The Real Estate Law Review: United Kingdom - England & Wales
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 United Kingdom. Draft legislation has been published and although its introduction has been delayed, the government remains committed to the proposals. There are also ongoing plans to introduce a system of electronic conveyancing to facilitate the online buying and selling of property. These plans seem likely to be accelerated by the Land Registry as a result of the increasing significance of e-commerce and the rapid development of e-signatures.
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 since April 2019, when non-residents were brought fully within the scope of capital gains tax on disposals of UK real estate.
Overview of real estate activity
Sadly, the devastating global impact of the covid-19 pandemic has continued to dominate the past 12 months. The pandemic is without doubt the most significant and damaging event in a generation. This tragic event continues to take its human toll with over 250 million global cases and more than 5 million deaths. With the world's leading economies under the threat of further disruption and intermittent lockdowns, the covid-19 pandemic has become a global financial crisis.
Real estate has been hit extremely hard by covid-19 with a sharp decline in values across all sectors. Retail and leisure were already in serious decline and have suffered the most, as footfall sharply declined. Any increase in online activity fell well short of compensating for the collapse in overall sales. Squeezed property companies have been caught in the middle with their tenants unable or unwilling to pay rent and their funders continuing to look for interest and loan repayments. The government has sought to encourage collaboration between landlords, tenants and funders and has introduced measures to prevent rogue landlords from taking enforcement action against struggling tenants, while seeking to ensure that those tenants that can pay continue to do so. The parties are expected to enter into open and fair negotiations as to how the arrears should be dealt with. A significant amount of arrears has accrued since March 2020, particularly during periods of lockdown. In an attempt to move forward and draw a line under the issue, the government has confirmed the ring-fencing of arrears accrued by tenants during periods of enforced closure and a new legally binding arbitration regime will be introduced to deal with those cases where a negotiated settlement cannot be reached. The Commercial Rent (Coronavirus) Act is expected to come into force in March 2022 and will amount to almost unprecedented government interference in commercial landlord and tenant relationships. The message remains that the situation is not the fault of any particular party and that the parties are expected to reach an agreement as to how to share the pain of the pandemic.
On 31 October 2021, the eyes of the world were focused on Glasgow as COP26 took centre stage. Greta Thunberg and US Presidents past and present convened in Scotland's biggest city to address climate change. Although the absence of a handful of key world leaders was disappointing, progress was made with pledges to fight global warming. The Glasgow Climate Pact was agreed at the last minute, subject to a controversial late amendment for the phasing down rather than phasing out of coal. There was also criticism that plans to limit a global temperature rise to 1.5oc do not go far enough. Climate change has a direct effect on all aspects of how we design, construct and use buildings. The increasing frequency of extreme climatic events and the resulting damage and devastation are of concern to us all. In addition to being an obvious casualty of climate change, buildings are a major contributor to the problem. The built environment accounts for around 40 per cent of the United Kingdom's carbon footprint and yet there remains a sense that the property industry was under-represented in Glasgow. Nonetheless, there is now a sense that environmental, social and governance (ESG) has finally gained traction and is receiving the full attention of the property industry. Although there is still plenty of work to do, landlords, tenants and their lenders are starting to pull together in the same direction. Collaboration and, in particular, the sharing of data are essential. Although the focus has inevitably been on COP26, it is important to remember that this was only part of the process and much remains to be achieved. One issue for real estate is the continued lack of a global baseline, the plethora of standards, while well intentioned, can be confusing, particularly to overseas investors.
The office sector is in the middle of a major reset. The covid-19 pandemic has had a profound effect on the market as occupiers across the spectrum have been forced to re-evaluate their UK and global office requirements. Unsurprisingly, the office letting market has been subdued and volumes are down significantly. Despite this, there are signs of stability and larger corporates and professional firms have continued to see the need for a landmark headquarters building to identify with their brand. International law firms have been particularly active and Slaughter and May is pleased to have helped fellow law firms Linklaters, Allen & Overy, Baker McKenzie, Skadden, Arps, Slate, Meagher & Flom, Travers Smith and others on their new London headquarters moves. The feared downsizing by corporate occupiers has failed to materialise and there is less vacant space than previously feared. Instead, the focus has been on using existing space differently. The return to the office must be a positive experience with attractive amenities and facilities to offset the appeal of working from home and the drudgery of the commute. The London office market offers flexibility to occupiers adjusting to new ways of working. In addition to landmark headquarters buildings, flexible short-term serviced office space will prove attractive as businesses settle on their preferred working model. Unsurprisingly, real estate investment volumes have also been adversely affected. Although there has been some resurgence in investment activity in recent months, this follows record lows during lockdown. Investment transactions have been dominated by overseas capital, while activity from UK buyers has tended to focus on smaller lots. Continued interest from overseas investors suggests that London remains a safe haven for investment capital in uncertain times.
