I INTRODUCTION TO THE LEGAL FRAMEWORK
i Ownership of real estate
The two main types of ownership of real estate in England and Wales are freehold and leasehold. Freehold is, in effect, absolute ownership for an indeterminate period, whereas leasehold is a right to possession and use of land for a limited period; the landlord retains its interest and grants the leasehold interest to the tenant for the term of the lease. Ownership of land also includes ownership of any buildings or other structures attached to the land and, as a general rule, includes the subsoil beneath and the airspace above the land.
Generally, freehold interests are more attractive to investors because they are not subject to termination and there are fewer restrictions on the owner, whereas a tenant is constrained by the terms of a lease. That said, long leasehold interests are often held for investment purposes. In central London in particular, properties may be owned by the Crown Estate, trusts, charities or other entities that may choose not to dispose of their freehold interests as a matter of policy, and will instead grant long leases. It is also common for leaseholds to be used when structuring joint ventures, and other arrangements and structures where owners wish to retain an element of control by imposing positive covenants.
A leasehold property held as an investment should be distinguished from an occupational lease, which is typically granted for between five and 20 years subject to a market rent, and, therefore, has a negligible capital value. An investment leasehold interest will most likely be granted for a term of between 99 and 250 years, at a premium. There are generally fewer onerous obligations on the tenant of a leasehold property held as an investment. The income generated from most investment properties is in the form of rent paid under occupational leases.
A relatively new form of land ownership called commonhold was introduced in England and Wales by the Commonhold and Leasehold Reform Act 2002. Commonhold comprises a freehold unit within a larger development and membership of the company that manages the common parts. As such, commonhold is suitable for residential flats as well as commercial developments such as shopping centres; however, its use has not been adopted by the property industry and it remains a rarity.
ii System of registration
Most freehold and long leasehold titles are registered at the Land Registry; however, a number of unregistered titles remain, and these will generally only become registered once there has been a dealing with the land that triggers a requirement for 'first registration'. Trigger events include sales, mortgages and leases granted for more than seven years. Until a trigger event occurs, titles will usually remain unregistered. Registration fees are payable, calculated by reference to the type of transaction and the price paid.
Registration at the Land Registry provides a state guarantee of title. Compensation is payable if loss is suffered because of a mistake on the register. Therefore, there is no separate US-style title insurance regime. The registered title has a unique title number and identifies the extent of the land on a plan. The register also provides details of the property, including any rights that benefit it, and identifies the owner and any rights or matters adversely affecting the property, including financial charges. It also includes the purchase price at which the owner acquired the property and the purchase date, if done so through an asset as opposed to a share purchase. If the property is leasehold, brief details of the lease are included. Various short leases and rights of occupation are not, however, required to be registered in their own right. These and some other non-registrable interests will bind a purchaser, and should be uncovered by the purchaser's due diligence process. Accordingly, the information on the register cannot be treated as being comprehensive. Documents and other information held by the Land Registry are widely available to the public, although it may be possible to protect certain commercially confidential provisions for a limited period.
The government is proposing to introduce a register of the beneficial owners of overseas companies acquiring real estate in the UK. Draft legislation has been published and the new register is expected to become operational in 2021.
iii Choice of law
Dealings with real estate in England and Wales will be covered by the law of England and Wales. Although a contract may include an express choice of governing law, which in general the courts will uphold, English law will still apply in relation to the transactional formalities that involve English and Welsh real estate.
Real estate law in England and Wales is different from real estate law in Scotland, Northern Ireland, the Channel Islands and the Isle of Man, and thus specialist advice is required where these jurisdictions are involved. Because of tax planning, property ownership vehicles are often incorporated in the Channel Islands, although the benefits of holding UK real estate through offshore vehicles have declined markedly following changes to the tax rules that took effect from April 2019, from which point non-residents will be brought fully within the scope of capital gains tax on disposals of UK real estate.
II OVERVIEW OF REAL ESTATE ACTIVITY
It is hard to believe that it is more than three years ago that the British electorate voted to leave the EU. For a while it looked as though Brexit would finally take place on 31 October, but that deadline, like others before it, came and went. Following the general election on 12 December, Boris Johnson's government has the majority to fulfil his manifesto pledge to 'Get Brexit Done' by 31 January. However, trade agreements with the EU and global trading partners must be concluded by 31 December, and uncertainty will continue as the UK seeks to complete the extraction process.
