Cities

Commercial to Resi – Will this trend continue to boom?

by mjdhughes

In this ongoing series, Property Investor Today will explore whether commercial to residential conversions – one of the biggest trends during the pandemic as the high street and offices have suffered more than most – will continue now that life has returned to something closer to normal.
Here, in part 1, we check in with two experts in their field for their thoughts on why the trend has emerged and how much legs it has moving forward.

Mike Hughes, Propertymark Commercial Chair

Commercial to resi has become a major trend – but is it only temporary?

Converting commercial property to residential property has always been a popular option for developers. Many commercial properties are conveniently located and occupy larger plots than existing residential plots. Add to this the car parks for existing retail, restaurants, pubs and other commercial units and this makes a change of use a financially attractive proposition for many developers.

How is commercial property faring now compared to the worst days of the pandemic?

Commercial property has fared better than most agents felt it would suffer throughout the pandemic. Business rate holidays and reductions together with the relaxation of rent costs have helped many operators. Existing owners have seen a reduction in income from lower rent, but this has been the same for all landlords. Property has continued to move, if at a slower rate of sale, but tenancy options have tended to be stagnant. Even this trend has been challenged with many smaller properties being attractive to those people who have looked for a change of direction post-pandemic and started their own business.

Are more commercial to resi conversions inevitable as offices continue to operate at lower or no capacity, and some parts of the high street continue to suffer?

Nothing is inevitable, and less so with development and change of use. The recent amendments to the planning act introduced by the government have not been attractive, and after the recent reshuffle are now on hold. Landlords are appearing to wish to keep existing tenants, even if this means lower rents, rather than test the market by putting properties on the market hoping for quick wins by selling to hungry developers. Many offices are not located in sites attractive to residential occupation (out of town office ‘parks’, etc). There is definitely the possibility for change of use, and maybe this could even be to warehouse storage as e-commerce increases. We are not yet seeing a rush to this, though.

City centre high streets are definitely suffering. Big names are abandoning the large city-centre sites, but agents are advising that market towns and many suburban high streets are flourishing with very little vacant property. Change of use can take a considerable amount of time to confirm with planners. This means that money is tied up for developers unless they have a clear timescale for the development.

Are mixed-used schemes, combining commercial and residential in the same development or project, a better compromise than just straight-up commercial to resi conversions?

This is a solution that would energise many town and city centre streets that have high pension fund ownership. Currently, these pension funds invest in commercial only, making the upper floors of retail units in many established high streets unlettable for residential use. A change to this would mean more inner-city/town living and solve issues relating to housing and bring life to areas after dark.

What are some of the challenges associated with repurposing commercial properties?

Many commercial properties require a complete refurbishment which is costly. For many, it is cheaper to knock down the property and rebuild. This means high development costs and lower profit for developers. Such developments are then unattractive. Added to this, many local communities do not want to see the loss of facilities. Pubs, cinemas, and shops have all seen recent opposition to change of use based upon the loss of the facility. The bottom line for any developer wishing to change the use of a property is that the change makes better economic use of the property or plot. With added costs, for whatever reason, this makes each proposed development a finely balanced decision.

Steve Jacob, CEO of Fabrik Invest

How easy is it to convert commercial premises into residential?

The ease of converting commercial premises really depends on the commercial property. B1 office to residential is a regular use class change, but listed buildings are tough to convert, as are those in conservation areas, as you need certain sign offs. That said, it can still be much quicker to get hold of a commercial building and convert it to residential accommodation than to build from scratch. If the layout is simple, then you can send in a fit-out team to put stud walls and electrics in, which can be a lot quicker and a lot more cost-effective. I’ve done a lot of commercial to residential conversions. I like getting buildings subject to planning and then sometimes flipping the building and sometimes developing the building out. There’s always a lot of potential.

What are the rewards and potential risks?

You can buy some really great assets when you look at commercial properties. For example, I recently bought a bank that I’m going to do up and turn into three apartments. It’s a superb building in a great location – banks tend to be built really well. The reward for me there is that I’ve got a bit of a trophy asset in a good town, with excellent potential. The risk is that it’s in a conservation area, so planning was slow, which meant I had to sit and watch development costs increase while I waited. The potential risk of development is always construction. Construction is risky. You need to find a good contractor and to limit any potential for issues to arise during the construction phase. The main reward is, of course, the financial gain that you can make on the property.

