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Private Rented Sector & Build-to-Rent: Legal Pitfalls

06 June 2019
Real Estate Sector

Welcome back to our series of articles on the Private Rented Sector (PRS) and Build-to-Rent (BTR).  In our previous edition we discussed the current political landscape and recent changes to legislation which have been impacting on the PRS and BTR markets.  In this edition, we will cover some examples of legal pitfalls and how to protect long term investment strategies.

Protecting Exit Strategies

One of the greatest aspects of the BTR product is that it is already something else.  On any given day, you could cease offering short term tenancies and start marketing the units for sale with (what should be) minimal fuss.  Assets which have been set up correctly should be able to switch easily, or at least have a navigable path to follow.  Depending on the design, any additional facilities (e.g. gym/pool, bars etc) could either be spun off and let to third parties as a separate business or added to the remit of a management company.

In our last article we highlighted some of the difficulties and uncertainties which may be coming down the road for the BTR sector and having a contingency exit plan gives a very high level of flexibility (more good news for the investors).  However, anyone who has been involved in the plot sales process (or buying/selling houses generally) will know there are innumerate spanners which can be thrown into the works so again the setup is key.

 

CML Compliance

Keeping in mind the requirements of the Council of Mortgage Lenders Handbook is important when acquiring or developing PRS/BTR assets.  What may be an acceptable risk to a developer or institutional funder may fall foul of high street bank lending where the computer can and often does 'say no' or otherwise requires conveyancers to take on the risk of confirming all is well.

In another vein, if you are taking out insurance policies (sometimes mistakenly viewed as the cure rather than risk mitigation) it needs to be considered whether the policy wording is sufficient to cover the alternative structure, even if the actual use of the building in practical terms may not change. It should also be considered whether policies are capable of being splintered if required and what the likely additional cost may be to achieve that.

 

Overage

Overage can be used as a tool in negotiation.  Offering up an overage stream can be dressed up as a protection for a seller or freeholder where they have any doubts about the true intention of a development.  If there was any cynicism then overage provisions could be drafted to bite on the grant of long leasehold interests and therefore not affect the BTR model.  However, this will impact on the viability of switching to a sales model and the further down the road you go, the higher the overage might be.

With BTR being relatively new there is in most cases going to be plenty of room to disagree on likely returns and possible revenue streams.  With that being the case, it's quite common to find overage attaching to a scheme, much to the consternation of those holding the purse strings.  Overage isn't irreconcilable with a BTR deal but does require some additional care.  Widely drafted wording around the grant of tenancies could possibly catch Assured Shorthold Tenancies which may have a devastating effect if the intent was only to relate to long leasehold grants (i.e. the typical sales model).

Further thought on what might and might not be acceptable to a prospective buyer of the asset needs to be given and how the risk of it being unacceptable can be addressed.  An option to buy out the overage at a given point might be one way to go.

 

Ground Rents

Ground rents may be on their way out as far as residential owner-occupier premises are concerned but in all other instances it still appears fair game. If the investor is liable to pay ground rents dependent on the number of units it holds then would those rents not then be passed directly on to the occupiers?  It still seems at odds with the principles being deliberated by politicians.

 

Collateral & New Home Warranties

You can never really have too many collateral warranties. Most BTR schemes will be structured around multiple parties (DevCo, PropCo, OpCo etc) and it doesn't hurt for each of them to have a route to claiming loss against deficiencies in the physical building.

Unfortunately we have seen examples where one party has incurred costs of remedying physical defects without the benefit of its own collateral warranties or being able to rely on any third party rights.  Plans to assign warranties between the parties could be one way of dealing with it but could be scuppered (and was in the instance described) by the limited number of assignments available.

Thoughts of NHBC, LABC, Premier etc (other guarantees are available!) can easily be banished from the mind when considering a BTR scheme. However, if the practices required in order to obtain those policies are followed then it is possible to obtain policies for the units and common parts retrospectively so it can still form part of a contingency plan where units are sold individually.

 

Sign-off

DWF in an international legal business, acting for a large number of PRS and BTR investors and developers on schemes and assets all over the UK. Please feel free to speak to one of our real estate specialists below for more information.

Further Reading

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