Perhaps not surprisingly, this year has seen a reduction in investment activity. Although high levels of interest remain, both buyers and sellers have shown greater caution resulting in fewer deals. A pricing gap has developed, buyers are concerned that real estate is currently overvalued and sellers are reluctant to lower their price expectations. In addition, owners enjoying healthy returns on their investments have been reluctant to sell and risk having to find a better home for their capital. Low interest rates and low returns on government bonds have helped to ensure that UK real estate remains a safe haven for investors from around the world. The accumulation of global investment capital is expected to cause a surge in transactions as and when market conditions allow. However, any optimism is largely predicated on an orderly exit from the EU.
The office market has continued to hold up relatively well despite the ongoing political and economic uncertainty. Many landlords have become less concerned about Brexit as the much anticipated collapse in demand has failed to materialise and, in many respects, the industry has already allowed for Brexit and the associated fallout. There has not been a mass exodus of international businesses from London and the UK. Although post-Brexit strategies have been implemented, relocations have not, at least as yet, had a significant impact on occupier demand. Major deals have included British Telecom's relocation to One Braham, London E1, WeWork's underlease of the European Medicines Agency's former offices at 30 Churchill Place, Canary Wharf (possibly its last major acquisition for some time), Diageo's new headquarters at 16 Marlborough Street, W1, Derwent London's pre-letting of Soho Place, W1 and Knotel's flexible office partnership arrangement with Great Portland Estates in respect of City Place House, EC2. Although the construction pipeline is reasonably strong, much of the space has been pre-let, ensuring that there will be healthy competition for space. Outside of London, regional cities such as Manchester and Edinburgh have proved particularly attractive for occupiers and investors. Both cities offer a strong talent pool combined with attractive amenities. While London will undoubtedly retain its attraction as a key global city in which to live, work and do business, evolving technology and flexible working practices have helped encourage growth in the regions, particularly in those towns and cities with a strong tech and media sector.
Notwithstanding WeWork's much publicised woes, the inexorable rise of the serviced office sector has continued and now accounts for up to 30 per cent of all letting activity, ahead of the tech and financial sectors. Although WeWork had been the dominant force in the co-working sector, its retrenchment is likely to be more than compensated for by a plethora of new operators. The sector has become an established part of the market, including the development of sub-markets as operators seek to establish niche appeal. There remains acute demand for good quality office space, available on flexible terms and in well-located office buildings.
In the residential markets, overseas investors have continued to focus on the private rented sector with up to 11 per cent of UK private rental homes now let by foreign landlords. The figure in London rises to 18 per cent, where the residential investment market is more established. Across the country as a whole, healthy returns combined with favourable exchange rates and continued low interest rates have helped ensure continued interest in residential property. The main change is the emergence of new regional hotspots while the once dominant central London boroughs, such as Chelsea and Kensington and Westminster, continue to languish at the bottom of the table with flat or falling prices. The country's housing crisis continues as successive governments have failed to meet new build targets and the UK's rising population will ensure that residential property will continue to provide opportunities for investors. There have even been reports of the first signs of green shoots in the capital's super-prime market. If this is the case, the rest of London will surely follow.
The UK's retail sector has continued to struggle, and more household names, including Mothercare, Arcadia, Debenhams, Thomas Cook and Monsoon, have joined the seemingly endless list of casualties. This has hit property companies and investors exposed to the high street as market rents and valuations have fallen. It is not all doom and gloom with London's high-end retail boosted by continued demand from overseas visitors keen to take advantage of a weak pound. New Bond Street is the third most expensive global location for retailers (behind New York's Upper 5th Avenue and Hong Kong's Causeway Bay) and the most expensive in Europe. In the wider market, retail parks have fared better than shopping centres and the UK's high street has continued to shrink as vacancy rates increase. There is more turbulence to come as traditional retailers adapt to the changing habits of their customers. Online spend continues to increase in the retail and restaurant sectors with a particular surge in e-commerce sales from mobile devices. Investors are having to rethink how they see retail property, and a number of recent schemes have sought to exploit the space for residential, leisure and other purposes. The industrial sector continues to attract investment and well located, high-specification distribution centres in the right locations have continued to benefit from the boom in e-commerce.
