Whilst potentially a great opportunity, mixed use developments give rise to significant legal and management issues for landlords and investors in connection with the residential elements that simply do not arise in respect of the commercial units.
Mixed use developments, which combine commercial and residential units, are becoming increasingly popular. Planning policy aimed at revitalizing urban centres, reducing demand for transport and creating more “interesting urban fabric” has resulted in the construction of more complex mixed-use developments, including offices, shopping centres, hotels, and leisure facilities.
Meanwhile residential property values have improved with international investment in the London housing market and increases in demand. Office accommodation requirements have changed with lower occupancy per employee and a desire for greater flexibility. This has seen the conversion of increasing amounts of office space to residential. Generally there is greater availability of funding for mixed use rather than office only development so there has been an influx of commercial developers into the mixed-use market.
This has created interesting opportunities for property developers, investors and managers. The booming residential market in the southeast has given vitality to some exciting new projects, so what could possibly go wrong?
Residential is not commercial without the desks
Over many years, politicians of all persuasions have passed legislation to protect residential tenants. The residential occupiers in mixed use developments are invariably tenants. They may have leases of 99 years or more (and would often be referred to as leaseholders) but they are still tenants and still subject to significant rights and protection which commercial tenants do not have. Investors need to understand the implications of that extra protection on the value and flexibility of their investment. They also particularly need to recognize that residential management is a job for the specialists.
Properly understood and managed well these are good investments and undoubtedly here to stay. However, for the unprepared, there are big risks from criminal sanctions and fines to rent and service charge payments that cannot be recovered. Landlords can lose the right to manage and control the developments they have invested in or even lose the investment altogether. Here are some of the causes of those restless nights:
1. Residential leaseholders can take over management of their part of the building
In broad terms, this applies if over 75% of the building is residential, let on long leases and a majority of the leaseholders want to manage themselves. Their landlord does not need to have done anything wrong. There is a statutory process to follow but then the tenants can take over management including “appurtenant property” which is any outbuilding, garden or yard usually enjoyed with the building, The right to manage includes the right to insure which can be very problematical for a landlord wanting to protect its investment.. The landlord retains responsibility for management of flats let by the landlord on short leases and of the commercial units. There is no mechanism in the legislation for dealing with split responsibilities to manage. This can and does lead to confusion and conflict. (Right to Manage - Commonhold and Leasehold Reform Act 2002)
2. Residential leaseholders can compulsorily purchase the freehold of their building
Similar criteria as above apply. Again the landlord need not have done anything wrong. Where this happens the leaseholders must pay market price but the landlord is forced to sell. The leaseholders take over ownership of the whole building including any commercial units (Right to Enfranchise - Leasehold Reform, Housing and Urban Development Act 1993).
3. Residential leaseholders have a right of first refusal before their landlord can deal with the freehold – with a large fine for the landlord if the process is not followed
If relevant criteria apply, before a landlord can dispose of all or part of the building, the landlord must give notice to the long residential leaseholders to allow them to offer to buy the interest on the same terms. The statutory process can significantly slow down any transaction. If the landlord does not give notice. the purchaser can be required to transfer the interest to the tenants on the same terms on which he acquired it and the landlord commits a criminal offence and can be fined up to £5000 (The Right of First Refusal - Landlord and Tenant 1987 Part 1)/
4. Residential leaseholders have the right to get the terms of their leases changed
They have the right to apply to the First Tier Tribunal (FTT) for a variation of their leases either because that is what the majority want or if a lease or leases fail to make satisfactory provision e.g. for insurance or to recover expenditure incurred by one party to the lease for the benefit of another. Landlords can also apply and where any order is made the FTT can order variation of all residential leases in the block so that all have similar provisions However there is no provision to vary the commercial leases in a mixed use so this can cause landlords in mixed use developments particular problems (Right to Apply to Vary a Lease - Landlord and Tenant Act 1987).
5. Failing to follow statute can leave a landlord seriously out of pocket
- Major works
Failing to properly consult with residential leaseholders before doing major works can leave the landlord unable to recover more than £250 per leaseholder towards the cost. The consultation requirements are very detailed and complex and there are numerous cases of landlords slipping up. If the landlord cannot get a dispensation from the FTT, the landlord has to personally fund the difference between the small amount recoverable for the leaseholders and the full cost of the works. (Landlord and Tenant Act 1985 s20 and Service Charge (Consultation Requirements) (England) Regulations 2003)
- Historic works
There are onerous restrictions on charging for historic works. Leaseholders are not liable for costs incurred more than 18 months ago unless notified previously in writing about the costs. Even if the landlord funded the work entirely for the benefit of the leaseholders, they cannot be made to pay . (Landlord and Tenant Act 1985 s20B)
- Proper information
A service charge demand is not payable unless and until it is accompanied by a Summary of Rights and Obligations in a prescribed format (s21B Landlord and Tenant Act 1985 and The Service Charges (Summary of Rights and Obligations, and Transitional Provision) (England) Regulations 2007 (SI 2007/1257) )
- Landlord’s address
No rent or service charge is payable unless a demand for rent is sent containing the landlord’s name and address (including an address in England and Wales for service). This cannot be the address of the managing agent.(Landlord and Tenant Act 1987 s 47)
- Formal rent demand
No rent is payable unless and until the landlord has given notice of the amounts due in a prescribed format even if the lease contains wording that rent is due “whether formally demanded or not” (The Commonhold and Leasehold Reform Act 2002 s166).
6. Landlord’s remedies against long leaseholders are restricted
Landlords have a range of remedies against defaulting tenants, the most powerful of which is forfeiture of a lease. Many defaulting commercial tenants can be forced back into line quickly with a threat to forfeit their lease. There are a number of limitations on this effective remedy in a residential context. Enforcement of judgements for debts in the County Court is a frustrating and often unsuccessful process so forfeiture is still a valuable remedy for a landlord but the restrictions can mean lengthy delays compared with dealing with commercial tenants
A landlord may not exercise a right of re-entry or forfeiture for failure to pay a service charge unless the amount of the service charge has been finally determined by a court or FTT or is admitted by the tenant (Housing Act 1996 s81)
A landlord cannot forfeit a long lease of a dwelling unless the unpaid rent, service charge or an administration charge (or a combination of them) is an amount that is over £350 or includes an amount that has been payable for more than 3 years. (Commonhold and Leasehold Reform Act 2002 s167).
A landlord may not start the forfeiture process for any other breach unless it has been finally determined by a court or FTT that the breach has occurred or the tenant has admitted the breach (Commonhold and Leasehold Reform Act 2002 s 168)
There is no equivalent of “peaceable re-entry” for residential leaseholders. The lease cannot be forfeited and possession recovered without a court order and use of court appointed bailiffs. The penalty for a breach is a fine up to £5000 or up to 6 month in prison (Protection from Eviction Act 1977).
None of the above means that investment in mixed use developments is not interesting or viable. However there are real differences between mixed use and purely commercial developments which need to be properly understood and catered for in an investment and management strategy. It may be tempting to see these as a bolt on to a commercial portfolio but that is the route to many sleepless nights. Properly understood and managed, these developments have considerable potential and are certainly increasing in popularity. However they are more different than they may seem and, in the long run, counting statues will prove better than counting sheep.