Office to resi: Fail to prepare, prepare to fail

The relaxation on planning restrictions on office to residential conversions for three years from May 2013 prompted a flurry of developers, tempted by the high yields and values to embark upon converting properties previously used as offices into flats.

The latest set of planning reforms propose making the permitted change from office to residential permanent and also opening the door to potential “other use” to residential conversions. This may well encourage developers to embark upon more residential conversions. However, developers should be aware of legislation specific to residential property, which can prove problematic once the development has been completed.

If a residential landlord wishes to make a disposal - which includes selling their interest in the property, granting a headlease and even granting a lease of any commercial elements of a mixed use building - they are, under certain circumstances, obliged to offer the property to the residential tenants of the building first. The notice must contain all of the agreed terms of the disposal and the tenants have two months to respond to the notice.

Developers ignore the tenants’ pre-emption rights at their peril. Failure to comply with the legislation is a criminal offence.

This process can be onerous on the developer. There may well be confidential elements of the disposal that they (or their buyer/tenant) do not want to be disclosed to the tenants.  This may put off prospective buyers. Further, there can be significant delays. If the developer is trying to exit the scheme or grant a lease, serving the notices will have significant impact on this as there will be at least a two-month delay. This is unattractive to a prospective buyer or tenant.

Developers ignore the tenants’ pre-emption rights at their peril. Failure to comply with the legislation is a criminal offence. Fortunately, there are ways to mitigate the risks, by way of structuring the title or, in some circumstances, setting up a group company. However, it is imperative that this is considered at the outset, as once the flats have been sold it will be too late. Professional advice should also be sought at the outset of the development and considered in conjunction with the developer’s tax and other needs in order to create the best structure for the relevant development.

There is also legislation permitting residential tenants to buy the freehold and any headleasehold interests in a residential building if certain criteria are met. If such a claim is brought, then the freeholder will be forced to sell its interest in the building.  

Again there are ways to mitigate the risk, though these require sophisticated structures with significant forward planning. Developers may decide that the cost of setting up the relevant structures to mitigate the risk of collective enfranchisement is not worth the benefit of keeping hold of the freehold.  

An alternative is to set up a management company at the outset, and when each flat is sold, each flat owner takes a share in the company. When the last flat is sold, the freehold is transferred to the management company, allowing the developer to have a clean break once they have realised all of the profit from the development.

However, there are further issues to consider. Residential tenants receive a far greater amount of protection than commercial tenants and there are a number of statutory pitfalls that prudent developers should avoid.  

Developers considering developing and then managing residential scheme should keep in mind the following:

• If the intention is to grant short, market let tenancies (less than seven years) the landlord is responsible for repair and maintenance of supply of services (water, gas, electricity and sanitation) and for checking these annually
• There is upcoming legislation which requires landlords to check the immigration status of a prospective tenant before entering into a residential tenant
• If the long leases of the flats are granted, there is a convoluted consultation process to go through if the landlord wishes to carry out major works (being works in excess of £250 for any one leaseholder). Failure to comply with the consultation can be very costly for the landlord, as they can then only recover £250 from each tenant. Landlords should seek professional advice before commencing expensive works, to ensure that the consultation procedure is followed properly.

Office to residential schemes are popular for obvious reasons. However, developers need to be careful to ensure that they are up to date and properly advised in relation to the potential pitfalls that residential development can bring. Most issues can be satisfactorily dealt with, providing that they are properly considered and professional advice is obtained at the outset of the development. Failure to do so can lead to delays and increased costs further down the line.

Robert Marchbank is a solicitor in Boodle Hatfield’s property team