Residential tenants benefit from a range of statutory rights, many of which can apply to both residential and mixed use developments. It is important to consider these at the commencement of a mixed use development, in order to ascertain whether they will apply and, if so, whether any steps can be taken to avoid or minimise their future effect.
Whilst the changes to ground rent charges introduced in The Leasehold Reform (Ground Rent) Act 2022 may impact the market for ground rent disposals, the tenants’ right of first refusal under the Landlord and Tenant Act 1987 will be an important concern for developers on a mixed use or residential scheme in terms of its impact both on the setting up and ongoing management of the scheme.
Assuming that the development once developed and let will constitute “qualifying premises” for the purposes of the Landlord and Tenant Act 1987, the tenants’ right of first refusal will be triggered by a “relevant disposal”. The grant of a lease of a single flat is an exempt disposal, so will not trigger the tenants’ rights. There is no exemption for the grant of a commercial lease.
Whether or not the tenants’ right of first refusal will arise on any “relevant disposal” of the whole or part of a new development will depend on its timing. Where there is a split exchange and completion, the “disposal” for the purposes of the Landlord and Tenant Act 1987 will take place on exchange of contracts, rather than completion.
The Landlord and Tenant Act 1987 only applies to premises which contain two or more flats held by qualifying tenants. If a disposal takes place before the second flat has been sold or let, the disposal will not be caught by the Landlord and Tenant Act 1987. If the disposal occurs at a later stage in the development, the Landlord and Tenant Act 1987 will apply if both of the following conditions are satisfied:
- The building has reached a sufficient stage in its construction to be a “building” containing “flats”. This will be a matter of fact and whilst the term “building” is not defined in the Landlord and Tenant Act 1987, it is likely to require at least walls and a roof.
- The building, or relevant part, contains two or more flats held by qualifying tenants and the number of qualifying tenants exceeds 50% of the total number of flats contained in the premises.
A landlord’s ability to avoid the tenants’ right of first refusal under the Landlord and Tenant Act 1987 is very limited, especially in relation to existing developments. It is generally much easier to put in place avoidance at the commencement of a development, before there are premises which qualify for the purposes of the Landlord and Tenant Act 1987.
Structures that may be considered in relation to new developments include:
- Entering into an agreement to sell or a forward sale prior to or during the development. If a developer intends to exit from the development as soon as it has been constructed and let, it may prefer to line up its purchaser at an early stage. If an agreement for sale is entered into before there are qualifying premises, then it will not be caught by the Landlord and Tenant Act 1987. Completion of the sale will then be exempt, as it will be a disposal in pursuance of a contract, option or right of pre-emption binding on the landlord;
- Granting a headlease of whole or part, prior to commencement of the development. Inserting a headlease between the freehold and the flat leases will usually mean that the freeholder is no longer the landlord for the purposes of the Landlord and Tenant Act 1987, with the result that, following the grant of the headlease, it will be able to dispose of the whole or part of its interest without first offering it to the qualifying tenants. As the disposal for the purposes of the LTA 1987 takes place on exchange of contracts, a binding agreement for lease entered into with an identified tenant before the premises qualify for the purposes of the Landlord and Tenant Act 1987 may be completed without triggering the right of first refusal;
- Ensuring that the premises are held in a special purpose vehicle, so that the premises may be sold by way of a share sale.
- Including sufficient non-residential space within the premises. With a mixed use development, it may be possible for a landlord to alter the proportion of commercial premises so as to ensure that it exceeds 50% of the internal floor area.
- Limiting the number of qualifying tenants within the premises. This may be an expensive and difficult process but it may be possible for a landlord to alter the tenant profile within the premises, to reduce the number of qualifying tenants and thereby ensure that there are insufficient qualifying tenants for the premises to qualify under the Landlord and Tenant Act 1987.
