Unlocking leasehold land for development

­­With the country’s housing crisis innovative options are emerging for increasing the supply of housing.

At first glance acquiring a historic long lease of a property which restricts the property’s use to commercial use only, may appear to be a closed door in terms of any potential for a residential redevelopment.  However, as the case considered in this article demonstrates, the door is very much ajar.

Under the provisions of section 84 of the Law of Property Act 1925 (the LPA 1925) the Upper Tribunal (Lands Chamber) (the UT) has the power to discharge or modify a restriction on the use of a property in a lease which was originally granted for a term exceeding 40 years where 25 years of the term have already elapsed.

The UT can discharge or modify the restriction if satisfied that one of the following grounds applies:

  • The covenant is obsolete (section 84(1)(a), LPA 1925);
  • The covenant impedes some reasonable use of the land (section 84(1)(aa), LPA 1925);
  • The beneficiary of the covenant agrees, i.e. in the context of leasehold property, the landlord (section 84(1)(b), LPA 1925); or
  • No injury will be caused (section 84(1)(c), LPA 1925).

Section 84(1)(aa) is the most common ground relied upon. It only applies where the UT is also satisfied that the restriction:

  • Does not secure any practical benefit of substantial value or advantage to the landlord; or
  • Is contrary to the public interest; and
  • in either case, that money will be an adequate compensation (section 84(1A) of the LPA 1925).

When considering the application of section 84(1)(aa), the UT also takes into account:

  • The development plan;
  • Any declared or ascertainable pattern for the grant or refusal of planning permissions;
  • The period and context in which the restrictions were originally imposed; and
  • Any other material circumstances (section 84(1B) of the LPA 1925).

Whilst existing planning consent will not ensure success before the UT, it is very compelling evidence that the proposed use of the land is reasonable. The fact that the UT is permitted to take into account wider planning concerns, means a section 84 application should be the preferred forum to test the issue of reasonableness of restrictive covenants through the courts (which will generally result in a much narrower contractual approach being taken, so that the likelihood of a favourable outcome will be that much lower).

In the recent case of Shaviram Normandy Ltd v Basingstoke and Deane Borough Council [2019] UKUT 256 (LC), the tenant applied to the UT to modify a restrictive covenant limiting the use of a property as offices only under section 84(1) of the LPA 1925 so as to allow residential use and the application was successful.

The property in question was built in the 1980s and is over 76,000 sq ft. The freehold is owned by the Basingstoke and Deane Borough Council (the Council) which had granted a 150 year lease of the whole the property in 1985 (the Lease).

The Lease included a tenant covenant restricting the use of the property to use as offices only. The Lease did not provide for payment of a ground rent to the Council but instead entitled the Council to 15.5% of the net annual rent received by the tenant pursuant to underleases which the tenant was to grant of the offices within the property.  On this basis, the Lease included a covenant whereby the tenant was obliged to use its reasonable endeavours to keep the property fully sublet. The Council’s consent to the terms of any subletting was required, subject to a proviso that it would not be unreasonably withheld.

The property used to be IBM’s offices.  However, since IBM vacated and their underlease determined in 2014, the property had been vacant ever since and had fallen into substantial disrepair. The expert evidence before the UT was that the property would require substantial improvement and modification before it could be marketed for letting.  Due to prevailing market conditions, it was also probable that the property could only be let by floors rather than as a whole building to a single occupant as it had been previously.

The current tenant bought the Lease in 2015 for £5.25 million exclusive of VAT. It wanted to create 114 flats and thought there would not be an issue in obtaining the Council’s agreement to vary the Lease to change the use to residential (there had been implications in the past that this wouldn’t be opposed).

The statutory “permitted development” rights allowing conversion from offices to residential use were confirmed as applicable by the Council in its capacity as local planning authority. However, in its capacity as landlord of the Lease, the Council refused to vary the Lease to change the covenant restricting the use to offices. The tenant therefore made an application under section 84(12) of the LPA 1925.

The UT applied the following principles on the facts and decided to modify the restriction on use as offices only to allow residential use:

  • The capital value of the reversion (i.e. the Council’s freehold interest in the property subject to the Lease) would not be adversely affected but would actually be enhanced by the modification of the use covenant. The proposal was to let the flats on assured tenancies which would generate more income than would be achieveable if the property were let to multiple occupiers as offices;
  • The particular location of the property was not an office location and the change would not adversely affect the Council in relation to its other office buildings nearby;
  • For the purposes of the application, the Council’s position had to be assessed in its capacity as landlord rather than the local planning authority but that, in any event, there was nothing in the proposal that went against the development plan. The UT therefore effectively rejected the Council’s argument that, if the tenant’s application was to be successful, the decision would be the “thin end of the wedge”, i.e. that the development, whilst not greatly harmful in itself, might create a precedent opening the flood-gates to similar applications the cumulative effect of which would be seriously harmful;
  • There is no stricter test for releasing a leasehold covenant compared with releasing a freehold covenant, i.e. a landlord does not enjoy a stronger position than a neighbour.

However, the UT refused to modify the requirement for the tenant to obtain the Council’s consent (as landlord) to underletting as this was not a “restriction as to user” (which it needed to be for the UT to have jurisdiction under section 84(12) of the LPA 1925).  The effect of this is that the tenant will still require written consent from the Council for every individual tenancy it grants of each of the 114 flats in the converted property!

Furthermore, the UT also found that the obligation on the tenant to use reasonable endeavours to keep the property fully let would extend to undertaking improvements if this was necessary in order to let it.

Every application under section 84(12) of the LPA 1925 will be judged on its own merits and in this instance the UT was swayed by the fact the capital value and returns were unlikely to be significantly different between office and residential use so that there was no significant benefit to the landlord Council in retaining the restriction on the use.

As in this case, if such an application is followed through and is successful, it can unlock leasehold land for development against a landlord’s wishes.  In light of this, the section is potentially very beneficial to developers looking to convert offices to residential use in light of permitted development rights and will, at the very least, provide a solid platform to negotiate from in order to avoid paying a premium.

Disclaimer

Cases of this type are likely to be fact specific and the type of application considered in this article will not be suitable in all cases.  The content of this article does not constitute legal advice and should not be relied on as such advice. The author and Bennett Griffin LLP accept no responsibility for any reliance placed on the content nor the continuing accuracy of the content.