Although the construction pipeline is reasonably strong, much of the new office space has been pre-let, helping to maintain healthy competition for new space. Outside of London, the regions will continue to benefit from the government's levelling-up objectives. Continued decentralisation will benefit cities such as Manchester, Leeds, Edinburgh and Birmingham. These regional cities, offering a strong talent pool combined with attractive amenities, have proved particularly attractive for occupiers and investors. Appetite for UK property is no longer totally focused on London and knowledgeable overseas investors have continued to look further afield for opportunities. While London will undoubtedly retain its attraction as a key global city in which to live, work and do business, rapidly evolving technology and flexible working practices established in lockdown mean that not everyone needs to be in the office all of the time. While major businesses are still likely to look for a flagship central London headquarters building, that building may well be smaller than before and repurposed away from simply providing as much desk space as possible. Sustainability is becoming increasingly important as landlords, tenants and funders come under pressure to achieve ESG targets. As ESG strategies develop, occupiers have become more willing to contribute to the associated costs in order to protect brand reputation, and attract and retain the best talent in a competitive labour market. This will focus demand on new developments allowing an occupier to impose its green credentials as part of its corporate identity. For example, the lease of Jones Lang LaSalle's new Docklands offices will contain the first legally binding green lease provisions on the Canary Wharf Estate, while the 67-acre Kings Cross Estate has become carbon neutral, with a commitment to renewable energy and a tree-planting scheme. The majority of new take-up is for buildings with high sustainability credentials and a Building Research Establishment's Environmental Assessment Method (BREEAM) rating of 'very good' or higher. Landlords, tenants and funders are now working together as meaningful green lease provisions and green financings start to become a reality, replacing earlier token statements of intent. A two-tier market is emerging with increasing vacancy rates in second-hand space and modern, safe and sustainable buildings with a broader social purpose and up-to-date amenities letting at a premium.
The co-working sector absorbed an immediate lockdown hit, particularly in central London. Rental values have since improved, initially in the wider market and ultimately in core office locations, following the start of the back-to-the-office migration. The demand for flexible space will remain and serviced offices have become an essential requirement for fledging businesses, as well as a key part of the occupation strategy of larger occupiers needing flexibility and the ability to move quickly. However, in addition to connectivity and facilities, providers will need to ensure that they can offer a safe place in which to work. The co-working sector has become an established part of the market, including the development of sub-markets as operators have sought to establish niche appeal. The sector will continue to be driven by demand for good quality office space, available on flexible terms and in well-located, safe and sustainable office buildings.
The covid-19 pandemic has caused the UK population to rethink its relationship between home and work. For many, working from home has become the new normal. Rapid advances in technology mean that long commutes to and from the office have ceased to be an essential, and time consuming, part of the working day. This has led to an increase in demand for larger residential properties with outside space, while the market for flats in urban areas has been muted. Interest has been strong outside of urban areas with increased demand for those looking to upsize in traditional second home locations such as Cornwall, the Cotswolds and Norfolk. Enforced lockdowns have confirmed that the traditional office worker no longer exists. As the distinction between office and home life becomes increasingly blurred, workers and their employers now have a choice as to where they live and work, and the market is changing to reflect this. The property industry will need to monitor working practices closely as the balance between working from home and personal attendance at the office begins to settle. It is no longer possible simply to move to new offices and expect the workforce to follow; push has become pull. The focus is now very much on what employees want and their individual wellbeing, both in terms of new developments and also the reinvention of existing space. To a certain extent offices have also started to come to the workers with new schemes in Elephant and Castle, Brixton, Vauxhall and other less fashionable parts of London. A long-term commitment to social values and the local community is essential if these neighbourhood working schemes are to prove successful in the long term.
