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Scanning the Real Estate horizon: May you live in interesting times

Scanning the Real Estate horizon: May you live in interesting times

Overview

2020 has been a tumultuous year; every part of our society and economy has had to adapt to a range of emergency measures and to an ongoing state of flux.  In the real estate sector this has meant both the derailing of some anticipated legal changes and the introduction of some unexpected legislation.  In this piece we try to make sense of what this means for us in 2021.

Covid's tail

As we have discussed in greater depth elsewhere, the Covid-19 pandemic and the responses to it have already had a significant impact on the real estate sector, and this will continue into 2021:

  • The protections given to commercial tenants under the Corporate Insolvency and Governance Act 2020 and the Coronavirus Act 2020 will end on 31 March 2021, and the Government has indicated that these will not be renewed. This means that landlords will be able to commence forfeiture proceedings and take insolvency action again from 1 April 2021.  We expect continued high activity for CVAs and other restructuring and/or insolvency procedures for companies particularly in the retail, leisure and hospitality sectors throughout 2021;

  • Particularly in the retail and restaurant sectors, the Covid-19 pandemic has accelerated emerging trends for shorter lease terms and turnover rents. These are expected to emerge as the new normal for leases within those sectors;

  • The Government has announced a review of commercial landlord and tenant relationships during 2021, in order to ensure a flexible and functional legislative framework. It will consider a broad range of issues including Part 2 of the Landlord & Tenant Act 1954, different models of rent payment, and the impact of coronavirus on the market;

  • There is increasing pressure on the Government to reconsider current levels of business rates. We expect the landlord body – as well as the tenant community, to continue to press for reform as the number of void units increases;

  • There is expected to be a significant oversupply of retail and office space across the country and speculation is mounting as to what will be done with these vacant buildings. It is thought that residential conversions will take up some of this space. Office relocation deals are still happening and we expect this to remain the case, although occupiers are generally looking for smaller or more flexible space;

  • There are fears that the end of the temporary SDLT stamp duty reliefs on 31 March 2021 will precipitate a fall in values; and

  • Expected changes to capital gains taxes with effect from April 2021 are likely to see an increase in deal activity in the first quarter of 2021, where this is a relevant factor.

Brexit

Although there is as yet no trade agreement in place between the UK and the EU, when the transition period ends on 31 December 2020 there will at least be an end to the uncertainty that characterised 2020.  At present, the following Brexit-related issues are likely to be central for the real estate sector in 2021:

  • Possible labour shortages in the care sector;

  • An even greater emphasis on logistics in terms of storage of goods and delays in import/export processes;

  • Some shortages of materials and supply chain problems; and

  • Less inward investment in the short term.

The road to zero carbon

In 2019 the UK became the first major economy to legislate for net zero emissions by 2050. The Government has introduced a range of measures towards achieving this goal. Those that are likely to affect the real estate sector in 2021 include the following:

  • The introduction of the Environment Bill 2019/20 into Parliament (see section 7);

  • Investing up to £1 billion additional funding to develop and embed the next generation of cutting-edge electric vehicle technologies, and £400 million into new charging infrastructure for electric vehicles;

  • Proposals to improve the energy efficiency of commercial buildings in the private rented sector, by setting minimum energy efficiency standards at EPC band B by 2030; and

  • A consultation in 2020 on introducing mandatory in-use energy performance ratings for business buildings.

The real estate community is generally taking steps to be ahead of legislative changes relating to environmental performance. 2021 is expected to be a key year in developing strategies for capturing carbon footprint data and the evolution of industry wide benchmarking standards.

Planning reform?

As we have described elsewhere, this summer the Government issued a momentous white paper "Planning for the Future". It promises reforms of the planning system to "streamline and modernise the planning process, bring a new focus to design and sustainability, improve the system of developer contributions to infrastructure, and ensure more land is available for development where it is needed". 

A consultation on these proposals ran until October and elicited a high volume of responses which the Government is currently analysing, the results of which process will inform the form of planning changes in 2021.  It is thought that the following responses are among the key criticisms of the proposals:

  • The proposals do not address how the new system will plan effectively for commercial property. This problem affects areas such as plan-making, design quality, and the new proposed Infrastructure Levy, and do not reflect the complexity of many of the urban regeneration schemes that are taking place across the country. The British Property Federation, for example, has suggested introducing a fourth category to the proposed tripartite system of zones.  This additional category would be a ‘long- term growth’ zone in which sites would not have an outline permission allocated at plan-making stage, but in respect of which details would be gradually developed alongside community consultation;

  • The proposals lack detail in various respects such as the way in which the Community Infrastructure Levy is to be reformed; and

  • The White Paper focusses on the challenge of delivering new homes for sale, but somewhat neglects other key development types such as the BTR sector and the various forms of housing for older people on the residential front, and the whole spectrum of commercial schemes.

An amendment to the Use Classes Order introduced new Use Classes effective from 1st September 2020. As we discussed in our note, this appears to have been designed to assist with the economic challenges arising from Covid-19 but also feeds into the Government's current 'build, build, build' philosophy. 

