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Build to rent: legal issues for a growing sector

  • United Kingdom
  • Real estate
  • Real estate investment


Eversheds Sutherland property column: March 2019

Over the last half decade, institutions and investors have become increasingly attracted by the dependable longterm income offered by large-scale professional residential letting.

The way investors acquire these developments very much depends on their risk appetite. For the most risk-averse (or those who require instant returns from their investment), the simplest option is to acquire a completed development, though there is little such stock available. These investors also have to accept that they will pay more SDLT than if they used the forward funding model.

Leaving aside the small group of investors who opt for this low-risk approach, the majority of build to rent (BTR) deals we are currently seeing involve an element of development funding. This generally involves the forward purchasing of sites from developers (taking care to comply with Prudential planning to benefit from potential SDLT savings), followed by capped-price development funding. Developers should be wary of "jumping the gun"and getting on with ground works while negotiating the forward funding deal. To do so may inadvertently have a materially adverse effect on the investor's SDLT liability and an unwelcome knock-on impact on the investor's appraisal. This is because the SDLT payable will be based on the value of the land, including any development, such as groundworks, on that land.

As in all young markets, many developers, investors and (if brought in by the investors) lenders are going up a steep learning curve. Established practices for developments of either build-to-sell housing or commercial building do not always help, and so cannot just be applied thoughtlessly. BTR deals have their own set of challenges:

Specification. The specification for the development is key and its importance cannot be overstated. The specification (together with location) ultimately drives the rents and therefore the yield. The specification must be comprehensive and detailed, even down to the type of furnishings to be provided. For that reason, we always push for a very detailed specification to be annexed to the development funding agreement and require very tight controls over the variations developers are permitted to make.

Costings and timings. Institutions require as much certainty as possible and examine the viability of a scheme in great detail before committing major resources to it. Developers should take care to avoid enticing investors with aspirational and unrealistic build programmes to avoid the risk of suffering liquidated ascertained damages (LADs) for late completion or unbudgeted cost-overruns. The usefulness of LADs and cost-overruns, of course, depends on the covenant-strength of the developer. The developer has to be worth pursuing!

Title and planning issues. Institutions require "oven-ready" developments, with all planning and title issues resolved, or at least with a clear, certain and costed path to resolution. Anything requiring a third party's consent or approval is (unsurprisingly) of particular concern. Such matters, depending on their severity and seriousness, can end up becoming either conditions precedent to the acquisition of the land or conditions subsequent which must be satisfied prior to first draw-down of funds. Neither are good news for the developers!

Truly turn-key. The day after practical completion, the properties must be capable of being lawfully let to residential tenants with very little or no snagging outstanding. Our list of pre-completion requirements for BTR deals cover both of these aspects and more. The list goes well beyond what is generally required for a standard commercial development, running to several pages and includes all types of regulatory signoff and safety certificates. It also includes matters which are more "operational" in nature, such as the production of key schedules, satisfactory drainage tests, acceptable telephone signal tests (and so on). From a practical point of view, what would normally be considered to be snagging must have been dealt with prior to practical completion. Added to this, we frequently include performance targets in the development funding agreements setting out timescales within which works of graded severity must be resolved.

Construction documentation. Institutions require complete and institutional-grade building packages to protect themselves and to facilitate sales. Comprehensive and complete building contracts and appointments are required.

The "Grenfell" risk. Who should take the risk of any change of what is an acceptable building material as the scheme progresses? There are various schools of thought. In one instance, I provided for replacement of any items which were deemed (at any time prior to practical completion) to be hazardous to health and safety, irrespective of where and when installed. In another, the developer only had to replace items in a stage of the development if any item in that stage (prior to building regulations sign-off of that stage) was deemed to be a prohibited material.

BTR is not, of course, the silver bullet to solve the UK housing crisis, but it is an important element of a sophisticated and diverse housing strategy. When a well-run BTR provides professionally managed and quality accommodation with landlords who are primarily interested in their customers remaining happy and in situ, it provides the institutions (at a time when it is increasingly difficult to place money) with good stable returns and an ability to increase those returns through the provision of extra tailored services. It also provides their customers with the flexibility to move without undue difficulty.

Legal issues aside, though, a key barrier to BTR is the view, embedded deep within British culture, that home ownership is always the most desirable choice. We will, as a nation, have to step back to a pre-1980s thought world, where it was accepted that home ownership and letting are equally valid life choices.