information age, the right to internet access is increasingly seen in the same bracket as the right to access basic utilities such as mains electric and running water. Meanwhile, the government is keen to ensure that the UK is ahead of the game when it comes to new technological developments such as the rollout of ‘5G’ technology – the superfast mobile network that will underpin a raft of technical advances, including driverless cars.
But for UK telecom and broadband operators to offer these services, they need many more masts in many more places, and endless miles of new fibre-optic cable. Much of this will inevitably involve accessing private land.
Telecoms companies have enjoyed rights to set up and maintain equipment on private property for some time, through a regulation called the Electronic Communications Code (ECC), which came into force in 1984. But this old legislation was notoriously badly drafted and openly lambasted by judges for its incoherence. The old rule has now been ditched and replaced by a shiny new ECC that took effect on 28 December last year.
The new version of the code is more than just a simple rewrite. It tips the balance further in favour of telecoms companies rather than landowners.
Gordon says: ‘The previous code has been described as the worst law ever written. The new one is arguably better and solved some of the problems, but inevitably it has created new ones – and it is very long. For example, there are 15 pages on the issue of termination. It is hugely complicated.’
He adds: ‘It was argued that where you have commercially experienced parties advised by lawyers, they should be able to come to their own agreement even if it contradicts the legislation. But the government was concerned that that could undermine the code and the policy behind it. So there are big chunks that you can’t contract out of. You can’t agree to terminate on a month’s notice, for example, [because] the code says 18 months. For landowners it is a more protracted process if you want to remove apparatus.’
'TRENDY' WORKSPACE DESIGNER FLEXES ITS MUSCLES
The rise of the flexible workplace has been one of the driving factors boosting a positive performance in the office market,
The report finds that WeWork is now the largest single corporate occupier of office space in London, having taken up more space in London’s key commercial property districts than any other occupier since 2012. WeWork has taken up more than twice as much space as Google, which leased 1.3m sq ft over the five-year period, while Amazon and Deutsche Bank leased just over 1 m sq ft and 0.9 m sq ft.
With trendy communal spaces that often feature extras such as an on-site cafe, a bike room, and even dog-friendly spaces, WeWork began in 2010 aimed at millennial tech start-ups, but has now broadened its reach to larger corporates.
Claire Nelson, real estate partner at City firm Wedlake Bell, says: ‘The way people are working is changing. Traditionally, a small business might rent a 15,000 square foot space in central London. Now, they’ll rent a few desks or a floor in a co-working space. They are not tied into a lease that they may not want in two or three years, and it is much cheaper.’
Under the new ECC, when charging the telecoms company for the use of its land, the landowner is no longer entitled to take into account the fact that the space will actually be used for telecoms purposes. This means that where a telco wants to put equipment on the corner of a farmer’s field, or on four square metres of a company’s roof, the landowner can only charge an amount that represents the value of that scrubby patch of grass or square of roof felt, without any telecoms use. Effectively, it means the landowner can charge much less than before. But while this is intended to be helpful to the telcos, it could backfire.
Sutherland says: ‘The new code effectively suppresses the return that landowners are entitled to. So that might make granting telecoms leases on your building not that attractive; especially as it has always been a bit of a nightmare to get rid of them once they are there.’
This may mean that landowners are more reluctant to voluntarily enter into deals with the telecoms providers, which will instead need to turn to the powers they are given under the statutory code to force the landowner to co-operate. ‘If the telecoms companies are prepared to use these powers, that is an area where we’ve not seen much litigation before and it could become a battleground,’ Sutherland predicts.
A court rebrand
While developments such as the energy efficiency changes and new telecoms code mean there is plenty to keep lawyers on their toes in the commercial property arena, one change presented with great fanfare last year has so far had little practical effect: the launch of the Business and Property Courts.
The new courts, which were announced last July and officially went live last October, are essentially a rebrand, creating a single ‘umbrella’ name for the specialist business courts across England and Wales. Heralding their introduction last summer, lord chancellor David Lidington said the new name was ‘squarely in the tradition of it does what it says on the tin’, while the chancellor of the High Court Sir Geoffrey Vos added that: ‘Trying to be as delicate as I can, lawyers have always rather liked using words other people cannot understand.’