Other than work-life balance, factors affecting the residential market include the government's phased ending of the stamp duty holiday, concerns about cladding and the safety of taller blocks of flats, and a shortage of properties coming to market. The country's housing crisis continues as successive governments have failed to meet new build targets. The United Kingdom's rising population will ensure that residential property will continue to provide opportunities for investors. Unfortunately, a combination of Brexit and the covid-19 pandemic has led to increased building costs and slow construction progress, with delays in the supply of building materials and difficulties in ensuring the availability of a skilled and unskilled workforce. More affordable homes are urgently required and there needs to be greater focus on social and economic factors in deciding where these should be built. Affordable housing and build to rent will make up a larger share of new developments and institutional investors are now alive to the opportunities. The anticipated growth of the retirement or later living sector could free up valuable housing stock as older owners are given the option of a dignified down-sizing. In difficult times, high net worth individuals have started to return to the capital's super-prime market, prompting optimism for the previously deflated central London investment market. This optimism seems well founded, provided that international travel resumes and the UK tax regime remains relatively favourable. Commentators will keep a close eye on the political climate as we approach a general election in 2024. The wider residential market may be tougher in 2022 as affordability starts to become an issue with rising inflation and the associated increase in borrowing costs. Overseas investors in residential property are now also subject to a 2 per cent stamp duty land tax (SDLT) surcharge that comes on top of the existing 3 per cent surcharge for additional properties and the 15 per cent rate for those buyers using corporate vehicles.
With the exception of the major supermarkets and established online retailers, it has continued to be a particularly difficult time for the United Kingdom's retail sector. A succession of household names has continued to join the seemingly endless list of casualties in a sector struggling even before lockdown. Yawning gaps on the high street and empty shopping centres stand as testament to a sector that has changed beyond all recognition. Traditional retailers have been forced to adapt to the changing habits of their customers, while online retailers and delivery companies have benefitted from a significant increase in custom. Technology has adapted rapidly to the situation and there has been a particular growth in e-commerce, including the use of data and development of online platforms. Investors will continue to rethink how they see retail assets and there will be a renewed focus on repurposing available space for residential, logistics and other more innovative uses. A number of major high street retailers have confirmed plans to diversify and to repurpose upper floors of flagship stores as offices or residential. Despite high vacancy rates, there is some cause for optimism as a number of value operators have confirmed plans to expand and smaller independent operators have the opportunity to take prime space vacated by larger chains on flexible and affordable terms. While London's West End has benefitted from a gradual uptick in international and domestic visitors, the City of London remains much quieter as workers continue to stay at home. Those workers returning are at their highest concentration in the middle of the week, and the City of London is noticeably quieter on Mondays and Fridays. This has made it difficult for the coffee shops and other businesses dependent on a consistent flow of customers to build up a proper head of steam. It will be some time before footfall in the City of London returns to pre-pandemic levels. Overall, there is a sense that the retail market has bottomed-out and values have stabilised in the worst performing shopping centre sector. Although opportunities remain for those looking for value, investors may have missed out on the bargains previously available. The London food and beverage sector is showing signs of recovery with a number of new openings beginning to fill the gaps left by operators unable to survive lockdown. London is reported to have welcomed 14 new international brands in 2021. Those restaurants and bars welcoming back customers have, however, struggled to find staff in a tight labour market.
The industrial sector continued to attract investment and well-located, high-specification distribution centres in the right locations continued to benefit from the boom in e-commerce. Logistics has been a rare success story with online retailers such as Ocado and Amazon looking to expand their distribution networks as the pandemic accelerated the demise of traditional retail. The sector has proved to be an attractive target for investment capital with logistics assets high up on the shopping lists of a range of overseas and domestic investors. Further logistics development is essential to serve the United Kingdom's supply chain, manufacturing and renewable energy sectors. In addition to good road and rail connections, an acute labour shortage means that the availability of a pool of skilled and unskilled workers has become an important factor in choosing viable locations. It has been a boom time for the television and film industry looking to catch up on a backlog of content. This has led to strong demand from the likes of Netflix, which has taken significant new space at Pinewood. Out of adversity comes opportunity with large vacant retail units offering opportunities for repurposing as studio space. There has also been an increase in hyperscale data centres, although the United Kingdom and Europe remain significantly behind the United States and China in this sector.
