The Property Speculator » security of tenure

Developing a Mixed-Use Property

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A very common way of getting started in property development and investment is converting or renovating a mixed use development.

‘Mixed-Use’ can mean a combination of Residential, Office or Retail within a single development (it’s highly unlikely Industrial type properties would be included in this, for example I can’t imagine a residential flat being situated above an industrial unit). So an example of this could be a shop with a flat/flats above it, or offices with residential above. Incidentally the residential portion is situated towards the top of the property because it’s not likely to require a street-level frontage, like a shop or an office might. The residential area of the property also tends to be quieter and the commercial occupants are less likely to have cause to go upstairs into this area of the property.

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It is certainly possible to convert only part of a property to a use that’s different to the original one. Be aware though that (currently) Planning Consent is required to change the use of a property (or part of a property) from Commercial to Residential and between sub-groups within Commercial. Building Regulations also need to be fully complied with.

The different ways of occupying a property are:

Freehold. This is the closest to owning the property outright (It’s only a Government body which can carry out compulsory purchase though). The Freeholder theoretically owns the plot, the land beneath the plot and the area above it (although this isn’t really enforceable in reality). Being a Freeholder offers the luxury of selling a leasehold interest in the property if he/she wishes.
Leasehold. This is usually for a period of time (term) of 99 years or more (sometimes 999 years). The freeholder effectively sells the right to use the property for the term stated in the contract. Along with this, the Leaseholder sometimes receives the right to allow Tenants to occupy the property and collect the rent. In order to reduce the chances of confusion, this is often called the Long-Leasehold interest. It is bought in a similar way to the Freehold Interest (i.e. a large amount of capital is paid for it, rather than a monthly or quarterly rent).
Tenancy. This is really just a different way of occupying the property under a leasehold interest, however for the purpose of avoiding confusion over these occupancies, I refer to it as a Tenancy (even though the occupational contract is still called a Lease…). This is paid for in the form of rent, usually paid monthly or quarterly (depending on it being Residential or Commercial). A tenancy is always shorter than the long-leasehold interest (even if it’s only 1 day shorter) but is usually much shorter, between 3 and 25 years is usual. A tenancy does not really have much value in itself other than to the landlord. This is because it’s not really possible to sell a tenancy by itself; you can however purchase the leasehold interest with a tenant already in place.

Commercial and Residential tenancies are usually quite different. The main issue is that all Commercial tenancies are awarded Security of Tenure unless specifically contracted out of it. This means that a Commercial landlord can only make the tenant leave the premise at the end of the term in certain circumstances (for example if the landlord wants to redevelop the property and has plans in place to prove this). To contract out of this, the lease agreement must specifically state that both parties wish to contract out of the Security of Tenure provisions of Part 2 of The Landlord and Tenant Act 1954, s 24-28 (or words to the same effect). Contracting out of the act should benefit both parties (such as when a lower rent is agreed upon to reflect a lower ‘risk’ to the landlord).

In contrast, Residential tenancies tend to be more heavily weighted in favour of the Landlord. A tenant does not really have any Security of Tenure at the end of the term. Many Residential tenancies are only for an initial period of 6 months. If the tenant stays in the property with the permission of the landlord at the end of the term, a Periodic Tenancy is formed. If the tenant pays rent on a monthly or weekly basis, this period becomes the notice period for either party to bring the tenancy to an end. A periodic tenancy continues until the landlord or the tenant brings it to an end.

It’s important to have an understanding of how the different types of occupation work. When developers of mixed use properties consider their projects, they intend it to work in a slightly different way to the usual private residential developer. Where a private developer buys a property at a reduced price, spends the bare minimum but produces a good finish then sells on to a new owner, a mixed use development often requires a different approach. Of course it is possible to buy and sell a mixed use development in the same way as a small residential (i.e. the freehold), but because of the combination of property types within the development it usually makes more sense to keep the freehold of the property and sell the long-leasehold interest as and when an occupier or investor is found.

