Led by Roche Partner Jackie Crisp, the webinar featured contributions from Birketts’ Senior Associate Steven Bell and Associate Joe Yexley, Price Bailey Partners Phil Sharpe and Dougie Todd, and Partner Sam Kingston, Associate Graham Jones and Building Surveyor David Hall of Roche.
A market update and Reinstatement Cost Assessments
Roche gave an update on the office, warehousing and industrial market, both nationally and in Norfolk.
Sam Kingston opened the webinar with an update on the warehousing and the state of manufacturing and logistics sector during the coronavirus pandemic nationally and in Norfolk.
Sam said: “Demand is really driven by supply chain resilience as a result of Brexit and COVID. The first half take up in 2020 is estimated at 22.4m sq ft, which was more than taken up in the whole of 2019. Amazon have taken approximately 30 to 40% of all that space, so in excess of 11m sq ft. With the growth of online retailing, this is only going to grow.
The warehousing and logistics market has now become a key location for investment. We're seeing yields of less than 5% in the South East. These sorts of yields were unheard of when, once upon a time, industrial yields sat between 7% and 10%. Similarly, in Norfolk, supply levels are at historic lows while demand remains strong, leading to rental growth across the county.”
At a local level, Sam pointed to strong rental prices in Thetford, Attleborough, Dereham and Wymondham, with space in King’s Lynn reaching rents as high as £10 per sq ft, outperforming some rents in Norwich.
Sam added: “In my opinion, the outlook is looking strong for continued growth and speculative development, for new commercial business parks. At the moment there are two speculative business parks emerging due to occupier demand: Diamond Point off Vulcan Road and another at the White Lodge trading estate, which would be the first major development in Norwich for about 15 years.”
Graham then guided those attending through the office market, which had been struck hard by the national lockdowns, but was still in need of new developments.
Graham said: “Generally there remains an under supply of Grade A stock in UK regions, with only 30% of the available space considered to be in this bracket, but this is decreasing as occupiers seek Grade A stock, putting pressure on the need for new development. Occupiers with medium or large requirements for office space appear emboldened to try to negotiate hard in deals, whereas those seeking smaller space are becoming frustrated by the lack of opportunity.
Uncertainty surrounding the lockdown and the possible no-deal Brexit is thwarting recovery, and agents are reporting businesses were unconvinced by home working as a long-term solution, so plans are still afoot for further office deals, in particular for tech firms and the heath sector.”
Graham explained the outlook was similar for the region, with the addition of demand for small flexible suites and freehold owner occupation. The ongoing pandemic and Brexit leaves the future unclear, but short-term stagnation of rents will hopefully be off-set by the limited supply of office space and a rebound in demand next year.
Reinstatement Cost Assessments
David finished the section with a look at Reinstatement Cost Assessments, establishing how much a building needs to be insured for and why that value is often insufficient.
David explained: “The Royal Institute of Charters Surveyors (RICS) recommends a building is reassessed every three years and should be indexed annually between assessments to make sure that the value insured correctly fluctuates with current build values.
“Does this happen? In my experience, probably not. Often when we undertake valuations, we find out that the sum the building was insured for was insufficient. Aviva conducted a survey a few years ago and that suggested that 77% of commercial property was underinsured, on average by 45%, which is quite staggering.
David explained that this insurance was covering more than the value of the building; it is also required to cover an entire project’s cost including potential demolition, site preparation, costs for planning and building regulations, meeting current standards, professional fees and any adjoining owners’ costs. The cost of underinsuring is even greater when a claim has to be made.
David added: “Most commercial insurance policies will calculate how much you're underinsured by, and they will reduce your payment by that proportion. If you had a building that you insured for £500k, and it turns out that the total project cost is going to be £1m, that pay-out would be reduced by 50%. So you would not get the £500k, you get £250k. That's an extreme case, but that under insured percentage applies to any claim that you would make.”
David recommended owners ensure their properties have been valued in the last three years or after any major redevelopment, and reminded any property owners that commercial leases will usually allow for the cost of a revaluation to be reclaimed from the tenant.
Use Classes, restrictive covenants and planning
Birketts' Joe Yexley and Steven Bell explained the impact restrictive covenants can have when purchasing a property and looked at some of the recent amendments to the Town & Country Planning (Use Classes) Order 1987.
Associate Joe Yexley opened the next section of the webinar, looking at the impact of restrictive covenants and how they can be mitigated in some cases, using a case study to illustrate this.
The options to mitigate that were discussed included indemnity insurance, obtaining a release of the covenant and developing around the covenant. The case study helped show this by identifying potential defects and pitfalls with each mitigation step along with guidance on how to avoid this.
For example, in looking at indemnity insurance, Joe said: “This does not prevent a claim being made for breach of restrictive covenant, in much the same way car insurance does not prevent you having an accident. Also, the indemnity policy will usually only cover the use of the property as explained to the insurer at the time the policy was taken out. If a property is developed for a different use that breaches the covenant and a claim is made, the policy is unlikely to cover that claim.
Use Classes and planning issues
In Steven’s section of the webinar, he detailed some of the problems that can arise due to changes under the latest amendments to the Town & Country Planning Use Classes.