General summary of the changes:

1.1.1   Classes A1/2/3 & B1 are now to be treated as Class E;

1.1.2   Class F1 includes non-residential institutions (such as educational buildings, art galleries, museums, public libraries, public exhibition halls, places of worship, and law courts) and Class F2 includes shops no larger than 280 sqm (selling mostly essential goods and at least 1km from another similar shop); community halls, outdoor sport/recreation areas, indoor or outdoor swimming pools and skating rinks;

1.1.3   For any planning applications submitted before 1 September 2020, the Use Classes in effect when the application was submitted will be used to determine the application; and

1.1.4   For any reference to Permitted Development rights attached to the now abolished use classes, and for restrictions to them or applications for Prior Approval, the Use Classes in effect prior to 1 September 2020 will be the ones used until the end of July 2021 (this is defined as the ‘material period’ in legislation so may be referred to as such).

A climate action lobby group, Rights: Community: Action, brought judicial review proceedings against three statutory instruments. Their key objection was that the reforms should have been subject to environmental assessment prior to being introduced to Parliament. Their arguments failed and were dismissed by the High Court, but the action group have lodged an appeal against this decision.  In the meantime, commentators have expressed hope that the new Order will help with the reinvigoration of the high street in 2021, but express concern that there is a lack of clear guidance as to how the use class changes affect empty properties, and how changes of use within the new 'Class E' is intended to work. 

Further changes to permitted development rights have been enacted, in summary:

  • Additional floors can be constructed on some existing residential buildings for residential purposes;

  • Class B1 buildings and free-standing purpose-built residential blocks constructed before 1990 and have been vacant for at least 6 months (subject to size limits) are able to be demolished to make way for new residential development without the need for planning consent, effective from 31 August 2020;

  • The Government is consulting on a proposal to allow buildings in the new Class E such as offices, restaurants, shops and gyms will be able to convert to residential use, subject to prior approval, without the need for planning consent; and

  • Further proposals are under consideration to simplify the permitted development rights regime in line with the changes to the Use Classes Order and to consider the scope of permitted development attached to specific uses, such as commercial buildings, to be in place by 31 July 2021.

Managing fire safety risks

The Grenfell Tower fire on 14 June 2017 caused the greatest loss of life in a residential fire since World War II.  Although Dame Hackitt's report "Building a Safer Future" was published in 2018, the fire's legal ramifications in the real estate and construction sectors are still gathering pace.  There are many as yet unresolved issues, some of which are expected to progress in 2021, including the following:

In the March 2020 budget, the Government announced a £1 billion Building Safety Fund in 2020/21 to support the remediation of unsafe non-ACM cladding system on residential buildings 18 metres and over in both the private and social housing sectors. The Government then announced on 17 December 2020 a 6-month extension the deadline for building owners to complete their applications to the Building Safety Fund from 31 December 2020 to 30 June 2021. To qualify, remedial works must commence on site by 30 September 2021. It is intended for both private sector building owners whose leaseholders would otherwise incur the costs through service charge arrangements, and for social sector housing providers who have demonstrated during the registration process that the costs of remediation are unaffordable or are a threat to financial viability. 

Nonetheless, there are still many tenants whose freeholders have not taken steps to remove the cladding from their buildings and who are therefore unable to sell their flats.  Other tenants have suffered financial hardship when their freeholders have removed the cladding but have run the costs through the service charge.  Steps were taken to improve the position of another group of tenants in November, when the Government announced that tenants in buildings without cladding will no longer need an EWS1 form to sell or re-mortgage their property.  Nonetheless, it is likely that 2021 will see increased calls to help tenants deal with the issues raised by the gradual removal of cladding from residential buildings.

The Government carried out a fire safety consultation in summer 2020 which included the text of a draft Building Safety Bill. The Housing, Communities and Local Government Committee published its report entitled "Pre-legislative scrutiny of the draft Building Safety Bill" on 24 November 2020.  It short, the Committee concluded that since the draft Building Safety Bill relies on currently unpublished secondary legislation, it lacks detail on key parts of the new regime. It consequently urged the Government to include as much detail in the final Building Safety Bill itself to give stakeholders the certainty they need to prepare for the new regime. It is likely that the reforms will include the establishment of a new regulator to ensure that residential buildings of more than 18 metres in height are safely designed and constructed and that they continue to be safe once occupied. The primary responsibility for this will be placed on the client, the principal designer and the principal contractor, as well as the building safety manager once the building is complete.

Separately, the Fire Safety Bill 2019/21 provides:

  • That the Regulatory Reform (Fire Safety) Order 2005 applies to external walls (including cladding, balconies and windows) and individual flat entrance doors in multi-occupied residential buildings;

  • That in multi-let residential buildings, the relevant responsible persons (either the freeholders, leaseholders or managers) must assess the fire safety risks of the premises and take the necessary precautions, and the Fire and Rescue Authorities will have the relevant enforcement powers to hold them to account; and

  • For the implementation of the specific recommendations made in the Grenfell Tower Inquiry Phase One Report.