If the freehold is retained, tenants can be found to occupy the office or retail portion. The residential areas of the building can be let the same way as the commercial but this involves a lot of management of tenants taking 6 or 12 month tenancies and of course, the developer will not receive capital in return in a lump sum. It’s far better to sell the long-leasehold interest in the residential units to either investors or leasehold-occupiers. This way, a profit can be made (the value of a long-leasehold interest is more-or-less the same as the freehold price) on individual units of the property. Investors or leasehold-occupiers can buy individual long-leaseholds interests one-by-one if necessary. If the residential units are above the ground floor, it is not possible to sell any of the freehold interests in these. A freehold must always be on the ground floor or associated with a property on a ground floor. If an investor purchases any of the long-leasehold interests, they will be obliged to honour any tenancies that might have been agreed prior to their completion.

It’s also important to understand how service charges apply to a property of mixed uses. A service charge is essentially a further charge to the tenant(s) to contribute to the upkeep of common areas such as grounds maintenance or cleaning and decorating of hallways and stairwells. Service charges should be ‘fair and reasonable’ and not produce a profit or a loss for the landlord. For Commercial tenants, The Royal Institute of Chartered Surveyors publish a Code of Practice guide on service charges. The method of dealing with dispute resolution will be stated in the lease. Residential tenancy service charges however, are very strictly regulated. A landlord who doesn’t follow the statutory procedures might find himself limited under law as to how much can be recovered from the tenant at the end of the occupancy.

Tenants should be supplied with a schedule of the previous year’s service costs and justification of the current level of charge. In a mixed use property however, tenants will occupy different sized areas and even use different facilities in the property. For example a Commercial tenant on the ground floor would not be expected to pay for the upkeep of a lift to service the residential units on the floors above. The principle way of deciding who should pay for what, is to consider which property a particular service will benefit. A Commercial tenant should have the opportunity of negotiating the service charge. It is sometimes possible to opt out of the charge for services that are available but will not be used.

Sep 4th, 2011

Understanding Residential Tenancies

It is important to know exactly how residential tenancies work when you are a property investor. It is unfortunately not simply a case of finding a tenant, verbally agreeing a few simple terms and collecting the rent each month. There are 2 different types of private residential tenancies and they have slightly different rules that you, as a Landlord must adhere to.

Legislation was originally introduced back in 1915 to protect Tenants against unscrupulous Landlords. Since then, all subsequent Rent and Housing Acts have evolved the system into what we have today. Most recent acts have over the years, created more and more favourable conditions for the Landlords in an attempt to re-invigorate the sector. This in turn, has given the Tenant progressively less security of tenure.

2 types of tenancies are still in use:

The Assured Tenancy was introduced by the Housing Act 1980 and replaced ‘Rent Act’ tenancies. They offer some degree of security of tenure to the tenant. A resident under this system cannot be evicted from a property unless the Landlord has sufficient grounds to do it:

The Landlord once occupied the property as his home and now wishes to re-occupy.
The mortgagee (mortgage company) wishes to gain possession
The Landlord wants to substantially redevelop or demolish the property.
The Tenancy has devolved under testacy or intestacy of a previous assured tenant.
More than 8 weeks of rent are owed.

Assured tenancies can be put in place for a fixed term (this is often just for an initial period of 6 months) or they can be periodic (meaning that they just continue from week-to-week or month-to-month indefinitely).

During the fixed term, they can only be brought to an end if the Tenant agrees to leave, or by a court order. If the tenant remains in occupation after the fixed term has expired (and the landlord is happy with the arrangement) then a Statutory Tenancy is created by default. This continues until a new tenancy agreement is introduced or a court awards possession to the Landlord. During this time, the terms of the original agreement must be followed, a Landlord cannot suddenly introduce new terms without the agreement of the Tenant.

If the Tenant pays rent on a monthly basis, then any increase in rent must be subject to a months notice. If the tenancy is less than 1 year old however, the Landlord has to wait for those 12 months to expire before initiating any changes to the terms.

2 Assured Shorthold Tenancies (ASTs) were introduced to give Landlords greater control over their properties. The end of the tenancy term gave them almost certain possession. For a lease to qualify as an AST, certain conditions must be in place:

The lease must be for at least 6 months.
The Tenant must be aware that the lease is an AST prior to signing the agreement.
If the AST term expires and both parties wish to bring another agreement into effect, the new one must also be an AST and on the same terms as the original agreement.
If any grounds for the tenancy to end (identical to the Assured Shorthold grounds for repossession above) occur, provided the Landlord serves 2 months written notice, the tenancy is automatically terminated (see below).

