Real Estate talking points for 2021

Introduction

There is no doubt that 2020 has been a year that no-one will forget. As CBRE highlight in their Market Outlook for 2021 hardly any area of economic or social activity has been untouched as governments all over the world try to control the spread of the COVID-19 pandemic.

During 2020 we have seen how lockdown restrictions and social distancing measures have affected businesses, particularly in the retail and hospitality sectors. We have also witnessed the dramatic shift to remote working and the continuing rise of e-commerce. As we come out of the pandemic we will begin to see the long term structural impacts that the pandemic may have on commercial real estate in the UK.

Many employees have seen the benefits of working from home and may well want to continue doing so, either on a full-time or part-time basis, even when COVID-19 restrictions are relaxed. There are clearly advantages in bringing staff back to the office in terms of greater engagement with colleagues, the supervision of juniors and so on, although these should be set against factors such as the potential saving in office costs where staff work from home. We discuss below how demand for office space might change going forward and what this means for landlords and tenants.

It is clear that logistics and data centres will continue to go from strength to strength in 2021 and we have identified some of the key themes for the logistics sector in 2021 here and of course the retail and hospitality sectors will still face challenges in 2021. We also discuss this in more detail below.

The Government recently announced that the current ban on commercial evictions, the ban on exercising CRAR and serving winding up petitions will continue until the end of March 20201 and whilst these measures will give struggling tenants further breathing space it does not change the fact that the rent remains payable and, in many cases tenants, particularly those in the retail and hospitality sectors will have built up substantial arrears since March of this year. 

Is this therefore simply a case of postponing the inevitable? If the moratorium ends in March 2021 (as expected) tenants will still need to address any rent arrears. This may mean that we will see a spike in tenant insolvencies at this point. Tenants should be actively engaging with their landlords where they have not already done so. To date, where tenants are struggling the majority of landlords have shown flexibility and agreed temporary rent concessions or deferments. However it does remain the case that in a minority of cases tenants who can pay their rent are simply choosing not to pay and so taking advantage of the eviction moratorium. Whilst landlords are prevented from exercising certain remedies until 31 March 2021 this are still a number of options remain open to landlords to recover rent. These include debt proceedings, recovery from guarantors and drawing down rent deposits. It is clear that many landlords have already started to use these remedies.

While no-one wants to see a tsunami of insolvencies, the reality is that insolvency proceedings are a necessary part of a well-functioning economy. However until the government COVID support measures are phased out, we can expect the economy to be burdened with a growing number of corporates which may no longer be commercially viable. Our hope is that in March, a more nuanced approach can be taken to provide tapered support where it is justified, but in a way that allows the insolvency regime to function properly to start to clean up the so-called 'zombie companies' and alleviate some of the growing economic pressure on other commercial stakeholders, including landlords and property owning businesses. Our Ashurst colleagues discuss this issue further here.

Whilst the extension of the moratorium on evictions was expected we were not necessarily expecting the Government to announce a wholesale review of commercial landlord and tenant legislation in 2021. Mr Jenrick has taken the opportunity to state that the Government is proposing to "review the outdated commercial landlord and tenant legislation to address concerns that the current framework does not reflect the current economic conditions". 

The aim of this review is to improve the leasing process and enable better collaboration between landlords and tenants. We do not have any detail as regards the scope of this review but it appears to have a broad scope and will look at forfeiture (which was considered by the Law Commission in 2006) and the security of tenure provisions in Part II of the Landlord & Tenant Act 1954 Part II, different models of rent payment, and the impact of Coronavirus on the market. The Government's commitment to such a review is welcome provided this is done in a balanced way and draws on the excellent work that the Law Commission has already done in this area.

So, let's take a more detailed look at some of the key themes we have identified for commercial real estate in 2021.

The death of the office?

There has been a great deal of publicity heralding the death of the office as a result in the surge in remote working driven by the pandemic but this does not take account of the benefits derived from employees coming together in a physical space. There is no doubt that remote working is here to stay and as a result office occupiers may have different priorities for their workspace. However the office sector can adapt to changing occupier requirements. Collaboration between owners and occupiers can bring about a re-imagining of the traditional office and create resilience in this asset class going forward as we emerge from the pandemic.

