Times of global crisis such as these are often a catalyst for accelerated social and economic change and technological development. The situation in which we now find ourselves is no different as we are seeing the wider effects of pandemic, climate change, recession and social injustice visibly informing commercial property investment decisions and how trustees (and their beneficiaries) strategise when it comes to managing their portfolios.
Priorities are changing and cross-generational expectations around investment outcomes are undergoing a paradigm shift; crudely put, for many it is no longer quite enough to secure income and capital growth in isolation without considering the wider, societal impact – both positive and negative.
This briefing identifies some key areas where the focus has shifted and has added greater complexity to the challenge of balancing the already sensitive matrix of competing fiduciary duties.
The emergence of impact investment is showing that these strategies are far more than a fad when it comes to decision making and, quite the opposite, they clearly chart longer-term horizons. For property investors and developers, this means having buildings, leases and tenants that are greener and cleaner and a greater sensitivity to creating a legacy of placemaking and sustainability. This trend is not just the preserve of the institutions and the pension funds – (U)HNW families, family offices and private capital also have these concerns in common, which of course makes sense in the context of wealth management and dynastic succession planning.
Tied into this are the political and reputational considerations arising out of the increasing transparency that comes with owning UK investment property, a lot of which involves the careful navigation through tightening AML regulation and the changes promised by the Overseas Entities Bill.
The anatomy of the dearly-held institutional lease has had to evolve to keep up with regulatory developments, with landlords putting tenants on the spot about working conditions, modern slavery and energy performance and tenants themselves making more demands of landlords in terms of environmental concerns, anti-corruption and anti-money laundering requirements. Stakeholders are managing their reputations through the lease – often a publicly registrable document – and who they choose to contract with, marking a shift away from pure covenant strength onto having a tenant mix with a more sustainable profile.
Impact investment and ESG in real estate
These terms are often used interchangeably but it is perhaps environmental, social and governance (ESG) factors that crop up more in the context of commercial real estate – both in investment management and development. These drivers are no doubt influencing decision making and, furthermore, are opening up alternative uses of land and shaping how that land is developed. This goes further than investors merely “greenwashing” their portfolios, although many will be future proofing against the inevitability of greater scrutiny over energy efficiency and the sharing of data relevant to that.
With a cross-generational wealth transfer estimated at $30tn set to benefit 75m millennials in the coming years, future generations of investors are likely to demand a more holistic return from their capital. Trustees will be preparing themselves for the pressures that will be placed on them to ensure that their investment decisions not only generate profit but also social gains, all the while with a firm grip on the legislative and regulatory framework. It is becoming increasingly apparent that pursuing one does not have to be at the expense of the other and the concept of ESG is likely to become a cornerstone of succession planning for years to come. Many trustees will however need to walk a tightrope between protecting their beneficiaries’ interests and making a positive social contribution, and it will take time and dedication to develop and implement strategies which enable these competing interests to be achieved.
For detailed commentary on a real estate view of investing in ESG please click here for the latest of our series of briefings on the subject.
Linked to the philosophy of using ESG to create sustainable and liveable communities is the concept of placemaking. This approach focuses on quality-led property development and building a legacy that benefits from the resulting built environment having an increased life span. Whilst this may well cost more upfront, the idea is that the prospect of capital growth will in turn be improved. For (U)HNW families involved in property development, there is something to be said for why this approach might appeal to those looking to secure long-term growth and to leave a positive social and environmental impact.
Farrer & Co and ADAM Architecture have produced an industry report, “Placemaking: a patient approach to creating communities”, that raises these questions and can be found here.
Transparency for UK property
The UK Government has committed itself to combatting money laundering and achieving greater transparency in the UK property market. As such, AML requests from counterparties are now commonplace on property transactions. Another key development is the (now closed) consultation on the draft Registration of Overseas Entities Bill (OEB). It is estimated that nearly 100,000 properties in the UK – that is, freehold and leasehold interests granted for at least seven years – are held by overseas entities. The OEB, when enacted as law, will create a publicly accessible register of those entities (similar to that found at Companies House listing persons with significant control) containing information on the entity itself and, crucially, its beneficial owners. The register will generate an ID number which will be shared with the Land Registry to process property transactions by entities with a verified ID number.