Under the Housing Act 1988, s.21 allows the Landlord to serve a notice to the Tenant of a minimum period of 2 months for the Tenant to vacate the property; although this can’t be served within the first 6 months of the term.

All tenancies from 28^th February 1997 onwards are automatically Assured Shorthold Tenancies unless specifically stated in the agreement. There are also conditions that prevent a tenancy agreement from being an AST (and subsequently will become an Assured Tenancy):

The Landlord is resident in some way.
The rent is greater than £25 000 per annum (this level is increased to £100,000.00 from 1st October 2010).
None of the tenants occupying the property do so as a principal home.
The tenant is a limited company, not an individual.
The landlord is a local council

Apart from the 2 types of tenancy agreement, Tenants do have other forms of protection against unscrupulous Landlords:

Rent Books. All tenants who pay on a weekly basis must be given a rent book. This contains information such as the actual weekly rental sum due, details of any security of tenure and agencies who can help in the event of a dispute.
Harassment Laws. It is a criminal act to harass or unlawfully evict a Tenant, regardless of circumstances.
Notice to Quit period. This must be the same period as the frequency as the rent payments (except in the case of annual payments – where 6 months is permitted)
Court Order. This rules that all occupiers can only be evicted after the due court process.

In summary, you cannot simply evict a tenant without the full compliance of the law. Even if you are certain you are acting within the law, it is very important to have a property Solicitor serve any notice for you. This is because the notice wording is extremely important, and he/she will also check you are acting within the law.

May 7th, 2011

Property Security of Tenure

If considering investing in commercial property, an important consideration is a factor that, in practice changes the basis of a business tenancy by quite some degree. This is known as Security of Tenure.

This was introduced by Part 2 of the Landlord & Tenant Act 1954 (LTA) (Part 1 deals with residential property and Part 2 deals with commercial), this is often shortened to simply ‘the Act’ as it is well known among Property Professionals. It was brought in for the purpose of preventing unscrupulous landlords exploiting tenants by evicting them with little or no notice; or allowing them to stay in occupation but increasing the rent to unrealistic levels.

The LTA gave the tenant (both residential and commercial) protection by listing the circumstances in which the landlord could evict them. A minimum notice period was also introduced which gave the tenant an opportunity to challenge the landlord’s decision. Likewise, a tenant was allowed to apply for a new lease upon expiry of the old one, and the landlord was not able to deny this, except on justifiable grounds. The new lease must be on ‘similar terms’ to the original one.

All commercial leases are automatically covered by the LTA 1954 Part 2. Therefore, the act will not be expressly mentioned within the lease because the assumption should be made that it is an ‘inclusive’ (meaning it’s within the act) lease. Parties can however, opt to contract themselves out of the protection of the act, for reasons that are mutually beneficial to the particular circumstances of the occupation. To be ‘exclusive’ of the act, the tenancy agreement must expressly state that both parties wish to ‘opt out of the Security of Tenure provisions of the act’ (or words to that effect).

Under Part 2, s.30 of the act, there are grounds of opposition that can be used by the landlord to justify requesting the tenant to vacate premises upon lease expiry:

Not complying with covenants to repair and maintain the property.
A constant delay in rent payments.
Any other breach of covenant that is ‘substantial’.
The landlord has offered the tenant suitable alternative accommodation.
The current letting is based on an area less than the entire premises, and due to the current letting being uneconomical, the landlord wishes to let the entire premises.
The landlord wishes to demolish or reconstruct the building, or carry out substantial work (this must be provable).
The landlord wishes to occupy the building for his own use.

Because the Act gives the tenant considerable legal power, this sometimes changes the investment value of a lease. Many commercial landlords regard the act as a burden, and a lease that is ‘inside’ the act as being somewhat less valuable than one that is ‘outside’. Likewise a tenant sometimes feels that without the protection of the act, he wishes to pay a lower rent to reflect his greater ‘risk’. This is an issue for negotiation. A landlord will push for an exclusive lease; a tenant will push for an inclusive one. The negotiated rent will normally settle at a rate that suits the eventual decision to include the act or not.