Alternative assets have become an established part of the investment market, alongside the traditional office, retail and industrial sectors. The build-to-rent boom continues as institutional investors look to increase their market share and there has been an increase in the number of new projects in the construction pipeline, both in London and the regions. Confidence remains high for operators in the specialist retirement living and student housing sectors, where major institutional investors have increased their portfolios. For example, Legal & General has entered into a £4 billion partnership with Oxford University to provide student and staff accommodation and innovation space. The hotel and leisure sector has continued to reap the rewards of a weak pound. Numbers of foreign tourists remain strong and increasing numbers of UK residents are taking staycations. More than 200 new hotels are currently planned for London, including the redevelopment of the former American Embassy on Grosvenor Square into a 137-bedroom luxury hotel. If the government wishes to preserve the UK's attraction to overseas visitors post-Brexit, it cannot rely on sterling's slump forever and investment in major transport infrastructure projects, including Heathrow, Crossrail 2 and HS2, remains crucial. Alternative real estate assets have helped to create a more dynamic investment market, offering exciting opportunities in this rapidly evolving and increasingly important sector.
Loan originations in the UK's commercial property market have risen despite the slump in investment activity across the country. There are always concerns of an overheated market whenever financing volumes exceed investment levels. However, lenders continue to be cautious when financing speculative developments and typically expect schemes to be at least 20 per cent pre-let. A diversified lending market has become the new normal as online platforms and peer-to-peer lending have joined debt funds, insurance companies and other non-bank lenders. The UK property finance market now closely resembles that seen in the United States. While activity from German Banks has declined, the slack has been taken up by UK and American banks, as well as funds and insurers. The market almost inevitably remains focussed on London but debt funds have shown increased interest in the regions.
III FOREIGN INVESTMENT
Overseas investors are able to own, sell and lease real estate in England and Wales without any legal restrictions. A legal opinion may be required to confirm that an overseas investor has legal power to enter into a transaction involving property in England and Wales, to deal with the property and to execute the relevant documents.
IV STRUCTURING THE INVESTMENT
A number of alternative structures are available for direct or indirect investment in real estate in England and Wales. The decision how best to structure an investment is likely to be dictated by tax considerations, and it is important to ensure that appropriate tax advice is sought, taking into account both UK tax legislation and that of the investor's own jurisdiction. There are, however, a number of advantages and disadvantages to each structure, which may also prove critical depending on the investor's particular objectives.
i Corporate entity
A company can hold assets in its own name and create floating charges. There is potential for flexibility in terms of share structure, and there can be the advantage of limited liability. More generally, corporate entities are widely recognised, and can promote a strong and legitimate identity. Nonetheless, there is a lack of confidentiality in comparison with other investment structures and the added administrative burden of complying with the relevant regulatory framework. There is also a lack of tax transparency, and it may be expedient to base the company offshore.
ii General partnership
Whereas property co-ownership is not in itself sufficient, the active, joint management of property may constitute a partnership; it is a matter of substance rather than form. The main advantage is tax transparency, while the main disadvantage is the unlimited liability of the partners.
iii Limited partnership
In a limited partnership, investors will be limited partners who are only liable to the extent of their investment. This limited liability is particularly advantageous when coupled with the tax transparency that, to an extent, is offered by a limited partnership. However, a limited partnership must comply with the Limited Partnerships Act 1907, and a limited partner should not become involved in the management of the partnership. This may prove to be unduly restrictive for investors looking to actively manage their real estate investments. The limited partnership regime has been modernised by the introduction of a new private fund limited partnership to help meet the needs of fund managers.
iv Limited liability partnership
Limited liability partnerships (LLPs) are governed by the Limited Liability Partnerships Act 2000 and combine limited liability for members with the tax transparency of a partnership. LLPs are not subject to the same restrictions as limited partnerships, and partners are able to actively manage the business of the LLP. Furthermore, an LLP is a body corporate (having a legal entity separate from that of its members), so there are no issues as to the legitimacy of floating charges. If the LLP is a collective investment scheme, it must be operated by an authorised person in accordance with the Financial Services and Markets Act 2000 (FSMA).
v Property unit trust
A property unit trust is an open-ended fund that allows pooled investment and is tax-efficient. A unit trust is governed by a trust deed, and as such may be an unfamiliar structure to certain overseas investors. One drawback may be the need for authorisation under FSMA. Offshore unit trusts are popular, and can provide further tax advantages because of their offshore status (albeit that such advantages have been largely curtailed from April 2019); Jersey property unit trusts in particular have been used extensively in recent years. However, there may still be local regulatory supervision, and the fact that the trust must be managed outside the UK may be undesirable for certain investors and difficult to achieve.
vi Property authorised investment fund (PAIF)
PAIFs are open-ended investment schemes that invest in property and are authorised under FSMA. The PAIF regime allows gross dividends to be paid, and was introduced to make property attractive to tax-exempt investors. A number of conditions apply for entry into the PAIF regime, including the need to carry on a property investment business and the genuine diversity of ownership condition. PAIFs benefit from SDLT seeding relief.