The House of Lords have returned the Bill to the House of Commons with some amendments, which will be considered on the floor of the House in 2021. One of these provides that freeholders cannot pass the costs of fire safety works onto their tenants. The Government is expected to counter this amendment on the basis that they do not take into account the fact that tenants expect to pay for routine repairs, and that the issue of remediation costs belongs to the Building Safety Bill not the Fire Safety Bill. 

Pre-pack administration reform

For several years there has been concern about the perceived lack of transparency and trust in the process of pre-pack administrations, whereby all or a substantial part of a business sale is arranged before the business enters administration, and then completed by the administrator immediately after they are appointed. Landlords in particular have reason to feel aggrieved when a tenant company transfers its business and assets to a connected party, such as a director or a shareholder, free of its leasehold liabilities.

In October 2020, the Insolvency Service issued a report based on its review of the regulation of administration pre-pack sales to connected parties, and announced that regulations will be put in place to prevent an administrator from disposing of company property to a connected party within the first eight weeks of the administration without either the approval of the creditors or an independent written opinion. The opinion provider, who must meet certain eligibility requirements, is required to state whether or not the case has been made for the disposal. A copy of the opinion will be provided to creditors and to Companies House. 

It is not clear when the new regulations will be introduced into Parliament, but it is envisaged that progress will be made during the course of 2021.

The Environment Bill 2019/20

The Environment Bill 2019/21 is due to undergo its report stage and third reading in the House of Commons at some point in 2021.  Much of it was drafted in the context of Brexit, because a large proportion of existing environmental law and policy in the UK derives from the EU, with its implementation largely monitored and enforced by EU institutions such as the European Commission. 

The Bill covers two broad themes. Firstly, providing a new domestic framework for environmental governance. Secondly, making provisions for specific environmental policy areas including waste, air quality, water, nature and biodiversity, and conservation covenants. 

A conservation covenant is an agreement between a landowner and a charity or public body to do or not do something on their land for a conservation purpose, for instance an agreement to maintain woodland and allow public access to it, or to refrain from using certain pesticides in a certain area.  These agreements can continue after the landowner has parted with the land, ensuring that its conservation value is protected for the public benefit.  Their introduction into the law of England and Wales has been awaited since the concept was recommended by the Law Commission in its 2014 report.

The beneficial ownership register of overseas entities that own UK property

It has long been recognised that the use of offshore corporate vehicles to obscure the true owners of UK property has attracted those who wish to hide illicit funds and launder the proceeds of crime.

As we have discussed elsewhere, the Government plans to create a register of beneficial ownership information for overseas entities that own or buy UK property or participate in UK central government procurement. On 23 July 2018 BEIS published a consultation seeking views on a draft Registration of Overseas Entities Bill which sets out provisions to establish the register, which will be managed by Companies House. 

The Bill provides that any overseas entity that wishes to own land in the UK will have to identify its beneficial owner(s) and to register them. Once registered, an overseas entity will obtain an overseas entity ID and will be required to update their information annually.  In order to register title to land, an overseas entity will have to be registered with Companies House and to have complied with its updating duty. Although registration is voluntary, an unregistered overseas entity will not be able to register as proprietor of land in the UK.

At the outset of 2020, it was thought that the Bill would be introduced in Spring 2021.

Collection of data about options and pre-emption agreements

In August 2020 the Government embarked on a consultation into its proposals to increase transparency of contractual arrangements used to exercise control over the buying or selling of land. Under the system it proposes, beneficiaries of options and pre-emptions would not be able to apply for an agreed notice to be registered at HM Land Registry without supplying the additional data that the Government requires. Unilateral notices would cease to be available for the protection of such interests.

The goal of such a regime would be to improve the ability of local communities to play an informed role in the development of their neighbourhoods and support the Government’s efforts to encourage more companies to enter the house building market.

The Government is currently analysing the feedback it received and is expected to report back in 2021.

MARKET COMMENTARY

We are likely to start to see the true impact of Covid-19 on the retail, hospitality and leisure sectors in the second half of 2021.  We expect this will include a new wave of insolvencies but also the emergence of new businesses, probably largely online.  In the office sector, there is likely to be a drive towards working from the office again when safe to do so.  However, as working from home practices have become established, it might require a cross sector approach – for example, a review of the cost and availability of public transport - to encourage people to resume their commutes. The true extent of voids across portfolios will probably therefore not be visible until this time next year, when there will need to be increased consultation on what to do with them, whether retail units or surplus office space.

As the Brexit transition period closes, the Government will need to resolve its dilemma of, on the one hand, an expected increase in taxation via CGT and/or SDLT in order to start repaying the debt arising from Covid-19 against, on the other hand, wanting to incentivise real estate market activity and inward investment. This will come at an interesting time when we expect greater scrutiny of Government policy. While many people hope that Brexit will present an opportunity for the UK to reduce regulation, red tape and taxation to incentivise overseas investment, there is a significant emerging protectionist movement.

Conclusion

The real estate sector has seen significant change in 2020 and this pattern looks set to continue into 2021. The key themes to emerge are likely to be an increased drive towards energy efficiency in the built environment, and a gradual resumption of inward investment.

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