When under the protection of the act, a landlord must serve a ‘section 25 notice’ to request the tenant vacates the property at the end of the term (this refers to s.25 of Pt 2 of the 1954 act). This is in practice, compiled by a Solicitor and delivered to the tenant between a maximum of 12 months and a minimum of 6 months before the landlord would like the tenant to vacate. In order to challenge this, the tenant must respond within 2 months of the serving of the notice.

The tenant can make an application to remain in the property after lease expiry, by the submittal of a ‘section 26 notice’ (again, this refers to s.26 of Pt 2 of the 1954 act). In common with the above, it must be completed by a Solicitor and served to the landlord between 6 and 12 months before the end of the term.

If a tenant remains in occupation of premises at the end of a lease term, the tenancy automatically becomes a Tenancy at Will. If the original agreement was under the protection of the 1954 act, then even though the original term has ended, the tenant still has Security of Tenure. This means that for the tenancy to be terminated by the landlord or extended by the tenant, a s.25 or s.26 notice must still be served under the same conditions as above.

Part 1 of the 1954 act concerns residential property. Although it doesn’t really apply much these days, it refers to protection being granted to:

1. Long leases; that is, more than 21 years long.

2. ‘Low Rent’ agreements (This is at a rent of below £1,000 per annum in London, or £250 elsewhere).

3. The property must be a ‘dwellinghouse’. Not a mixed-use property.

So the chances are, an aspiring residential property investor is unlikely to come into contact with the 1954 act. However, in the 1980’s, the Assured Tenancy and the Assured Shorthold Tenancy were introduced. These are protected tenancies types and the landlord can only take possession if:

The landlord occupied the property at some time, and wishes to return.
The mortgagee of the property (the lender) wishes to exercise a power of sale and sell with vacant possession.
The landlord wishes to demolish and/or reconstruct the property and there is no way of accommodating the tenant during these works.
The tenant dies.
The tenant is more than 2 months in arrears.

The most common form of residential tenancy now, is the Assured Shorthold. This is the default tenancy, as an Assured Shorthold Tenancy can only be created if expressly mentioned in the lease. Assured Shortholds provide the tenant with some protection but still allow the landlord to regain possession when required:

The tenant can request the detailed terms of the lease if not already supplied.
The landlord cannot request occupation until after the first 6 months have passed.
The Rent Assessment Committee has jurisdiction over the rent level, but on only one occasion which must be after more than 6 months after the start of the tenancy.

Apr 3rd, 2011

What to look for in an Investment Property Lease

If you are searching for an investment property that does not require (much) work to be carried out, there is a good chance that you will find yourself evaluating a property that has a tenant already in occupation. Under The Land Registration Act 1925 and 2002, if you purchase the Freehold interest in a property, you are legally obliged to honour all existing leases and agreements. In law, the rights of the person(s) in occupation override that of even the freeholder’s.

The terms⃰ of any lease in place on the property will affect its value to some degree (for example, a poor ‘quality’ tenant in place for the next 15 years does not represent an ideal situation and subsequently will be less desirable than a good quality tenant that renews a lease regularly). The main aspects of any tenancy agreements are:

Parties involved. All tenants and the Landlords name or company will be stated on the tenancy agreement.
Lease term. This is the period of time the tenant is permitted to occupy the property. This period may be either reduced, extended or become ‘open ended’ by agreement with the landlord. What commonly happens in residential tenancies is that the initial term is set at 6 months. The tenant may then continue in occupation (with the landlord’s approval) for an indefinite period of time, paying rent on a monthly basis. This is what is known as a ‘periodic tenancy’. The frequency of rent payments then becomes the period of notice for either party to bring the agreement to an end. For example if the rent is paid monthly, then the landlord or tenant can give a months’ notice to bring the occupancy to an end.
Rent Payable. This is the sum of money charged regularly by the landlord so that the tenant is permitted to remain in occupation. The rent is set initially as the tenancy agreement is created. Residential tenancies are usually paid monthly in advance; commercial ones are usually quarterly in advance.
Deposit payable (if any). This will be stated in both words and numbers.
Rent review. This is a clause in the tenancy agreement that allows the landlord to increase the rent payable so that it reflects continually changing rent values. It is very common in commercial tenancies but less common in residential ones. After the initial rent level is set at the beginning of the lease term, it might be reviewed at 3 yearly intervals (for example) to increase in line with the general level of economic inflation. Sometimes these reviews (most commonly commercial) are ‘upwards only’; meaning that the new rent level will be the lowest value of either the existing rent level, or a sum agreed by both parties as being an accurate reflection of current rates. In the event of disagreement of this level, the tenancy agreement will prescribe a method of establishing a new rent by a third party.
Break Clause. In place on commercial properties. This is a clause that allows either the tenant or the landlord to bring the agreement to a premature end. This is very often subject to around 6 months notice. Landlords sometimes charge a premium to compensate them for the risk of a subsequent rent void when the tenant moves out. This has mixed opinions amongst property professionals, some regard it as justified, and others see it as completely unnecessary.
Security of Tenure. This is a legal term that means the landlord cannot simply evict the tenant. It is now almost extinct in residential tenancies. Only agreements entered into before the 15th January 1989 are protected (known as Rent-Act tenancies), and provide the tenant with security of tenure. This has the result of substantially reducing the property value to around 50% of that in vacant possession. However, that is not to say that tenants under more recently drawn up contracts can be evicted on a whim. Far from it. You cannot evict a tenant without a Court Possession order. If a tenancy agreement has been in place, it cannot be substantially changed even if it is renewed. Any new agreement must be on similar terms. All residential tenancies granted after the 28^th February 1997 are ‘Assured Shorthold Tenancies’. This still provides the tenant with security of tenure, but the landlord will be granted a possession order on certain grounds after the initial term of the lease has passed and it has become a periodic tenancy. The specific grounds for possession are listed in the Housing Act 1988.

Commercial tenants are automatically given the protection of security of tenure under the Landlord and Tenant Act 1954 (known as the ’54 Act). This means that tenants can only be evicted under particular circumstances (such as the landlord wishing to occupy the property or develop it). The parties involved can specifically opt out of this act if it suits their circumstances. This is known as an ‘exclusive’ agreement, as opposed to an ‘inclusive’ one. This act can have quite an effect on the value of the tenancy, for an inclusive agreement puts the tenant in a strong position and an exclusive one does the same for the landlord.

When taking on ownership of an investment property with tenant(s) already in place, great care should be exercised in establishing which tenants actually should be in occupation. Once the conveyance process is completed, anyone in occupation of the property (whether they pay rent or not) is automatically granted rights to remain there. If you later find out that individuals should not be in occupation, court action might be required if they will not co operate and move out.

In all leases, there are ‘implied’ covenants adopted. These are:

The Tenant:

To pay rent as agreed.
To pay utility bills as required including connection fees.
To vacate the property upon lease expiry
To keep the property in good condition and not to commit ‘waste’ (which is where the tenant allows the property to fall into substantial disrepair through neglect)
Not to make any alterations to the property other than with the express, written permission of the landlord.
To allow the landlord (or representatives) access to the property (normally subject to 24 hrs notice) for the purpose of maintenance or inspection.
A requirement to report any damage to the property to the landlord to enable him to repair it or make an insurance claim.
Not to change the locks on the property with express permission.
To allow viewings of the property for prospective tenants within 2 months of term expiry.

The Landlord:

To keep the property in acceptable, habitable condition for the tenant.
To allow the tenant ‘comfortable enjoyment’ of the property.
To insure and keep insured the property against the usual fire and other risks.
To return any rent paid to the tenant for any period the property is not inhabitable.
To cover any outgoings that the tenant does not pay.

The landlord has the right to enter the property if the rent remains unpaid for 14 days or more; or if the tenant breaches his covenants or enters bankruptcy proceedings.

⃰Note. In property law, the word ‘Term’ (singular) refers to the length of time of the lease; whereas the word ‘Terms’ means the conditions contained in the lease agreement that the tenancy is based upon.

Sep 5th, 2010