Alternative assets have become an established part of the investment market, alongside the traditional office, retail and industrial sectors. The build-to-rent boom continued as institutional investors looked 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. A number of high-profile private equity backed investment vehicles have recently signalled an intention to develop and operate new tech-enabled build to rent neighbourhoods, underlying the growing significance of technology-led platforms in the sector. Despite immediate covid-19-related operational difficulties, confidence remains high for operators in the specialist retirement living and student housing sectors, where major institutional investors are looking to increase their portfolios. Purpose-built student accommodation has largely weathered the storm now that students have returned to campus. Although demand from private equity and institutional investors remains high for quality stock in strong regional cities, compressed yields are leading to more speculative development funding as investors look for value in the student market. The retirement living sector has much further to go if it is to emulate the North American, Australian and New Zealand models. Later living developments must provide an attractive community in which to live that adapts to provide care as the need arises. Perhaps not surprisingly, there has been a surge of interest in the life services sector, with the Oxford-Cambridge arc attracting the most attention. Innovation hubs thrive on shared technology and a dynamic talent pool and must compete on a global platform. The hotel and leisure sector has been desperate for a return to healthy occupancy rates. Last year, this was met, at least in part, by domestic travellers in dire need of a post-lockdown vacation. More recently, there has been a gradual increase in overseas visitors as passenger planes returned to the skies. Confidence in the travel industry is essential with a steady flow of foreign tourists required to fill an increasing number of available beds, particularly in London where a number of major new hotel projects are planned. Opportunities can be found in the pub sector where some leading pub chains have expressed an interest in expanding their estates and have taken advantage of buying opportunities. Although now open, the long suffering nightclub and live entertainment sectors have had to cope with confusing health and safety requirements. Alternative real estate assets seem likely to offer opportunities as investors are forced to be more flexible in their quest for growth in this rapidly evolving and increasingly important sector.
It has been a difficult year for the UK lending market with an increase in defaults, restructurings and refinancings. The retail and leisure sectors have been particularly badly hit. Banks are anticipating problem loans and have reconstituted their bad bank structures to work out portfolios of non-performing loans. Businesses will struggle with increased levels of debt and face liquidity problems, particularly if interest rates increase in line with expectations. Landlords and developers have found themselves squeezed in the middle as rental arrears have accrued, making it difficult for borrowers to meet their loan obligations. Development loans have been adversely affected by delays and defaults on construction contracts where shortages of labour and materials as well as persistent supply chain issues have led to significant cost overruns. This has also fed into an increase in lending costs. Despite caution in the banking sector, it is hoped that an already diverse lending market will help maintain liquidity. A significant development has been the emergence of green financing to support developments and activities with a green or broader social purpose. Sustainable finance has become an established component of lender and corporate business strategies. Inevitably, the stress of the pandemic will prove to be too much for a number of borrowers and there will be increased opportunities for investors in distressed assets and mortgage debt.
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.
Structuring the investment
A number of alternative structures are available for direct or indirect investment in real estate in England and Wales. The decision as to 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 since 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 United Kingdom may be undesirable for certain investors and difficult to achieve.
vi Property authorised investment fund
Property authorised investment fund (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 was 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
On the basis of an investment structure first developed in the United States, real estate investment trusts (REITs) were introduced in the United Kingdom 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. Naturally, as well as sharing risk, parties share gains and management, so joint venture provisions need to be considered carefully.
Real estate ownership
The planning administration in England and Wales primarily consists of local planning authorities (LPAs) and the Secretary of State for Levelling Up, Housing and Communities. 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 a mix of government policy and statutes, the most important of which is the Town and Country Planning Act 1990. Under the 1990 Act, planning permission is required for 'development', a term that includes both works and changes of use, although certain forms of development are automatically granted planning permission (they have 'permitted development rights') under the Town and Country Planning (General Permitted Development) Order 2015. Separate planning controls exist for property in conservation areas and for listed buildings under 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 to the courts 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 contains a separate planning regime 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. 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 United Kingdom 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.
Value added tax
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 value added tax (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.
Stamp duty land tax
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; there is an additional 3 per cent charge on second homes and most buy-to-let properties and, from April 2021, a further 2 per cent surcharge on purchases by non-UK residents, thus making for a marginal rate of up to 17 per cent. 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. 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 United Kingdom 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. An SDLT holiday introduced by the government at the start of lockdown to help support the housing market came to an end on 30 September 2021.
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. A business rates holiday for all retail, hospitality and leisure businesses applied for the 2020–2021 tax year and an expanded retail discount continues to apply to those sectors until 31 March 2022. A new, temporary business rates relief for the 2022–2023 tax year was announced as part of the 2021 Autumn Budget.
