Beware of residential rights

How mixed-use developers can design buildings to avoid certain residential rights arising

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With the constant cry for more housing, commercial developers are increasingly including residential flats in their plans. Whether they are converting offices into homes or building new mixed-use schemes, developers must be aware of the raft of rights that residential tenants enjoy which are not available to commercial tenants. With some careful planning, some of these rights can be avoided.

The rights and obligations of commercial tenants are largely governed by the terms of their leases. In the case of residential tenants, the lease is only the beginning. Statute has stepped in to require residential leaseholders to be consulted on what maintenance works should be done to the building and to limit the amount of service charge recoverable from them to sums which were “reasonably incurred.”

Statute also allows long leaseholders to oust the landlord’s rights of ownership. If the relevant conditions are fulfilled, leaseholders are entitled to collectively purchase the block, take over its management or exercise a right of first refusal in relation to any proposed disposal by the landlord of any part of its estate.

Enfranchisement

The Leasehold Reform, Housing and Urban Development Act 1993 (“the 1993 Act”) confers on leaseholders the right to acquire an extended lease of their flat or to collectively purchase the block from the landlord. This is a form of compulsory purchase and the 1993 Act contains a formula for calculating the price. In the context of a mixed-use block there are a number of ways in which the risk of enfranchisement might be avoided.

The 1993 Act entitles leaseholders to acquire either a self-contained building or part of a building. Any “part” must constitute a vertical division of the building and the structure must be such that that part could be redeveloped independently. In addition, the services to that part must be provided independently of those to the remainder of the building or be capable of being so provided without undue interruption to the other occupiers. So, for example, if there is an external boiler house supplying hot water to the block and a neighbouring block, there will be no right to enfranchise – Oakwood Court (Holland Park) Ltd v Daejan Properties Ltd [2007] 1 EGLR 121. Similarly, if the building formed part of a terrace but there was an underground car park running beneath the block and an adjacent block, there would be no vertical division – Holding & Management (Solitaire) Ltd v Finland Street 1-16 RTM Co Ltd [2008] 1 EGLR 107.

The 1993 Act also excludes the right to enfranchise if more than 25% of the internal floor area of the building is neither occupied nor intended to be occupied for residential purposes and does not form part of the common parts. Accordingly, if the development consists of shops at ground-floor level with two floors of flats above, the right to enfranchise will not arise.

 Of course, another deterrent to leaseholders enfranchising mixed-use blocks is the cost. Many commercial units are let on short leases at a rack rent which may render the freehold value unattractive to flat owners who may well be reluctant to become commercial landlords anyway.

The right to manage

Leaseholders can, however, get control of their building without needing to buy it at all by exercising the right to manage (“RTM”) under the Commonhold and Leasehold Reform Act 2002. This is done by the leaseholders forming an RTM company which steps into the shoes of the landlord in relation to its “management functions” under the lease. The RTM company takes over responsibility for repair, maintenance and insurance and collects the service charges in accordance with the residential leases. The landlord, however, retains responsibility for the commercial units and any parts of the building which are vacant or let on short residential tenancies. This can lead to duplication of responsibility, which is not entirely satisfactory.

The qualifying criteria for exercising RTM are essentially the same as those for collective enfranchisement and the landlord can again prevent the right arising by structuring the development in such a way that the premises themselves do not qualify.

The right of first refusal

Part 1 of the Landlord and Tenant Act 1987 (“the 1987 Act”) confers on residential leaseholders a right of first refusal in relation to any “relevant disposal” by the landlord. Where the landlord proposes making any such disposal, it must serve an offer notice on leaseholders notifying them and offering them a right of first refusal to purchase whatever is being sold for the same price. If the requisite majority of qualifying tenants accept the offer, the landlord can either sell to the leaseholders’ nominee or abandon the proposed disposal.

The right of first refusal applies to buildings which contain at least two flats held by qualifying tenants and where more than 50% of the flats are held by such tenants. Both Rent Act tenants and short-fixed-term residential lessees qualify, although business tenants and assured tenants do not. Again, the premises will be excluded from the 1987 Act if there is substantial commercial use but this time more than 50% of the internal floor area must be occupied for non-residential purposes.

Where a flat straddles two buildings, the leaseholders are entitled to acquire the smallest part of the property that can be divided vertically from its neighbour. If there is an insufficient proportion of flats held by qualifying tenants in that part, the building will not qualify. Another way of avoiding the Act for corporate landlords is to sell the shares in the company to the purchaser rather than the property itself.

Certain disposals are exempt – for example, the sale of a single flat – but there is no exemption in relation to disposal of a commercial unit. Although largely overlooked, technically the disposal of any commercial unit within qualifying premises would be caught by the 1987 Act.

It pays to be aware

Whenever there are residential tenants in a mixed-use block, the landlord/developer must be aware of their statutory rights. Failure to do so can be an expensive error.


This article was first published in the Estates Gazette.