vii Offshore vehicle
Offshore vehicles can take advantage of lighter regulatory and tax regimes. As well as Jersey, popular offshore locations include Luxembourg, Guernsey, the Isle of Man, the British Virgin Islands and the Cayman Islands. UK corporation tax will be extended to the UK property income of non-resident companies without a UK permanent establishment with effect from April 2020.
viii Listed property company
Investing in a listed property company offers a popular means of investing in UK real estate. Listed property companies can benefit from a high profile and augmented credibility as well as greater liquidity. The drawbacks include stringent regulatory and filing obligations, and a general lack of confidentiality. In addition, listing may be costly and places extra pressure on the company management to perform. The investor also has limited control over the underlying real estate assets.
ix Real estate investment trust (REIT)
Based on an investment structure first developed in the United States, REITs were introduced in the UK in 2007. REITs are tax-efficient, as they are exempt from tax on income and capital gains arising from property rental business; distributions of profits are treated as property income in the hands of the shareholders and are generally subject to withholding tax at 20 per cent. To gain REIT status, a company must comply with a number of conditions, including a requirement to be listed and either widely held or owned by specified types of 'institutional investor' (such as pension funds), and have property rental business as its predominant activity.
x Property joint venture
Joint ventures allow parties to share risk, and, therefore, provide a particularly attractive investment structure while the availability of debt remains constricted and investors are keen to mitigate risk exposure. A property joint venture can be structured in whatever form the parties choose, and in many cases may involve more than two parties. Of course, as well as sharing risk, parties share gains and management, so joint venture provisions need to be considered carefully.
V REAL ESTATE OWNERSHIP
The planning administration in England and Wales primarily consists of local planning authorities (LPAs) and the Secretary of State for Communities and Local Government. The Mayor of London is also able to exercise specific planning powers at a London-wide level, including the power to decide strategically important planning applications. Planning administration is governed by various statutes, the most important of which is the Town and Country Planning Act 1990. In general, planning permission is required for development, including material changes of use, although certain restricted types of development are automatically granted planning permission under the Town and Country Planning (General Permitted Development) Order 2015. Particular planning requirements exist for conservation areas and listed buildings, as determined by the Planning (Listed Buildings and Conservation Areas) Act 1990. Third parties have a right to make representations about any planning application, which in turn must be considered by the relevant LPA. Applicants are able to appeal LPA planning decisions to the Secretary of State, in which case the Secretary of State will decide the application afresh and on its merits. Third parties have no such right of appeal but they (and applicants) may appeal decisions of the Secretary of State on the grounds of legal error. LPAs have enforcement powers to deal with development that is carried out without or in breach of planning permission. The Planning Act 2008 provides a streamlined decision-making process for nationally significant infrastructure projects, which are projects within the five general fields of energy, transport, water, wastewater and waste, as well as certain commercial and residential projects. A development consent order granted under the Planning Act 2008 provides a single consent for such projects, thereby removing the need for developers to seek planning permission and other related consents separately.
The environmental issue of particular significance to investors is the contaminated land regime, which is set out in Part IIA of the Environmental Protection Act 1990, as amended by the Environment Act 1995. Contaminated land is land that is causing, or may cause, significant harm to the environment or human health, and the regime also applies to water pollution. Local authorities are obliged to inspect their land to identify areas of contamination. Where land is deemed to be contaminated and is not being remediated voluntarily, the local authority or the Environment Agency (in England) or Natural Resources Wales (in Wales) is obliged to serve a remediation notice on the relevant persons requiring the clean-up, investigation and monitoring of the contamination. It is a criminal offence to fail to comply with a remediation notice. In general, those who cause or knowingly permit land to become contaminated are responsible in the first instance; however, if no such person can be identified, the current owners and occupiers of the site may be liable for remediation costs. While regulators in the UK do not take enforcement action as readily as in other jurisdictions, remediation costs can be substantial, and it is often necessary to obtain specialist advice when dealing with land that is or may be contaminated.
The starting point is that a supply of land (i.e., any sale, letting or licensing, or the grant or surrender of property rights such as rights of light) will be exempt from VAT. However, the seller or landlord can exercise the option to tax, which will generally make any sale or letting of the property by that seller or landlord a supply subject to VAT. The standard rate of VAT is currently 20 per cent. The landlord or seller can then recover the VAT charged on supplies of goods and services made to him or her in connection with the property concerned. In addition, supplies of land are generally subject to VAT if the sale involves a new commercial building completed within the past three years, or an incomplete industrial or commercial building.