Is converting existing stock more sustainable and eco-friendly than building new homes?

With a new build, you can ensure that all of your materials and your whole supply chain is eco-friendly, as well as the build process, so that’s probably the more sustainable option. That said, there’s a huge amount you can do with conversions to make them more eco-friendly. You can have solar panels, powerwalls, biomass boilers…there are lots of ways in which you can make a conversion eco-friendly.

Are there certain commercial premises that are easier to convert than others – for example offices being easier than a former restaurant or bank?

Certain commercial premises are easier to convert than others. It largely comes down to the shape of the building. You don’t want too many jagged corners or a building in the shape of a hexagon or an octagon! The squarer a building is, the better. A building that’s a funny shape can be a real pain. Much also depends on where the stairwells are in the property. If you can utilise an existing staircase or a lift shaft, that can save you a lot of money. As a developer, the more symmetrical the development is, the lower the cost. If you can use a cookie-cutter template for your apartments, it’s going to cost less than having to deal with different size kitchens, different shape bathrooms and so forth. The more symmetrical the property, the more value you can squeeze out of it and the more you can save on tradespeople’s time.

This trend has exploded since Covid, but is enough support being provided to make it a long-term viable strategy for developers and investors?

I think there’s enough support. The government is trying to make it easier to convert properties, although planning is extremely painful! I think if they stop printing money, it will make it a lot more of a long-term viable strategy, because it will slow down inflation. They need to taper quantitative easing, but then will that create a correction within the market? The thing that’s killing developers at the moment is the constant rise of construction prices. Developers have got to really fight to get these projects through and it’s very hard when your construction prices keep going up. Construction companies keep changing their pricing. Inflation is going to be the biggest killer for developers over the coming years, I would imagine.

What else should developers/investors know?

If you’re doing any kind of commercial to residential conversion, always obtain a ‘subject to planning’ contract. It protects you. I don’t buy things that are unconditional. The only time I’ve ever done that, it’s been frustrating and stressful. I’m a great believer in the commercial to residential strategy. I’ve got plenty of those kinds of deals in the pipeline and now we’re working alongside institutions and funds it’s even more fun than it used to be. Long live commercial to resi conversions!

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Covid-related legal protections for Commercial Tenants in arrears of rent in England

by mjdhughes

Landlords of commercial property in England face further extensions to temporary laws that protect their commercial tenants from specified legal actions against them to recover rent arrears – and a new and unexpected ringfencing and arbitration procedure.

First, the temporary moratorium against forfeiture of a lease for non-payment of rent has been extended by nine months, until 25 March 2022. Under the moratorium, commercial landlords cannot forfeit a business tenancy for non-payment of rent if the non-payment is due to COVID-19.

The government has also extended the temporary restriction stopping landlords from bringing Commercial Rent Arrears Recovery (CRAR) proceedings against commercial tenants in arrears, until 25 March 2022. When they apply, CRAR proceedings permit landlords to give a notice to pay to tenants whose arrears have reached a certain level. If the tenant does not comply, the landlord can seize the tenant’s assets and sell them at auction.

Third, the temporary prohibition stopping landlords from using statutory demands against commercial tenants who are in arrears of rent because of COVID-19 has also been extended again, to 30 September 2021. Ordinarily, if a landlord serves a statutory demand for arrears and the tenant fails to pay within 21 days, the landlord becomes entitled to petition the court to have the tenant wound up.

In addition, and unexpectedly, the government has said it intends to bring in new laws that will ‘ringfence’ arrears of rent that have built up during the pandemic. Once COVID-19 restrictions are lifted, landlords will need to make allowance for them and share their impact – for example, by making an agreement with their tenant to waive part of that amount, or accepting a long-term repayment schedule.

If they fail to reach such an agreement, an automatic, legally binding arbitration procedure will apply, presided over by approved private arbitrators. No detail has yet been given as to the approval criteria for arbitrators, or which factors they will take into account when deciding whether, when and how a landlord will be allowed to recover all or any of the outstanding rent.

This appears to go against the previous government approach, which was that unpaid rent during the pandemic would become payable in full after the pandemic ended.

Kirsty Jackson, Head of Commercial Property at Ramsdens commented: “Commercial landlords should review their budgets and processes, and consider whether to take specialist advice, as a result of the further extensions and particularly the proposed new ringfencing and arbitration process.”