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.
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 the contents of a lease and, subject to the tenant's security of tenure and the government's tenant protection package, there are relatively few statutory provisions affecting the landlord and tenant relationship under a commercial lease. The Code for Leasing Business Premises seeks to encourage fairer and more flexible terms for tenants; but, despite industry endorsement, remains voluntary, at least for landlords and tenants. 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 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 the retail sector, may also be calculated by reference to turnover. A combination of insolvency procedures, such as company voluntary arrangements (CVAs) and restructuring plans, and the covid-19 pandemic have accelerated the focus on turnover rent structures. Many existing leases of retail premises have been re-geared to include an element of turnover-based-rent. This trend will continue as the retail and leisure sectors look for a viable business model in the aftermath of covid-19. This, in turn, will increase the significance of data and technology in the landlord and tenant relationship. 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. Liability for any wants of repair typically crystallises at the end of the term when the landlord prepares a schedule of dilapidations. The tenant may also be required to reinstate any alterations made to the premises during the term.
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. The government introduced a number of measures to protect tenants adversely affected by covid-19, including a moratorium on forfeiture and other enforcement action.
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. The government has announced a review of commercial landlord and tenant legislation to ensure that the LTA remains fit for purpose in the context of modern business leases.
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. The minimum standard is expected to rise to band B or better by 2030. A significant amount of existing commercial stock does not currently meet this higher 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 exemption is 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.
x Mixed-use developments
Mixed-use developments are generally permitted in England and Wales, and have become a key form 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.
Developments in practice
i Commercial property relationships during the covid-19 pandemic
Commercial premises, particularly in the hospitality, leisure and retail sectors, form a fundamental part of the economy and have a crucial role to play in the post-pandemic recovery. The government has acknowledged this and previously consulted on what should happen once its existing tenant protection package comes to an end in March 2022. The consultation has resulted in the publication of the Commercial Rent (Coronavirus) Bill together with a new Code of Practice (the new Code) as the government seeks to draw a line under rent, service charge and insurance rent arrears accrued during lockdown.
Rent arrears accrued during periods of legally mandated closure will be ring-fenced to allow landlords and tenants to continue to work together to reach a negotiated settlement as to how those arrears are to be dealt with. If agreement cannot be reached, either party can refer the issue of what the tenant should be obliged to pay to a legally binding arbitration process. The arbitrator can decide to what, if any, relief the tenant should be entitled. In making the award, the arbitrator should seek to preserve the viability of the tenant's business. However, that should not come at the expense of the landlord's solvency. In determining what the tenant can afford to pay, the tenant is not expected to take on further debt or to enter into a restructuring. The new regime is expected to be enacted by March 2022 and either party will have six months from that date in which to make a reference to arbitration. The arbitrator's award can allow the tenant up to two years to pay the amount determined. In addition to the existing measures protecting tenants from forfeiture, Commercial Rent Arrears Recovery and winding up, landlords will also not be able to bring a debt claim or look to rent deposits in respect of the ring-fenced arrears.
The new regime is supported by the new Code that is intended to encourage open and fair negotiations between the parties and also support the new arbitration regime. The new Code also contains a summary of the mandated closures and those business sectors affected together with a helpful summary of the arbitration process. The new Code applies to all rent arrears accrued since March 2020 and not just to those that are ring-fenced.
The British Property Federation suggests that the majority of commercial landlords and tenants have already reached agreement as to how to share the pain of covid-19 arrears. The significance of the new regime might just prove to be its role in encouraging one last push to return to the negotiating table, with arbitration itself being pitched as a last resort. Either way, the new legislation will amount to a significant piece of statutory intervention in an industry where, CVAs and restructuring plans notwithstanding, the parties have been traditionally bound by the terms of their lease.
ii Covid-19 and lease renewals
The courts have almost inevitably been required to consider the effect of the covid-19 pandemic on commercial leases, including renewals under the LTA. The court has discretion to determine any changes proposed by either party to the terms of the existing lease. In a series of unreported cases, the courts have assessed the effect of lockdown on market rents as well as pandemic-related amendments to the existing lease. Unsurprisingly, many of the cases have involved lettings in the retail sector.