SDLT is a transactional tax payable by the buyer on the acquisition of a chargeable interest, and applies to any chargeable consideration payable by the buyer on a relevant transaction. The rate depends on the value of the transaction, and the highest rate for non-residential transactions is currently 5 per cent in respect of that part of consideration that exceeds £250,000. Residential properties are subject to rates ranging from 2 per cent up to 12 per cent for higher-value properties where the consideration exceeds £1.5 million, and there is an additional 3 per cent charge on second homes and most buy-to-let properties. Where the buyer of a residential property costing more than £500,000 is a corporate vehicle, the rate of SDLT is 15 per cent and an additional annual charge may also apply. The government has announced that there will be an additional 3 per cent charge for non-residents buying residential property in England. A new land transaction tax replaced SDLT on property transactions in Wales with effect from April 2018, which, following the introduction of a similar tax in Scotland in 2015, leaves England and Northern Ireland as the two areas of the UK where SDLT remains in place. SDLT is also payable by the tenant on the rental element of a lease on grant, and is charged at banded rates of 1 and 2 per cent of the net present value of the rent payable for the term of the lease. Limited types of transactions are normally exempt from SDLT, including mortgages and personal licences to use or occupy land. A number of reliefs that may apply, including group relief, sale and leaseback relief, acquisition relief, reconstruction relief and charity relief. It is important to consider how best to structure a transaction for SDLT purposes, although the introduction of various anti-avoidance provisions has made it increasingly difficult to implement tax-saving schemes.
The occupier of a business property is responsible for the payment of business rates, which fund local government expenditure and are calculated by reference to the rateable value of the property. Rateable values are usually assessed every five years, and a revaluation took place in 2017 based on 2015 rateable values. This has resulted in a significant uplift, particularly for those businesses in property hot spots such as central London. Following a significant reduction in the relief available, business rates are generally payable on empty properties, and this has become a significant issue for owners in sectors with high vacancy rates.
iv Finance and security
Lenders will generally require security over real estate, the best form of which is a charge by way of legal mortgage. It is necessary to register a mortgage over land at the Land Registry. If the company giving the security is registered at Companies House, the security must also be registered at Companies House within 21 days of creation. The mortgage will typically impose restrictions on the ability of the borrower to deal with the property and obligations on the borrower to preserve the value of the security. Security is also commonly taken over the rental income derived from occupational leases.
VI LEASES OF BUSINESS PREMISES
In general, the landlord and tenant are free to agree the terms of a commercial lease. The law does not prescribe a particular form or contents of a lease and, subject to the tenant's security of tenure referred to below, there are relatively few statutory provisions affecting the landlord and tenant relationship under a commercial lease. The Code for Leasing of Business Premises seeks to encourage fairer and more flexible terms for tenants but, despite industry endorsement, remains voluntary. Traditionally, the industry has not enjoyed a reputation for being customer-driven, and leases have tended to be lengthy, complex and onerous for tenants. This is, however, changing as owners seek to meet the needs of their occupiers. The position for commercial leases should be contrasted with that for residential leases, where statute plays a significant role.
Leases can be granted for a wide range of terms. Leasehold interests held for investment purposes are normally held on long leases for a term of between 99 and 250 years. Historically, occupational leases were granted for a term of 20 or 25 years; however, shorter terms of 15 years, 10 years or less have become more common recently. A tenant of an occupational lease may also require a right to determine the lease before the end of the term. For example, the tenant of a 10-year lease may have a contractual right to determine or break the lease at the end of the fifth year of the term.
ii Rent increases
The property industry has traditionally required five-yearly upward-only rent reviews to the open market rental value of the property. This guarantees a minimum return of no less than the original rent for the remainder of the term of the lease, even if market rents have fallen. Although there has been some pressure on the property industry to offer leases on more flexible terms, it is still very rare to see rent review provisions that allow for the rent to go up or down in line with the market. An alternative form of rent review is indexation, for example in line with the retail price index or the consumer price index, but this, too, is often on an upward-only basis. Fixed uplifts in the rent are another possibility, and changes to the rent can also be restricted by agreed caps and collars. An element of the rent, particularly in large retail developments, may also be calculated by reference to turnover. VAT may be charged on the rent if the landlord has exercised the option to tax.
iii Tenant's right to sell and change of control
There are likely to be restrictions on the tenant's ability to sell, charge, underlet or share occupation of the property without the landlord's consent. In a typical occupational lease, consent must not be unreasonably withheld. In considering applications for consent, the landlord will be keen to ensure that a tenant of good covenant strength is responsible for paying the rent. Provisions restricting a change of control of the tenant itself are, however, rare.