Covid has accelerated changes that were already happening to some extent. Employers were already thinking about how they could adapt office space to encourage greater innovation and collaboration. This may mean less space allocated to desks and more flexible space for meetings and team or project collaboration and better-designed workspaces will be a significant factor for employers adapting to the changing work patterns of their staff. 

At the moment we are guessing at how remote working will sit alongside office working in the post pandemic world. We are seeing both sides of the space debate. More people working remotely requires less office space vs those people working in offices will require more space per head. There is no doubt that decisions on space take will be delayed in this period of uncertainty. As we saw prior to the pandemic, flexibility will drive those decisions in terms of both physical configuration but also length of lease term and the ability to upsize and downsize. We have seen a number of landlords successfully providing their own offer of flexible work space and we are likely to see more of that space being delivered in the short/medium term.

In conclusion offices are likely to remain a key feature for businesses. However leasing terms are likely to be more flexible and there will be more emphasis on how the physical space supports the health and well-being of its occupants.

Is the digital revolution set to continue?

Back in March when we faced lockdown 1 it was apparent that we would face logistical difficulties in completing real estate transactions. This was exacerbated by the fact that HM Land Registry, at that time, were insisting on wet ink signatures for registrable deeds. However, despite this the use of electronic signatures for non-registrable documents increased dramatically. It was probably fortuitous that the Law Commission had confirmed in its 2019 report that an electronic signature is capable in law of being used to execute a document, provided that the person signing the document intended to authenticate it, and that formalities relating to the execution of that document are satisfied. So, it was very welcome news indeed when H M Land Registry announced in July this year that they would – until further notice – accept registrable deeds which were signed using simple electronic signatures provided the parties to the deed followed H M Land Registry's specific requirements as set out in Land Registry Practice Guide 8.

Digital signatures and digital signing platforms are fast becoming part of the solution in organising remote signings; However it is important to follow proper procedures to ensure that they are legally robust. Our article here discusses the issues in more detail.

It is worth noting that this is not just about the here and now. H M Land Registry is driving innovation in the property market through its "Digital Street" project and achieving a long-term, sustainable and secure means of signing property transactions would be the next component of a wholly digital conveyancing process. Hence H M Land Registry have announced their next step in the digital transformation journey is to allow the use of Qualified Electronic Signatures because they have added security and will enable joined-up and automated processing elsewhere in the transaction.

The Law Commission is also continuing its work in this area. On 17 December 2020, the Law Commission published a call for evidence on smart contracts. The call for evidence seeks views about, and evidence of, the ways in which smart contracts are being used, The law Commission is aiming to focus on uncertainties and gaps in the law and to identify potential areas for law reform. This call for evidence closes on 31st march 2021.

What is the future for the High Street?

Company voluntary arrangements were already a feature of the retail landscape before the pandemic, often proposed by struggling retailers to reduce rental overheads and close unprofitable stores. Some of these CVAs were ultimately unsuccessful in staving off insolvency, despite the CVA, and the retailer subsequently went into administration. Landlords suffer twice if their tenant becomes insolvent and they are unable to re-let the property: they not only lose the rental income, they also become liable for unoccupied property rates. It is no surprise that COVID-19 has led to an increase in retailer CVAs. What has emerged is the increasingly common but controversial proposal for the CVA to impose turnover rents on landlords. This was a feature of the recent New Look CVA which had been approved by creditors, and included provision for 400 of its store rents to be linked to turnover. However, some landlords who believe that they have been unfairly prejudiced by the terms of the CVA have lodged a challenge and this is likely to come before the court in March next year.

During the pandemic the number of requests from retail tenants for turnover rent arrangements on new lettings and lease re-gears has increased on a temporary or more permanent basis. But this is not just a sudden change due to the COVID-19 . This shift has been evident for some time as the high street grapples with the challenges it faced before the COVID-19 restrictions began in March.

Proponents argue that turnover-based rents are the future, as they align retailers' and landlords' interests so both parties are invested in the success of the tenant's business. Although not new, a turnover-based model has become more attractive after the onset of the pandemic as retailers search for a solution to get them through the crisis and landlords need to attract tenants take up some of the increasing amounts of empty space. Landlords have traditionally been reluctant to commit to turnover leases in the long term as they depend on a secure income stream. To mitigate this landlords frequently require a guaranteed minimum base rent with a turnover top-up. However turnover leases are not necessarily a "one size fits all" solution. The is further complicated by the difficulty in effectively capturing a true representation of turnover in an "omnichannel" retail environment where the physical store operates as a showroom and consumers make their purchase online or take advantage of click-and-collect.