In WH Smith Limited v. Commerz Real Investmentgesellschaft mbH, the court considered WH Smith's application under the LTA for a renewal lease of its premises at the Westfield Centre. The store contained a post office and, as an essential retailer, WH Smith remained open while the units all around it were forced to close. The parties had agreed to most of the terms of the renewal lease, but although the concept of a pandemic rent suspension clause was agreed, the parties could not agree on the trigger for rent suspension to operate. The court accepted the tenant's contention that the trigger should be the enforced closure of the surrounding non-essential retailers and not the WH Smith store itself. In relation to the rent, the court considered that pandemic rent suspension clauses had become market standard and had already been priced in by the market. It awarded a new rent of £404,666, less than half the pre-pandemic rent of £953,000.
In Poundland Limited v. Toplain Limited, the parties had already agreed a reduced rental figure and the case relates to other changes to the existing lease proposed by the tenant on renewal. These included a new covid-19 clause that would reduce the rent and service charge by 50 per cent if the tenant was unable to trade because of a future lockdown. The court was able to distinguish WH Smith, where the concept of such a clause was already agreed, and decided that such a provision was not fair and reasonable. It was not appropriate for the landlord to share the risk of a pandemic and the tenant was likely to be entitled to government support in the event of a future lockdown.
In S Franses Ltd v. The Cavendish Hotel (London) Ltd, the county court considered the amount of rent payable by the tenant on a renewal of a lease premises on Jermyn Street. This case followed the Supreme Court's landmark decision that the tenant was entitled to a renewal under the LTA. Expert evidence showed that 11 of the 57 shops on Jermyn Street were vacant at the time of the trial. The rent under the old lease was £220,000 and the court decided that this should be reduced to just £102,000. The decision serves as a stark reminder of the significant effect of the pandemic on rental values in London's West End and the wider rental sector.
Outlook and conclusions
More than ever it is impossible to predict the future. The covid-19 pandemic has thrown much of what we know and trust into confusion. The pandemic has had a profound effect on how people around the world live and work. Despite positive news regarding the progress of vaccine programmes, it is very clear that covid-19 in some shape or form will remain with us for some time to come, and real estate and the wider economy will feel its legacy for longer still. Most of the United Kingdom has already been in lockdown at least twice and, at this stage, it is impossible to completely rule out future enforced closures and other preventative measures. Indeed, parts of Europe introduced new restrictions as infection rates began to surge towards the end of 2021 with the unwelcome arrival of the omicron variant.
Although flexible working practices will clearly become a more accepted part of how we work, the lockdown has also confirmed that face-to-face contact is a key part of our working lives. It is not just the existing workforce that needs to be catered for but also the generations to come. Physical presence in the office has traditionally been an essential part of the learning curve for those starting out on their careers or changing jobs. Remote working may prove to be an unsatisfactory substitute giving credence to those currently advocating greater attendance. Although fewer workers may need to be in the office, those workers will be more conscious of what the office has to offer. The City of London has lagged behind the West End as office workers have been slow to return in significant numbers. Trends starting even before the pandemic have become established as mid-week office attendees have left the City of London feeling empty on Mondays and Fridays with a knock-on effect on the dependant retail, food and beverage and leisure businesses. Corporate owners will need to focus on how space can best be used. It is no longer sufficient to simply build an office and expect workers to fill it. Architects have been forced to focus on purpose rather than simply appearance and the number of workstations. Tenants have finally become customers and landlords need to become customer relationship managers with all parties actively engaged throughout the contractual term and beyond. The office has a key role in attracting staff and talent retention; it is no longer just a place to work. The gap between new-build product and second-hand office space will widen and this will result in a repurposing of redundant buildings. Hybrid working has shifted the purpose of the built office environment as employers seek to provide an altogether better workplace experience. Confidence is key and offices must be seen as attractive places to work and play, particularly in London, which thrives on large numbers of talented people from all over the world wanting to work and live in a world-leading financial and cultural hub.