iv Tenant liability and security for payment of rent and performance of covenants
The Landlord and Tenant (Covenants) Act 1995 (LT(C)A) introduced a regime whereby tenants of new leases (granted on or after 1 January 1996) are released from liability on an assignment of the lease. The tenant's guarantor is also released at this point. This is in contrast to the previous regime, whereby the tenant and its guarantor remained liable for the duration of the term of the lease under the doctrine of privity of contract, even after an assignment of the lease. The doctrine continues to apply to old leases (granted before 1 January 1996). The LT(C)A also introduced authorised guarantee agreements (AGAs), which provide the landlord with a guarantee from the outgoing tenant for the incoming assignee's obligations under a new lease. The AGA is for the duration of the assignee's term only, so that when the lease is assigned again, the original tenant is released from all liability. The decision in K/S Victoria Street v. House of Fraser (Stores Management) Ltd and others2 confirmed that, although an existing tenant's guarantor cannot guarantee the liability of an incoming assignee, it can guarantee the outgoing tenant's obligations under an AGA given by that tenant in respect of the assignee. This has been considered by the High Court in Co-operative Group Foods Ltd v. A&A Shah Properties Ltd3 where it was held that the guarantor's obligations amounted to a guarantee of the tenant's obligations under the AGA and were enforceable. In EMI Group Limited v. O&H Q1 Limited,4 the court confirmed that a purported assignment of a lease to the tenant's guarantor was void and of no effect. A landlord will also consider other security, including a rent deposit or bank guarantee.
v Repair and insurance
A tenant of business premises will usually be expected to be responsible for all liabilities in respect of the property, including maintenance and repair costs. Where a property is multi-let, those costs are recovered through a service charge. The landlord generally insures the property, but recovers the cost of the premiums from the tenant. As a result, leases of business premises are often known as full repairing and insuring (FRI) leases. An FRI lease is important for the UK real estate investment market, as it allows the landlord to receive a clear income stream without incurring any expense itself in relation to the property.
vi Collateral warranties
For investors in a property that has been recently constructed, collateral warranties provide investors, funders, tenants and other third parties with a contractual link that can be used to enforce the performance of the duties of the professional and construction teams. Third parties can also be given equivalent rights under the Contracts (Rights of Third Parties) Act 1999.
If the tenant fails to pay the rent or is in breach of any of its other obligations, generally the landlord is entitled to bring the lease to an end by forfeiture; however, the tenant is given the opportunity to remedy the breach and can apply to the court for relief. The landlord's right to forfeit also normally applies if the tenant of an occupational lease becomes insolvent. In Vauxhall Motors Ltd v. The Manchester Ship Canal Company Ltd,5 the Supreme Court confirmed that relief from forfeiture was also available in respect of possessory rights as well as proprietary rights, in this case a right to discharge surface water into the canal.
viii Security of tenure
The Landlord and Tenant Act 1954 (LTA) provides security of tenure to tenants of commercial properties in England and Wales. If the property is occupied for business purposes, the tenant has the right to remain in occupation at the end of the term of the lease and is entitled to apply for the grant of a new lease on substantially the same terms; however, the landlord may be able to resist the grant of a new lease based on one of the grounds prescribed by the LTA. The most common ground relied on in practice is that the landlord plans to redevelop the property. This ground is not always easy to establish and, if the landlord is successful, the tenant may be entitled to compensation. Security of tenure can be a valuable statutory right for tenants, and can have a significant effect on a landlord's plans for dealing with its property, including future development. It is possible for the landlord and tenant to agree to contract out of the security of tenure provisions of the LTA. To contract out, a notice must be served on the tenant explaining that security of tenure is to be excluded, and the tenant must make a declaration acknowledging this before the lease can be completed. Contracting out tends to be more common in relation to short-term leases. A recent reform ensures that tenants operating a business from home do not acquire security of tenure.
ix Energy efficiency
The minimum energy efficiency standards (MEES) came into force in April 2018. Landlords are not able to grant new leases unless the property meets the required energy efficiency rating. The rating for a property is set out in its energy performance certificate. From April 2023 (and April 2020 in respect of domestic property), MEES will apply to all existing lettings. A property must have an energy efficiency rating of band E or better to meet the minimum standard. If a property is substandard, the landlord must carry out energy efficiency improvement works unless one of the exemptions applies. Any relevant exemption must be registered and will normally last for five years. If the property is sold, the new landlord must register the exemption if it continues to apply. The main exemptions are:
- the seven-year payback exemption for commercial property, which applies where the cost of the relevant energy efficiency improvement cannot be recovered by way of energy savings over a seven-year period;
- the all-improvements-made exemption, where all the relevant energy efficiency improvements have been made and the property is still substandard;
- the third-party consent exemption, where a third-party consent is required for the improvement works, such as planning permission or the consent of a superior landlord, mortgagee or tenant, if the landlord has sought to obtain the consent and it was refused or granted subject to a condition that the landlord could not reasonably comply with; and
- the devaluation exemption, which is available where an independent surveyor has provided a report indicating that the energy efficiency improvement measures would result in a reduction in the value of the property or building it forms part of by more than 5 per cent.