The new name encompasses the London Rolls Building courts – the Commercial Court (including what was previously called the Admiralty Court and the former Mercantile Court, now renamed the Circuit Commercial Court), the Technology and Construction Court and the courts of the Chancery Division – as well as the business courts in the regional centres of Manchester, Birmingham, Bristol, Leeds, Cardiff, and more recently Liverpool and Newcastle. The new courts are also intended to enhance the ‘super highway’ – as Lidington described it – between London and the regions, with more cases being sent out from the capital under the mantra that no case is too big for the regions.
But beneath the umbrella, each individual set of courts still operates under its own set of procedural rules. A promised harmonisation of procedure has not yet happened.
So have the new Business and Property Courts had any practical impact? Sutherland says: ‘Based on a straw poll internally [at Burges Salmon], the view is that we have seen a change, but not a massive change.
‘Certainly courts have been more willing to allocate cases to the regional district registries of their own volition. If you just issue in London because that’s what you’ve always done, you’ll find it will be transferred out. But we expected the courts to have more dialogue between themselves in terms of transfers. Instead, a case will be transferred out of London, and the first the Bristol courts will know about it is when the note of transfer turns up.’
Has the name change made the courts more accessible from the client’s perspective? Sutherland points out that in the commercial property arena, it is ‘extremely rare’ for a client to issue proceedings themselves; they rely on lawyers to do that. He adds: ‘The client doesn’t care what the court is called.’
TENANTS LIABLE FOR RECLADDING
Last month a tribunal ruled in a potentially significant case dealing with the issue of who should pay for the cost of replacing cladding in a block of flats in Croydon.
The judgment on 9 March in the First-tier Property Tribunal was widely watched, with many similar cases waiting in the wings in the wake of last June’s Grenfell Tower disaster.
The case concerned the Citiscape development in Croydon (pictured), which was built by Barratt Homes in 2001. It comprises one 10-storey block of flats and a second six-storey block. Following the Grenfell fire, the property management company, FirstPort Property Services, established that the blocks had similar aluminium composite cladding to those at Grenfell. It commissioned an agency to provide a ‘waking watch’ fire marshal to patrol each block at a cost of £14.75 plus VAT per hour, amounting to an annual cost of £263,000.
FirstPort initially used its internal surveyor to assess the cost of replacing the cladding, which estimated this at £483,000. It then sought to recover this cost, and the cost of the fire marshal, from tenants though a service demand. It was these charges that were the subject of the tribunal dispute; although it later transpired from an external survey that the actual cost of recladding will be even higher at up to £2.5m.
The tenants held 999-year ‘tripartite’ leases that were originally made between Barratt Homes Ltd, FirstPort Property Services (under its previous name) and the individual lessee. Barratt has since sold its freehold interest to Promixa GR Properties, which is owned by the family trust of property tycoon Vincent Tchenguiz.
Unlike a traditional 99-year lease, a 999-year tripartite lease is designed to allow landlords to rid themselves of the responsibility of maintaining the property, transferring that duty to a third-party company instead. In most cases, this company is controlled by the lessees, who have a capital interest in the property. But importantly in this particular case, the third party was a professional manager, FirstPort, with no capital interest in the building. In reality, it was simply a managing agent.
In its ruling on 9 March, the tribunal concluded that the tenants themselves were liable for the cost of replacing the cladding, upholding the service charges that had been levied in respect of the ‘waking watch’ cost, and the £483,000 cladding estimate.
The tribunal said: ‘By granting 999-year leases the original freeholder was effectively relinquishing any capital interest in the flats. There is no prospect of the freeholder receiving other than nominal premiums either on enfranchisement or on individual lease renewals under the Leasehold Reform, Housing and Urban Development Act 1993.
‘In such circumstances it is reasonable to conclude that the parties would have intended that all future costs associated with the blocks would be the responsibility of the tenants. That intention is reinforced by the use of identical words to define both the manager’s obligation to undertake work, and the tenant’s obligation to pay for it.’
Richard Clark, head of the real estate group at Burges Salmon, comments: ‘To reclad a large residential, mixed use or even commercial building, you are looking at millions; so that is a large potential liability floating around in the market. Who is responsible? In [this] case the tribunal said it was the occupiers; but it was at pains to say this will not always be the case.’
The ruling may be appealed.
Rachel Rothwell is a freelance journalist and editor
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