The industrial sector has fared best in the current crisis. Demand for logistics space remains strong to meet the requirements of internet shopping and UK-wide distribution. The post-Brexit spike in demand for commercial storage space and a move to refocus existing buildings for distribution and storage use has continued. The industrial sector has become the top performer and a new safe haven for investors. The boom in life sciences also seems set to continue. There has been a surge of interest in film and studio space as the industry seeks to catch up with consumer appetite for new content. With the exception of the major supermarkets, the retail and leisure sectors face an uncertain future and we will see further insolvencies and restructurings. Discount and value operators will take up some of the space vacated and there will be opportunities for new entrants and independents to take space at affordable rents. The pub sector is an obvious target for bargain hunters and chains planning to expand their footprint. Even when the threat of lockdown is lifted fully, it will take some time for confidence to bounce back and for footfall to return to viable levels. Rental structures are likely to evolve further to enable landlords and tenants to share the pain and gain, by reference to turnover and commercial success. The obtaining and sharing of data will become an increasingly important part of the landlord and tenant relationship, not only in relation to turnover rents but also to help meet respective ESG targets. It will be fundamental that people feel safe where they live, work and relax. The normally robust hotel sector may also take time to recover as confidence returns and global travel restrictions are lifted. Even then, it is likely that air travel will remain well below pre-pandemic volumes as businesses review their travel policies in the light of ESG strategies. The serviced apartment and holiday let sector may benefit as people prioritise their own personal space and facilities. The central London residential letting market has started to pick up as workers, students and tourists return to the capital. Demand for housing is likely to remain strong, although the pandemic may involve a rethink in the design and location of new developments. Those finding themselves working from home on a much more regular basis may start to prioritise space over convenience.
A combination of the covid-19 pandemic and Brexit have already led to intermittent problems in the supply chain and issues associated with ensuring both skilled and unskilled workforces have led to delays on construction projects. The covid-19 pandemic will also cause a major rethink on major infrastructure projects as we revaluate our transport requirements and funding becomes stretched. To the great disappointment of the Northern Powerhouse Partnership, the Leeds link of the HS2 project has been controversially dropped. Following significant delays and cost overruns the Elizabeth line is yet to open fully and Crossrail 2 remains on ice as part of the funding agreement reached between the government and a cash-strapped Transport for London. The proposed expansion of Heathrow remains open to further political, environmental and economic debate. Supply chains are expected to shift to rail to counter an acute shortage of HGV drivers, a problem that has been brewing for a long time owing to declining pay and conditions in that sector. The United Kingdom's ongoing transport requirements will need a degree of re-evaluation once new patterns of living and working become established. As once-in-a-lifetime climatic events threaten to become more frequent, increased expenditure on flood defences and other infrastructure is required to limit the damage caused by such events and to enable much-needed development to occur on floodplains and in other vulnerable locations.
The covid-19 pandemic has put concerns about leaving the European Union into perspective. Indeed, the all-encompassing effect of the pandemic has to some extent levelled the post-Brexit playing field. In order for the recovery to continue, the market needs certainty and that certainty will only arrive once the covid-19 threat is contained. As and when coronavirus (covid-19) and its many variants are under control, renewed optimism is likely to prompt a large surge in activity. There is no shortage of global investment capital and it is reasonable to believe that UK real estate will remain attractive to investors. London in particular will retain its position as a leading global city. However, competition will be strong and the United Kingdom must work hard to ensure that it remains attractive as a place in which to live, invest and do business. Much will depend on the steps taken to stimulate the economy by a government saddled with increased debt. Despite the all-encompassing doom and gloom of the past two years, there has been a post-covid bounce. The EY Item Club's growth forecast for the UK economy in 2022 is 5.6 per cent, which although down slightly on its previous prediction still represents a significant recovery from lockdown's near 10 per cent plunge. Significantly, the FTSE 100 has just about managed to steady itself above the psychologically important 7,000 barrier. However, a constantly mutating virus, rising inflation, higher borrowing costs, ongoing supply chain disruption, product and labour shortages and the withdrawal of pandemic-related government support are persistent headwinds facing the UK recovery.
The lifting of travel bans has encouraged activity from overseas investors looking for an attractive destination for their pent-up capital, and investment volumes in the last quarter of 2021 have reached pre-pandemic levels. Interest from Asian investors has been strongest followed by the United States, the Middle East and Germany. China has faced troubles of its own with the introduction of its 'three red lines' debt controls to address the issues in its own real estate market highlighted by Evergrande. This and existing exchange control measures may curb Chinese enthusiasm for UK real estate, at least for the time being. Some sectors have changed forever and the real estate market will never be the same as it was before the pandemic. There has been a significant resetting of the United Kingdom's property requirements and investors will need to show imagination and adapt to the new world order.
After a gloomy couple of years dominated by the covid-19 pandemic, it is sincerely hoped that next year's edition brings with it much more positive updates from England and Wales, and the rest of the world. Those planning a return to Cannes for MIPIM in September 2022 will certainly hope that there is plenty of good news to share.