There is also the problem of more vacant space on the high street and the lack of demand for that space. As a result we are now seeing more activity around repurposing vacant space with local authorities very keen to see boarded up high streets brought back into use. In September we were greeted by substantial changes to the Use Classes Order 1987 which are designed to meet the changing needs of the high street. Further details can be found in our briefing here. The implementation of these changes was overshadowed by the judicial review challenge by Rights Community Action. However, in November the High Court dismissed the challenge. This means that the new Class E, F1, F2 and sui generis uses remain, as do the new permitted development rights to build upwards and demolish and rebuild 

The introduction of the new "Class E (Commercial, Business and Service)" allows for a mix of retail, leisure and business uses to reflect changing retail and business models. It recognises that a building may be in a mix of uses at once (clothes shop and beauty salon) or be used for different uses at different times of the day (office and gym). Uses which fall within a particular class are allowed to change to another use within that class without the need for planning permission. So, for example, under the new rules, a shop will be able to change to an office and then to a gym and back again, without planning permission or any other planning approval. Generally, the changes allow greater flexibility and therefore better management of assets, which is crucial in the current market and, of course, removing planning risk can have a significant impact on the value of the asset. 

Hot on the heels of the changes to the use Classes Order was the recent publication of a further government consultation which proposes a new permitted development right for the change of use from any use within new Class E to residential. The consultation says that "this right will provide much needed new homes across the country, giving clarity and planning certainty and attract footfall to high streets that new residents will bring." This proposal would allow any property falling within Class E on 1 September 2020 to change to residential without requiring planning permission. But, if this proposal does become law it may not necessarily have the desired effect because, if a large number of commercial landlords were to elect to take advantage of this then the high street could become predominately residential and therefore lose the vibrancy which the government is seeking to preserve. 

Building back better – does this mean a sustainable resilient recovery?

The OECD Policy response to COVID-19 (5 June 2020) concludes that "for the economic recovery from the COVID-19 crisis to be durable and resilient, a return to ‘business as usual’ and environmentally destructive investment patterns and activities must be avoided." Therefore ignoring sustainability is not going to be an option for building owners, investors and occupiers. The built environment accounts for approximately 40% of the UK's total carbon footprint. Much of that comes from operational emissions (from energy used to heat, cool and light buildings). So it is fairly obvious that the energy efficiency of this sector must improve dramatically if the UK is to meet its ambitious target to be carbon neutral by 2050. 

It is mandatory to provide an Energy performance Certificate (EPC) when a building is sold or rented out. An EPC provides an asset rating based on the performance potential of the building itself (the fabric) and its services (such as heating, ventilation, insulation and fuels used). The rating ranges from A (most efficient) to G (least efficient). The EPC also provides recommendations for how the energy efficiency of the building could be improved. In September of this year the Government published as Action Plan setting out a pathway to improve the EPC system from exploring ways to increase the quality of EPCs, to improving regulatory compliance and ensuring the data infrastructure underpinning EPCs is fit for the future. However any changes are likely to require legislative changes to the Energy Performance of Buildings (England and Wales) Regulations 2012.

So we can safely assume that EPCs are here to stay and will form part of the Government's strategy to drive improvements in energy efficiency of the built environment. To this end the Government has recently published its Ten Point Action Plan which re-iterates the UK's commitment to decarbonisation and sustainability. It indicated that one of the Government's key targets for 2021 is to set out its heat and buildings strategy.

At present all rented non domestic buildings are required to have a minimum energy efficiency standard (MEES) which is set at an EPC rating of E. The Government has confirmed in its Energy White Paper 2020 that this will rise to EPC band B by 2030, where this is cost effective and we can expect a consultation in 2021 dealing with the implementation and enforcement of this target.

The disadvantage of the asset rating provided by the EPC is that it does not measure the actual operational performance in buildings. Driving down carbon emissions will necessitate the improvement of the actual operational performance of buildings. So the Government is also proposing to introduce a performance based rating scheme for large commercial and industrial buildings and again a consultation is likely in early 2021 with the launch of the scheme expected by 2022/23.