A temporary six-month exemption may apply in certain circumstances where the relevant person has suddenly become the landlord of a property, including where the grant of the lease is down to a contractual obligation, the lease has come into effect by operation of law and the new lease has been granted under the Landlord and Tenant Act 1954. With effect from April 2023, the landlord will have a temporary six-month exemption when it becomes the landlord of an existing lease as the result of a purchase of the property.
x Mixed-use developments
Mixed-use developments are generally permitted in England and Wales, and have become a facet of urban renewal. There are specific issues relating to mixed-use developments, including increased levels of statutory protection for residential tenants. Residential tenants' rights include collective enfranchisement and individual lease extension rights, as well as the right of first refusal and protection in relation to service charges and the management of the property.
VII DEVELOPMENTS IN PRACTICE
i Brexit and frustration
In contrast with its impact on the property market, the legal implications of Brexit for property are limited. The High Court decision in Canary Wharf (BP4) Ltd v. European Medicines Agency6 confirmed that Brexit would not frustrate the European Medicines Agency's (EMA) lease of 30 Churchill Place at Canary Wharf. Following the outcome of the 2016 referendum, the EMA made it clear that it would need to leave London and relocate to new European headquarters in Amsterdam. The EMA had argued that Brexit would frustrate the lease and entitle it to walk away without any further liability to pay the rent or comply with the other tenant covenants.
The High Court did not accept that the EMA had to remain at Canary Wharf until 2039 when the lease expires. The possibility of the EMA needing to relocate had been addressed by the terms of the lease, and in particular the comprehensive alienation provisions that permitted assignment and underlettng with Canary Wharf's consent. The EMA had consciously entered into a 25-year lease without a break clause and had contractually assumed the risk of subsequent events including Brexit. Although the EMA had been granted leave to appeal to the Court of Appeal, the parties settled after the EMA agreed to sublet 30 Churchill Place to WeWork. Accordingly, the High Court decision remains good law. This is good news for landlords, offering some certainty in uncertain times.
ii Landlord's intention to redevelop
The Supreme Court has allowed the tenant's appeal in S Franses Ltd v. The Cavendish Hotel (London) Limited.7 As mentioned above, a landlord may be able to prevent a tenant from obtaining a new lease under the LTA if it can show that it intends to redevelop the property and requires possession in order to do so. To establish the redevelopment ground of opposition, the landlord must show both a firm and settled intention to do the works and a reasonable prospect of achieving that intention. This decision adds a new element by considering the landlord's motive behind its intention to carry out the works. The tenant held a lease of part of the Cavendish Hotel. The landlord wished to obtain vacant possession and designed a scheme of works to satisfy the redevelopment ground. It was accepted that the works had little practical utility and the sole purpose of implementing the scheme was to prevent the tenant from obtaining a new lease.
The Supreme Court ruled that the landlord's intention to carry out the works must not be conditional on the tenant seeking to claim a new lease. If the landlord would not have carried out the works if the tenant had left voluntarily, the necessary intention is not met. Accordingly, the landlord's intention to redevelop must exist independently of the tenant's claim for a new lease under the LTA. There are concerns that the decision may make the LTA renewal process more complicated. However, those landlords with genuine redevelopment plans should have no real cause for concern.
iii Forfeiture and company voluntary arrangements
The use of company voluntary arrangements (CVAs) by insolvent occupiers to restructure their debt has faced increased hostility from landlords in the beleaguered retail and restaurant sectors. Many landlords have been forced to accept reduced rents and closed outlets. Fellow retailers and restaurateurs are also unhappy as they are at a competitive disadvantage to rival businesses benefiting from lower rents and more favourable terms under a CVA. In Discovery (Northampton) Ltd v. Debenhams Retail Ltd,8 a group of landlords, backed by a major retailer, challenged the Debenhams CVA on the grounds of unfair prejudice and material irregularity. The CVA compromised the landlords' right to future rent and made changes to the leases, including the right to forfeit.
