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Attractive leases – structuring for freehold reversion sales

Thu 27 Nov 2014

Various factors can be taken into account at site-set up which will make a development more attractive to a purchaser of the reversionary interest of the freehold. Bearing these in mind will avoid price chipping, delay and due diligence problems when completing the sale of the freehold.

A key factor to consider ensuring the smooth running of the sale of the reversionary interest is the structure and drafting of the plot lease. This article looks at tips to ensure there are no issues in the plot lease that would cause concern for a subsequent purchaser.

Recovery of service charges from tenants

One of the main concerns for a freehold purchaser is that all costs associated with the development are included in service charge provisions and payable by tenants.

If there are gaps in the coverage of service charges, grey areas, or any risk that the freeholder may be liable for, a purchaser will look for indemnities or payment for possible liabilities.

To avoid this, service charges should preferably be referred to as a fair and reasonable proportion, rather than a set percentage. If a percentage is used this should be clearly stated as being able to be amended by the management company or landlord (acting reasonably) at any time, not only on the re-planning of the estate. It is important to ensure that the service charge percentage covers 100% of all service charges and to ensure that any deficit is not payable by the management company or landlord.

The services should include a general provision that includes all costs required for good estate management (or similar, also known as a sweeping clause) and include inherent structural defects. Services should also include all costs associated with any title covenants or other matters affecting boundaries of the estate etc. Another factor to bear in mind is compliance with specific title covenants in relation to maintenance of a boundary or an access way and to state clearly that these are recoverable from tenants and included in the ‘estate’ as defined in the plot lease.

Income and Rent

Clearly one of the most important covenants to ensure is correct is the covenant to pay rent. The final signed leases should state a single figure, not a range of rents depending on the number of bedrooms. If rent is to be reviewed this should be stated as upwards only and the review mechanism should be clear. The commencement date of the lease should be one date in all leases (not stated as the date of the lease) so that review periods for all leases of the development are the same. Rent should be payable if demanded or not.

It is vital that rent is payable to the freeholder. Older plot leases, drafted before the increase in value of the freehold reversion, may state rent is payable to a specific management company and the management company pays rent to the freeholder under a headlease arrangement. If the management company goes into default, the freeholder is at risk of not being able to recover rent directly from tenants.

A rent cesser clause states that if the property is damaged, the tenant can reduce the rent payable proportionate to the damage until fixed. If this clause is included, the lease should also include the ability for the landlord to recover the cost of loss of rent insurance from tenants and should be included in the list of insurable risks.

Many valuation calculations will include the ability to place buildings insurance and if possible the landlord should have the right to insure, or to nominate the insurer.

Landlord Covenants

A purchaser will look to carve out of the covenants contained in the freehold transfer any landlord covenants that relate to development, such as adoption of roads or sewers. It will make a smoother due diligence process to state in the lease that these only apply when the developer is the landlord.

Plot leases will often contain a restriction in favour of the landlord requiring consent for any transfer of the leasehold title. If the restriction is linked to the specific developer, all restrictions on all leasehold titles need to be amended to the new freeholder on completion. This is a step that may be easily missed and creates ongoing problems for tenants when units are transferred at a later date. Any restriction should be stated as benefitting the current owner of the reversionary interest.

Retaining information

During construction, retaining or obtaining discharges of all planning obligations or S106 obligations is essential. This includes instructing architects etc to chase the relevant local authority for written confirmation of discharges, and keeping these where obtained. Any third party confirmations that these are satisfied will help the freehold purchaser’s due diligence process and will help avoid the Developer being asked to give indemnities or retentions for funds that cannot be shown to have been paid.

Purchasers will want to see any environmental reports, flood reports or remediation reports that are provided to a local authority during the construction phase.

While it is standard practice, Developers should ensure that all NHBC information is retained.

Where any payment for void service charges is made (payable by the landlord for unsold units), obtain evidence from the management company that the account has been cleared.

By retaining as much information as possible during development, and ensuring that the plot leases contain the above provisions, the freehold purchaser’s due diligence process will be simplified, reducing costs and resulting in a quicker sale of the freehold reversion.

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