The Better Buildings Partnership (BBP) has already launched a new scheme in the UK to assess actual operational energy performance of offices. The scheme, NABERS UK, builds on the work already undertaken in Australia, which launched the original NABERS scheme. NABERS UK is designed to provide an investment grade operational energy rating for commercial buildings and will enable investors and landlords to understand the true operational performance of their properties. Buildings will be rated according to a 6-star scale, with 1-star representing poor operational performance, through to 6 stars representing market leading performance. BRE has been appointed as the scheme administrator for NABERS UK, owing to its significant experience in the management of its own rating scheme, BREEAM. At present the rating is limited to commercial office properties, but there may be scope for this to develop into other areas into the future.  

The future

The legal agenda in 2021 is shaping up to make for a busy year. As we recover from the pandemic uncertainty in inevitable but with hopes of a successful vaccination programme we have much to look forward to. 

A sustainable resilient recovery will bring many benefits to our economy and to the health and well-being of us all. The UK Green Building Council has just launched a new initiative with their publication of Net Zero Whole Life Carbon Roadmap for the built environment and we foresee plenty of engagement with the numerous Government consultations aimed at improving the energy efficiency of buildings referred to above. The Prime Minister has set an ambitious target of a 68% reduction in GHG emissions by 2030 and the Committee on Climate Change has just published its Sixth Carbon Budget to support the transition to net zero covering buildings, construction and transport as well as all other sectors of the economy.

Prior to the COVID-19 pandemic, sustainability was already becoming a key topic and that has now accelerated up the agenda in a remarkable way. It is ever more important to factor environmental, social and governance (ESG) risks and opportunities into investment and management decisions. To this end Ashurst has developed a new cloud based digital product called ESG Ready to help banks, asset managers and other financial services firms to ensure compliance under the new EU Sustainable Finance Disclosure Regulation. If this affects your business then Ashurst has designed the digital tool to help navigate the complexities. Further information can be found here.

All these measures go hand in hand with the Prime Minister's call to "build, build build" which saw the launch of radical reforms to our planning system in 2020. The Planning for the Future consultation proposed reforms of the planning system to streamline and modernise the planning process, bring a new focus to design and sustainability, improve the system of developer contributions to infrastructure, and ensure more land is available for development where it is needed. The proposals would have major implications for our planning system and this will definitely be a long term project. Our planning team highlighted the key takeaways from the consultation here. There will clearly be a number of further developments on this in 2021. So watch this space.

The courts have had a busy year in 2020 and this looks set to continue in 2021. We expect the Supreme Court to hand down the judgment in the business interruption insurance case FCA v Arch Insurance (UK) Ltd and others. This High Court was asked to assess 21 different types of non-damage business interruption policy wording to provide guidance as to whether or not cover is triggered as a result of COVID-19 The Financial Conduct Authority described the case as "probably the most important insurance decision of the last decade". Our briefing on the decision can be read here. The insurers and the FCA were granted permission for a leapfrog appeal direct to the Supreme Court and the case was heard on 19 November 2020. The Supreme court judgment is expected in early 2021 and will hopefully bring much needed clarity to some 370,000 affected policy holders.

Judging by the number of cases in 2020 the Electronic Communications Code is likely to be the subject of more disputes between landowners and operators. A particularly contentious issue concerns the inability of an operator to claim code rights where they were holding over as a tenant at will or periodic tenant when the new Code came into force on 28 December 2017. The Court of Appeal will have a chance to consider this issue further in 2021 when it hears the appeal in the case of Arqiva Services Ltd v AP Wireless II (UK) Ltd.

It also seems that the residents of Neo Bankside will get another stab at convincing the courts that overlooking does fall within the tort of nuisance. The residents claim that visitors to the adjacent Tate Modern interfered with their enjoyment of their flats because the Tate's viewing gallery allows visitors to look straight into the flats. In February 2020 the residents lost their claim in the Court of Appeal. You can read our detailed analysis of this case here. The Supreme Court has granted the residents' appeal application and will hear the case in 2021. We will need to wait and see whether the boundaries of private nuisance can be extended.

So, in conclusion whilst we are still navigating through uncertain times we can be sure of one thing - there will be definitely be great deal to talk about in 2021.