Mixed-use developments: getting the structure right

What matters

What matters next?

In an uncertain market, there is often a renewed emphasis from investors not just on liquidity and rate of return on property investment opportunities, but also on the structuring of legal interests and the ability to ‘exit’ from a scheme. 

Investors are increasingly prepared to venture outside the traditional realm of office-led city centre schemes into residential and mixed-use projects, but there are inherent complexities to be worked through by those seeking to promote such schemes. 

In any development concerning a multi-let property, where the ultimate ambition is to realise capital value, thought needs to be given from the outset on sequencing and how a developer or investor can obtain a ‘clean edge’ - ensuring future custodianship of the property sits in the correct hands.

Multi-building, mixed-use schemes

Take an example of a multi-building, mixed-use scheme, which can be seen in most city centres across the UK. A common development strategy, beginning from a position of holding a freehold interest in the estate, is to twin-track long lease disposals of commercial buildings to institutional investors and residential units directly either to owner occupiers or individual investors. 

Typically, such an approach produces a diversity of interests in the estate and the individual buildings within it and ‘gaps’ of unlet parts, which remain with the freeholder. 

Consideration must be given at the outset to which party takes responsibility for the structure of buildings, common parts - both external and internal - servicing and insuring. 

In the case of a single office building sold to an institutional investor for letting, the answer is straightforward. However, where common amenities such as shared car parks, external open spaces and structures are involved, the picture becomes more nuanced. 

Management companies 

The traditional answer has been incorporating one or more management companies. 

The attraction is clear – an entity separate to the freeholder assumes responsibility for everyday maintenance of the estate and buildings, tenants ‘buy-in’ via shareholdings and all runs smoothly. 

In theory, this approach is simple. 

In practice, there is a degree of pre-planning, sequencing and administration that can be overlooked in the hurry to progress development and disposals. A failure to pre-plan can come home to roost.  

Manager of last resort   

In a lease arrangement involving a management company, the landlord will invariably covenant to perform repair, servicing and insuring obligations in case of management company default. This will be a requirement of both the landlord to protect its investment, and of prospective tenants of a building where it has not previously been operational. 

While attractive in the short to medium term, there are questions over how a developer or investor is willing to manage the risk of a management company failure? This is a burden, which in the absence of an appropriate release under Landlord and Tenant (Covenants) Act 1995, would not be released, even on disposal of the building.

Points for a developer or investor to consider, include:

  • Do they ultimately propose to exit the building and hand freehold ownership to a third party – if so, whom?
  • At what point do they intend to exit the scheme?
  • What degree of control does the developer or investor wish to retain over property management and any management company pending realising capital value in the scheme?

The answers to these questions will inform decisions that should be taken at the outset of development in order to formulate a plan, which can be documented and followed-through. 

Residential considerations

With a trend towards mixed-use and residential-led developments, developers and investors need to factor in residential tenants’ statutory rights to self-management, enfranchisement and pre-emption on disposals, such as those enshrined in Landlord and Tenant Act 1987.

For example, once a s.5 right of first refusal has arisen, it is a criminal offence for a building owner to not follow a s.5 process to give qualifying tenants the opportunity to acquire the building prior to any proposed third-party disposal.

A s.5 process can be a costly and time-consuming process that can be avoided with pre-planning for an ultimate disposal – e.g. a contract between the developer and management company or third party to acquire the freehold entered into prior to the threshold of qualifying tenants being reached.

Similarly, steps can be taken to ‘hard wire’ landlord releases under the 1995 Act at an early stage.

It is, therefore, critical to consider these matters early and in the round with a programme, disposal strategy and the ultimate goal in mind. 

Disclaimer

This information is for educational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given. © Shoosmiths LLP 2024.

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