 

Business

With one quarter rent day just gone what looms for commercial landlord and tenant relationships?

by mjdhughes

‘Propertyweek’ the respected journal for property industry has reported that experts are predicting as few as 10% of commercial property tenants will pay their rent this quarter. The article, that subscribers can read in full, actually claims only 10% of rents will be paid. If we look at this another way maybe the prediction is for more tenants paying but only part of their rent? Time will tell. This second possibility would certainly make sense. With businesses hit hard from retail to office, and leisure to industry, paying some rent rather than all will help to pour oil on troubled waters between the historically fractious relationship of landlord and tenant.

Landlords need tenants, and tenants need landlords who will work with them. This is true of the current situation and also for the foreseeable future. Maintaining a cordial relationship can only help both sides in the long run.

The High Street has been on a downward spiral for many years and certainly since the credit crisis of 2008. Leisure and hospitality has fared no better as operators open and fail with concepts that consumers quickly tire of. Both sectors went into the covid-19 crisis with few reserves and rents that were based upon a performance that was impossible to achieve. The size and space in a unit  was used to calculate how many consumers could pass through the doors, and spend per head was the key to maximising the value for the tenant operator and by default the rent that could be paid to the landlord. Space remains key to the sustainability of a business, but with social distancing the value plummets as one consumer can take up 4 square metres. Compare this to 1 square metre and 25% of historical trade levels becomes a reasonable expectation.

A quarter of the turnover of a pre-covid operation sounds bad enough but with furlough and possible redundancy the experience of most customers, savings and overdrafts will have been delved into during the lockdown and expendable income must decrease at the very best for the short term.

Propertyweek spoke to many of the movers and shakers of the property world and has come up with some chilling quotes for our time:

When commenting on the low level of rent collections, Vivienne King, the CEO of Revo commented, “If that is the case, it will have severe implications for property owners, their lenders and ultimately pensioners and savers who rely directly or indirectly on retail property for income. These are unprecedented times, but despite the lockdown measures those businesses that can pay, should pay – and those property owners that can support businesses genuinely in distress, should do so. Whilst reinforcing the contractual obligation, this is what the Government’s Code of Practice expects.”

Robert Hayton at Altus Group thinks that the rent collected by landlords will be as low as 10% of what would be expected, “Occupied retail, leisure and hospitality premises in England have received a business rates holiday during 2020/21 worth £10.13 billion but landlords have largely been overlooked despite being asked to play their part by waiving or deferring rent to help their tenants survive. It is only fair that there is tax parity and that the rates holiday is extended to those properties vacant and to let.”

The importance of landlords and tenants working together was commented on by Melanie Leech, chief executive of the British Property Federation, “For any business that is concerned about how it is going to meet its rent obligations, I urge you to refer to the Government’s code of practice for commercial real estate, published on 19 June, as a way to engage with your landlord. Businesses in genuine need of support will find landlords wanting to offer what support they can, and a range of possible options in the code – including flexibility around rents and other lease terms could include moving from quarterly to monthly rent payments and providing rent deferrals or payment holidays, depending on individual business’ financial circumstances.”

No one will be the winner if tenants fail due to rent demands and landlords have to sell due to a sharp decline in  their returns. Some tenants think this is a golden opportunity to buy the property they rent and end throwing money down the drain when they could own the property. This is a naïve way to think as history has shown that this is not the outcome of such circumstances. If landlords find their only option is to sell the property  it will go to the buyer with the biggest and easily accessible source of funding. The result will be that the tenants still need to pay their rent but to another landlord. This new landlord, having bet on a certain level of return will not be as flexible as the existing landlord who can appreciate the tenants business and the relationship of landlord and tenant has already been established.

We should all be careful for what we wish for.

Business

Pubs and restaurants reopening 4th July 2020 – Government Advice

by mjdhughes

England only! Northern Ireland will be implementing a re-opening in early July with Scotland and Wales yet to confirm dates.

Information relating to the reopening of Pubs, restaurants and other sectors of the hospitality industry can be found at the following link:

https://www.gov.uk/guidance/working-safely-during-coronavirus-covid-19/restaurants-offering-takeaway-or-delivery?

If you are a pub or restaurant operator and have any specific questions relating to your own circumstances please contact us directly at info@mjdhughes.com