Steven added: “It is always worth considering that, just because the Government have changed the Use Classes or even permitted development, you still need to be very, very careful as to what the planning permission granted and the planning conditions attached to that.
“When dealing with issues surrounding the latest changes to Use Classes, watch your planning permissions, engage with the local authority, and if necessary take legal advice.”
You can see more from Joe and Steven detailing the issues surrounding restrictive covenants and Use Classes in the in the full recording of this webinar.
Managing cash flow, HMRC awareness and stakeholder management in a pandemic environment
Price Bailey provided advice on maximising and managing cash flow in a post-pandemic environment, discussed HMRC's areas of focus on the sector, and provided advice on stakeholder management in times of uncertainty.
HMRC awareness and leases
Tax Partner Dougie Todd started with the options for landlord and tenants looking to vary existing leases.
Dougie said: “A variation of the lease has traditionally been treated as a supply of services, with the VAT liability of the supply following the ‘option to tax’ status of the person receiving consideration, whether that's monetary consideration or in any other form.
However, due to the increasing number of variations of leases over the last two or three years, it became evident that in fact there was a barter transaction between the landlord and the tenant. This resulted in concession letters being granted alongside variations becoming increasingly time consuming and complex. Helpfully, HMRC has issued some guidance to the VAT treatment of lease variations.”
Dougie explains that HMRC’s view states that if a variation of a lease is ‘simply’ a unilateral payment, or rent payable adjustment, or variation, which extends or prolongs the lease, there is no VAT liability arising from the variation of that lease. This leaves ‘quid pro quo’ agreements, where there is a genuine supply of services going both ways between the tenant and the landlord, though there may need to be consideration of the VAT liability arising from the variation.
This guidance does not address every scenario. For example, what if you have varied a lease and accounted for VAT prior to the guidance being issued and any VAT that was accounted was irrecoverable, by either the landlord or the tenant? What happens if you have a variation where there is a landlord break clause?
Dougie adds: “What we are suggesting to clients is to recognise that the ‘vanilla’ guidance that HMRC have issued does not apply to every scenario and to still apply an analysis on a case-by-case basis, albeit with the HMRC guidance as framework to establish a starting point.”
Addressing the repurposing of buildings, Dougie said that several clients have had issues changing the use of their properties – for example research labs being used by a non-charitable entity for vaccine research, or student accommodation being repurposed as accommodation for key workers or the homeless at the height of the pandemic.
He added: “The consequences of that change of use can be quite significant. Those sorts of premises were typically constructed with VAT at 0% on the basis that they're relevant residential or charitable purpose buildings. However, that rate comes with a condition that if there is a change of use over a 10-year period, where the relevant charitable or relevant residential use is more than 5%, a VAT charge will arise on each occasion on the construction costs, which has to be paid by the occupier of the building.
HMRC have issued some guidance on this. They will invite businesses faced with a situation to approach them, giving rulings on a case-by-case basis. What they are not willing to do, however, is to grant advanced clearances on the basis that they consider that that might facilitate tax planning. So there's a question mark over how much comfort a ruling can actually give a business.”
Corporate Finance Partner Phil Sharpe finished the presentation with a collection of considerations and insights in to the property landscape.
Phil said: “Economic changes from the last 15 years or so were already being felt in the property sector and have only been accelerated by COVID. The big challenge is that properties and leases in their nature don't support businesses to adapt quickly. As a result, we expect to see quite a bit of fallout from the property sector. Looking back at the presentations from the team at Roche, we can already see this.
Previously we've had W-shaped recoveries with a double bounce back, we've had V-shaped recoveries, but I think what we will see in the property sector is a K-shaped recovery – parts of sectors will bounce back, such as warehousing and office space, but others such as retail will continue to decline.
I think lenders into the sector will look at this in a broad sense. Despite some properties and territories doing well, we'll see lending overall reduce across the sector as people get concerned about valuations, increasing the equity gap. Funds will be more difficult to get hold of, meaning projects will slow down or reduce in number, and funding or cashflow will become an issue within certain companies.”
Assessing the opportunities and threats for stakeholders, Phil warned further that price corrections could pose a problem, as well as the downturn putting an additional strain on lenders, landlords and tenants across the board – but the potential transformation of the high street could present the right set of circumstances for some.
Phil added: “I expect lenders to become more cautious, but tenants will also be assessing the requirements of their property and weighing up how much they are happy to pay, leaving landlords sat between them being squeezed. We've already seen them being squeezed through measures like payment holidays for leases, so I think it will become more difficult for certain landlords.
As we go forward that’s bound to lead to some opportunities for certain parties, and I think we’ve seen the high street continuing to transform, but potentially now office space will be transformed as well. For businesses with strong cash flows and balance sheets, there are plenty of opportunities to invest further.
I tend to think of ‘stakeholders’ as broader than just lenders and equity providers. It also includes customers, suppliers and employees of the business as well. When considering stakeholder management it's important not just to think about your own lenders or funders, but also to look at all of those impacted by your decisions. If you are faced with bad news, previous experience shows engaging early with funders is important. Engage early, make sure you understand where the challenges are and what the impact on the business is or will be, but also how you're going to mitigate those challenges and take those stakeholders with you.”
To watch the webinar in full, please visit Birketts’ YouTube page.
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