The High Court decided that reducing future rent was not automatically unfair, though this might be different if the reduction took the rent to below market levels. In addition, normal business practice meant that there was justification in treating the landlords differently to trade creditors, who were paid in full. However, the Court did decide that the CVA could not alter the landlords' right to forfeit the leases. The right to forfeit was a proprietary right as opposed to a contractual right and could not be taken away by the CVA. Although this offers some good news for landlords, forfeiture is often not the most attractive option for landlords seeking to preserve an income stream from the property.
iv Electronic Communications Code
The Electronic Communications Code provides telecommunications operators with Code rights to install, inspect, maintain, upgrade, operate and share telecommunications equipment on another person's land to facilitate the provision of network services. Although the Code seeks to strike a balance between operators and landowners, both sides remain dissatisfied with the rights and obligations conferred by the Code. For operators, the Code does not go far enough in allowing them to install their apparatus in the best position to provide nationwide connectivity. Landowners are concerned about the extent of Code rights, lengthy procedures required to terminate Code agreements and remove operators' apparatus and the payment of lower levels of compensation calculated on a 'no scheme' basis.
The government has proposed legislation to give operators greater rights in respect of blocks of flats where a landlord has not been cooperative. The introduction of the new Code in 2017 has seen an increase in the number of cases heard by the Upper Tribunal (Lands Chamber) following applications by operators seeking to assert their rights under the Code.
v Rateable value
In Jackson (VO) v. Canary Wharf Limited,9 the Upper Tribunal considered the rateable value of stripped out premises. Canary Wharf had stripped out floors in its One Canada Square building after tenants had vacated. The floors were then marketed in a shell state to enable new tenants to fit out the premises as required. The stripped out floors had been vacant for more than three years, and the issue before the Tribunal was their valuation for business rates purposes. The Valuation Officer sought to value the premises in an assumed stated of repair and claimed a rateable value of £1,830,000 while Canary Wharf believed that the premises in their stripped out state only had a nominal rateable value of £1.
The Tribunal found in favour of Canary Wharf. The key question was whether the premises were capable of beneficial occupation. If they were not, they could not be a rateable hereditament. The premises had been stripped back to their shell so that a substantial scheme of refurbishment could be carried out once a tenant had been identified. The floors were incapable of beneficial use and should have been removed from the rating list. There was no requirement for there to be an identifiable redevelopment scheme as at the date of valuation, it was sufficient that the premises were not capable of beneficial occupation. This is good news for landlords faced with substantial business rates liabilities in respect of their vacant properties.
VIII OUTLOOK AND CONCLUSIONS
Although it is impossible to predict the future, the outlook for UK real estate is more positive than had been feared. Market activity has held up remarkably well since the outcome of the 2016 referendum and it is hardly surprising that there has been a slump in investment activity in the year that Brexit was expected to happen. What the market needs is certainty, and when that certainty arrives, renewed optimism is likely to prompt a surge in investment activity. There is no shortage of global capital, and UK real estate seems certain to remain high up on global investment shopping lists. London in particular will retain its position as a leading global city, whether the UK is in or out of the EU. The delay in implementing the result of the referendum has given the property industry plenty of time to allow for the effect of Brexit.
Investors take a global view, and Brexit is seen in the context of continuing global political and economic uncertainty. In other words, there are more significant things going on, including the Trump administration and its trade war with China, the effect of climate change and natural disasters, political instability in Europe, the Chinese economy, concerns about North Korea, conflict in Africa, tensions in the Middle East, unrest in Hong Kong and the war on terror. In the context of a global investment market, these are all of potentially greater significance than Brexit. Real concerns for investors include the threat of a Labour government, the tightening of the UK's tax regime for non-residents, the lack of an efficient and flexible planning system, a shortage of affordable housing, the threat of unduly restrictive immigration policies and a lack of investment in transport infrastructure. Competition is strong, and the UK must work hard to ensure that it remains attractive as place in which to invest and do business. Political uncertainty has not helped speed up progress in a number of key areas. Very little has happened in progressing the expansion of Heathrow Airport, the opening of the Elizabeth Line has been delayed further, decisions on key projects such as HS2 and Crossrail 2 remain outstanding and substantial investment is required to meet expected levels of transport and digital connectivity.
There are many positive indications of the continued strength of the UK real estate market as a wide range of global investors continue to look to UK property for value, stability and competitive rates of return. The UK's appeal for overseas investors has been largely undiminished by Brexit and it is hoped that political certainty in 2020 will deliver a healthy boost to investment activity.