Can landlords recover any loss at lease expiry on change of use from offices to flats? What is the dilapidations position in the context of residential conversions?
Since 30 May 2013, when the government widened the scope of permitted development rights ("PDR"), an option for landlords at the end of an office lease has been conversion from use class B1(a) (offices) to C3 (dwellinghouse). This may represent the most attractive option in some secondary or tertiary locations with little demand for office buildings.
When negotiating dilapidations in such buildings, outgoing tenants commonly assert that the buildings are as valuable out of repair as in, since their highest open-market value will be achieved by conversion to housing. The tenant’s position is that, with no diminution in value, the landlord has suffered no loss pursuant to section 18(1) of the Landlord and Tenant Act 1927 and that any repairs that were to be carried out would be superseded by the conversion. Is this correct?
The diminution of value argument
The position is not new. In Ultraworth Ltd v General Accident Fire & Life Assurance Corp  EWHC 172 (TCC);  2 EGLR 115 it was considered by the Technology and Construction Court in relation to an office block in New Barnet with planning permission for residential conversion. The court found that the value of the reversion was not affected by the disrepair and awarded no damages for this.
A landlord may assert that it intends to retain the existing use when the lease expires in the hope of establishing a greater diminution than if the building is converted and the use changed.
This will not have any effect if there is a better market for conversion to residential than for offices; the market value will be calculated by reference to a hypothetical willing seller in the open market, regardless of the landlord’s actual intentions.
If a landlord intends to utilise PDR by demolishing and rebuilding or by carrying out structural alterations, no damages may be awarded for dilapidations because of section 18(1). If an owner or developer is retaining parts of a building within its conversion, what, if anything, can be recovered for dilapidations?
The position is set out in Latimer v Carney  EWCA Civ 1417;  3 EGLR, where the judge commented that a landlord would have to show that specific repairs would survive refurbishment to be entitled to be able to claim in respect of them.
The landlord’s loss if it carries out the work is the cost of the method of repair that a reasonable, practical surveyor would choose. Where there is more than one option, the tenant, as covenanter, is entitled to choose the cheapest. Diminution in value is likely to be calculated by reference to the cost of these repairs.
In such a case it is necessary to identify those aspects of disrepair for which a tenant is liable and which would also need to be remedied for conversion to residential. Commonly these will include repair to the exterior of a building and sometimes core elements such as lifts and lift shafts.