The commercial property investor and residential tenancies

Most property investors occasionally deal with properties subject to residential tenancies. Politicians have naturally interested themselves in the housing market, and the result if a raft of rights for tenants and duties for landlords. This is the first of three articles, intended for those with little familiarity with the residential sector, that briefly survey the legislation affecting the relationship between a landlord and a residential tenant.

The first deals with pre-emption and enfranchisement rights available to tenants holding "long leases" - those with a fixed contractual term of ver 21 years at a low rent, referred to as qualifying tenants. The second deals with service charge regulation and the rights given t o tenants who may be suffering bad management. The final article considers the protection that tenants of short leases enjoy, be it in the form of security of tenure, rent control or limitation of repairing obligations.

Tenants' rights begin to bite an investor even before it has purchased a freehold interest. By virtue of the Landlord and Tenant Act 1987 in certain circumstances tenants benefit from a right of first refusal to purchase an outgoing landlord's interest. To succeed, qualifying tenants must pass the following tests: the property being sold must consist of the whole or part of a building; at least two flats must be held by qualifying tenants; the number of flats at the property held by qualifying tenant must be more than half of the total number of flats; and if part of the property is intended for non-residential occupation, then that part must be leas than half of the internal floor area of the whole. This last test particularly confronts the commercial investor: It can catch buildings that comprise office or chops with flats above. Where the tests are met, it is a criminal offence not to offer the freehold of tenants.

A complex procedure must be observed - and one that over the years has proved to be far from perfect. Piecemeal legislation has gradually improved it. In brief, the landlord must offer to sell the freehold to the tenants on certain terms. If the tenants do not accept those terms, the disposal of the freehold can proceed, but only if it was on the same or better terms than offered to the tenants. In some cases, tenant with "short" tenancies may benefit from the right as well as tenants under long leases.

Tenants of a block of flats may in certain circumstances become entitled collectively to acquire the freehold from the landlord at market price. A sufficient number of tenants must satisfy tests of ownership and of residence of the property before this right can be exercised, and the right only arises in respect of buildings where the floor area of non-residential part does not exceed 10% of the whole.

It is also possible for individual tenants of flats to extend their leases by 90 years on payment of a market price. In such cases, the new leases are on the same terms as the old leases, except that the rent is nominal. The residence test here is tougher in that occupation of the flat as the tenant's only or principal home must be proved fro three years over a ten-year period. Company tenants cannot pass this test but the rules have been relaxed to permit beneficiaries under trusts to do so.

There is a further right for tenants of "houses" to purchase the freehold. A "house" needs to be detached, but no part of it may lie above or below another property. There are other technical requirements. Alternatively, the tenant may apply to extend the term of the lease by 50 years.

When a lease is "married" with its freehold some value can be released because the whole is worth more than the two component parts. The statutory valuation process is advantageous to the tenant - sometimes considerably so. Specialist valuation advice should be sought in every case.

The complexities of the rights of enfranchisement and leasehold extension have had a number of consequences. The rights are not well understood and therefore often not taken up. Collective enfranchisement has been a failure because it is complicated and requires a disparate body of tenants to act efficiently and in harmony. This has lead to lease extensions being much more popular, thereby perpetuating leasehold tenure rather than reducing it as had been intended. The Government has recently undertaken a consultation exercise and aims to simplify the process.

At the end of a long lease, the landlord may be obliged to grant and assured tenancy to the tenant in possession. While such tenants are entitled to security of tenure, the landlord has at least the advantage of being able to charge a market rent.

This note is intended to provide general information about developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained. If you would like further information or specific advice, please contact Macfarlanes.