Controversially, if an entity has not complied with its registration requirements, its ability to deal with property will be restricted. This could delay property transactions and registrations if the register is not up-to-date and, as currently proposed, there will be criminal sanctions for non-compliance by beneficial owners or officers of the entity, or for attempting to make disposals which cannot be registered (although these may be replaced by civil penalties in the first instance).
There have been criticisms that the register could undermine the anonymity and even the security of beneficial owners. A link could quite easily be made between legal and beneficial owners, family members, lenders, and professional trustees – equally, there could be an impact on sensitive trust and matrimonial disputes.
Trustees who hold UK property will need to be mindful of these changes when they take effect. Even though the UK Government – perhaps due to other distractions – has not made any recent announcements on the proposals, there is already legislation in draft which was tabled to come into force in 2021. When it does, trustees will be well-advised to make sure the register is kept updated and, in any event, updated before any dispositions of land are made.
Landlord and tenant relations and the commercial lease
Relationships between landlords and tenants have been put under great strain by a pandemic that has left many commercial properties unoccupied. The past twelve months have seen a knee-jerk rebalancing of interests to protect businesses that operate from rented properties – embodied in statute by the swift enactment of the Coronavirus Act 2020 and its sections dedicated to business tenancies and their protection from forfeiture and, in the retail, hospitality, leisure and childcare sectors, relief from business rates.
But landlords themselves have had to react as well as the legislators. Tenants have, with varying levels of justification and success, requested rental concessions or variations to the rental structure in their leases to, say, a turnover rent model. The relevant statutes do not compel landlords to cede to these requests, but many landlords have agreed to relaxations, perhaps fearful of the spectre of that tenant entering into a company voluntary arrangement (CVA). CVAs, more often than not, mean less rent received by landlords and, in the case of last year’s New Look CVA, over 400 leases were subject to a request by that tenant to switch to turnover rents. Clearly, turnover rents will stay low for premises that are not trading.
With adverse market conditions and businesses failing, the question arises as to whether landlords really have the luxury of insisting on tenants with good governance or green credentials. An ESG-compliant tenant is of course not immune from insolvency but there is a noticeable trend towards the notion that a “good tenant” is more than one that simply pays its rent on time and in full, but also one with the right profile. This trend is being borne out not only in the drafting of new leases, but also in the mix of tenants preferred by landlords and how those tenants are using the land for more sustainable and more varied purposes.
The investment landscape has altered in that mainstay asset classes such as shops, offices, leisure and car parking are being challenged by alternative uses that are more geared up to deliver content directly to consumers, often in their own homes. We have seen an increased demand for data centres, telecoms sites, storage and distribution facilities, innovative agritech space and even TV production studios. Paradoxically, the scale demanded by the rise of the digital economy has brought with it new pressures on land use. The signs of this trend were all there in the days pre-Covid, but developments in this area have, largely by necessity, taken an unexpected jump forward.
For more detail on commercial leases in the time of COVID-19 please click here for the latest of our series of briefings on the subject.
The government announcement issued here on 10 March 2021 contains the following headlines on commercial leases:
- The moratorium on forfeiture is extended to 30 June 2021.
- Commercial Rent Arrears Recovery Provisions (CRAR) will be amended so the amount of overdue rent required for CRAR to be used must be 457 days’ rent if claimed between 25 March 2021 and 23 June 2021, and 554 days’ rent if claimed between 24 and 30 June 2021.
- There will be a call for evidence on commercial rents to see what landlords and tenants are agreeing and to ascertain what further support the government could provide.
- Intention to carry out a wider review of commercial rents and the Landlord and Tenant Act 1954 later in the year.
If you require further information about anything covered in this briefing, please contact Fred Lee or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2021