Time to Convert?

Trainee Solicitor Victoria Bottomley looks at the increasingly prevalent subject of the conversion of commercial premises for residential use, providing insight into the key matters landlords should consider.

In the wake of the Covid-19 pandemic, many landlords may increasingly find themselves with tenants who no longer want to occupy the premises with a business tenancy - or with a prospective tenant looking to acquire the lease and then convert the premises to residential. Whilst typically the landlord may not be inclined to permit the change, the current circumstances may prove that it is beneficial to at least carefully consider it.

A Case for Change?

Amidst the sea of legislative change that has taken place this year, the Prime Minister announced that radical reforms to the planning system would allow vacant buildings in town centres to be converted to housing and that existing commercial properties, including newly vacant shops, could be converted into residential housing more easily. This would therefore provide a means for landlords and developers to expediently repurpose vacant premises and protect their interests in the longer term.

An initial consideration for landlords is the overarching viability of the conversion – essentially the business case for doing so. There are many factors to consider. Location is a critical factor. Are the premises located in an area within reach of key amenities? Shops, schools, transport or healthcare settings? Is the local infrastructure accessible and convenient for domestic purposes? Perhaps more fundamentally, are the premises appropriate for conversion and is it served by key utilities? Are there VAT implications for both parties for each supply (i.e. the premium and any rent) which would depend upon whether the parties have opted to tax the property and whether the landlord is VAT registered?

Once addressed, there are additional considerations when permission to change the use is sought and how such a transaction should be recorded.

Change of Use

Most leases include restrictions on the permitted use of a premises and the circumstances in which consent may be required. A change of use may also be prohibited by statute, planning permission or restrictive covenants on title. There are some instances where planning permission is not required for change of use to residential, if it falls within permitted development. However, even with planning permission for change of use to residential, it may be necessary to secure permission for the actual development of the property if the external appearance is to be changed for example. The government has recently updated the guidelines for permitted development rights and changes to the Use Classes Order, which can be reviewed here: https://www.gov.uk/government/publications/permitted-development-rights-and-changes-to-the-use-classes-order

Reasonableness

Where tenants are seeking consent to convert the use of premises, the issue of reasonableness is a key factor to consider in providing consent, particularly where there may be implications for the value of the property, its suitability or impact on its immediate environment or similar. As an overview, leases will typically include types of covenant that preclude, prevent or make change permissible:

• An absolute covenant precluding the tenant from doing something.
• A qualified covenant that prohibits a tenant from a particular activity without first seeking the landlord’s consent; which is not be unreasonably withheld.
• A partially qualified covenant prohibiting the tenant from undertaking a particular activity without the landlords consent however, there is no obligation on the landlord to act reasonably in giving consent.

In determining what is deemed reasonable, landlords should be aware that many long leases contain qualified covenants which may place an obligation on the landlord no to withhold consent unreasonably. In the context of change of use, and where the covenant is qualified, s.19(3) of the Landlord and Tenant Act 1927 provides that a landlord may not impose a fine in respect of the application. In the case of International Drilling Fluids v Louiseville Investments [1986] 1 All ER 321 it was notable that the responsibility of proving that consent has been unreasonably withheld was with the tenant and further, that other prominent cases* highlight that consent could be refused on the grounds that change would detract from the value of the premises or the economic fabric of the immediate area, If the landlord is provided with insufficient information to make an informed decision or where the change would increase the risk of enfranchisement and the landlord is withholding consent as a means of protecting the value of the premises.

Deed of Variation or Surrender & Re-Grant?

Providing that the changes to the lease are unsubstantial, a change of use could be dealt with by a Deed of Variation to amend the existing terms of the lease (where required). This transaction would not attract Stamp Duty Land Tax (“SDLT”). A surrender and re-grant occurs if a lease is varied in such a way that the variations cannot be effected without the grant of a new lease. It should be noted that surrendering the lease will release the parties from their respective obligations and any previous breaches, with any covenants expressed to arrive at or upon expiry of the term falling away. The effect on any registered third-party charges or rights, guarantees or underleases would therefore need to be considered.

In summary, there are key points for careful consideration – both in the benefits and potential pitfalls. Granting a change of use to an able tenant may lessen or remove the burden of liability to maintain the premises, (which would include paying the service charges, and paying the business rates) – however, consenting to a change of use may open the landlord up to issues which usually arise only from residential tenants, such as their ability to apply for the right to manage, their statutory right to extend their lease and their ability to challenge the reasonableness of service charges via the Tribunal.  If the premises forms part of a mixed-use development, a change of use may classify the premises as “qualifying”; meaning that the leaseholders could make a claim for enfranchisement, which if successful, could remove a landlord.

If you wish to discuss any of the areas discussed in this article, please contact us: v.bottomley@jbleitch.co.uk

*See: (Tollbench v Plymouth City Council [1988] 1 E.G.L.R 79); (Kened v Connie Investments [1995] 70 P & CR 370), (Warren and another v Marketing Exchange for Africa Ltd [1998] 2 EGLR 247) OHS v Green Property Co) [1986] I.R. 39); and  (Supreme Court Case: Sequent Nominees Limited (formerly Rotrust Nominees Limited) v Hautford Limited [2019] UKSC 47, [2019] All ER (D) 186).