Stefanie Price considers potential issues arising when occupiers acquire the reversion to their existing premises.
Newly built, made-to-measure office stock is hot property. Many occupiers are reconsidering space requirements as a consequence of hybrid working patterns while simultaneously contemplating their ESG credentials, seeking bespoke, highly efficient and “green” workspaces for the future.
Bucking the trend, however, are recent occupier acquisitions of premises of which they were already sole or majority occupational tenants. So, if not green-led decisions, what are some advantages of buying the familiar, tested, occupied space, rather than renewing the lease or moving on? And do the advantages outweigh potential drawbacks?
Time and place
Taking and inhabiting space is a time-consuming, expensive and disruptive business. Location searches, feasibility assessments, planning requirements and fit-out works can take months, sometimes years. Acquiring a space that has already been moulded around the tenant-buyer, through considered and implemented fitting-out to the entity’s exact requirements, can eliminate considerable wasted expenditure. Any replacement premises (if not new stock) may require refurbishment and fitting-out. Any vacated premises may, where the term is ending, require extensive works to remove alterations and reinstate the premises pursuant to yielding up provisions. This doubling-up of building expenses is largely removed where the tenant acquires the reversionary interest (though the saving may be partially negated by any uplifted premium which the tenant pays for the convenience of acquiring its existing premises).
Location is often paramount. A tenant that has established its primary trading centre, or headquarters, on a particular site may be reluctant to stray from that area. The tenant’s “brand” may be enhanced by its location or building. Premises of equal capacity, stature or convenience may be hard to find. Where the premises are multi-let, the flexibility (as incoming landlord) to reacquire space in the building from vacating tenants may allow the new buyer to consolidate its property holdings and pool staff in a single, central location, without disrupting its existing business.
Taking control
Tenants, particularly where not in sole occupation, have minimal control over management of that space.
For example, sole or majority occupiers of multi-let premises bear the bulk of the service costs without control over the selection or performance of services. Purchasing the whole of the property, even where subject to other minority lettings, allows the buyer to take control of building investment. It can then implement changes in a manner compatible with the building’s needs, but also sensitive to the requirements of the owner-occupier. For many occupiers, layout and amenities may be pivotal to their working culture, brand ethos and identity.
And while the acquisition of older building stock is not an obviously green-led decision, it may allow more environmental considerations to guide future spending. Investment in leasehold premises can see tension between differing stakeholder incentives. For example, a landlord may install plant and machinery on, or refurbish, the building, but lacks the incentive to maximise energy efficiency if the tenant is entirely fiscally responsible for payment. An owner-occupier tenant has control over investment and much greater ability to satisfy its own stakeholders and the market as to the green credentials of its property and its business.
Similarly, the owner-occupier will have control over the administration and cost of services. The corollary of this is a greater burden of management and building oversight, which may necessitate additional internal staffing and/or external appointments. An investor-purchaser would ordinarily arrange for its own property and investment management team to take over the administration of the building following acquisition. Owner-occupiers are less likely to have sophisticated building management systems in place, and may opt, in the short to medium term, to take over the seller’s existing arrangements.
However, this new control puts greater focus on the buyer’s physical survey. The owner-occupier will remain either solely, or jointly, with other occupational tenants, responsible for a share of service costs, and will need detailed oversight of the condition of the premises and conduits, and any immediate or foreseeable repair and maintenance issues.
Keeping control
Acquiring additional space in a multi‑let building can be a lengthy and cumbersome process for a tenant, involving negotiation with the outgoing tenant and satisfaction of the landlord’s own consent and security requirements. Removing some of those hurdles to expansion through acquisition of the reversion can facilitate expansion plans.
An owner-occupier can also exercise rights to recover premises held by other tenants under protected, but expiring, leases through the exercise of ground 30(1)(g) of the Landlord and Tenant Act 1954. To do so, it must intend to occupy the tenanted space for the purposes of its own business following the end of the occupational lease. However, this ground cannot be used if the landlord has held its interest in those premises for less than five years (section 30(2) of the Act), thwarting any immediate recovery of additional usable space for its own purposes where the sitting tenant wishes to renew. Where expansion is not key, owner-occupation enables greater control over the ongoing tenant mix and letting terms.
A tenant, even a substantial one, under a contracted-out lease can rarely be certain of the landlord’s intentions for the premises or building once that lease expires.
Acquisition of the reversion to leased space which works for them reduces ongoing or future concerns over protracted, difficult or uncertain negotiations for a renewal lease.
Furthermore, premises which include an element of mixed-use space such as retail or hospitality offer potential for an incoming owner to exploit that space to enhance or develop its brand, or to provide additional in-house services to its employees.
Acquisition quirks
Occupier acquisitions are not one-size-fits-all, and sale quirks might including the following:
• Many larger office premises are acquired by way of share sale, through the use of special purpose vehicle acquisition companies, to allow flexibility in terms of future disposal routes. This offers certain advantages:
1. SDLT may not be payable if the property has been held for three years or more (though note the First-tier Tribunal decision in TC07102: Hannover Leasing Wachstumswerte Europa Beteiligungsgesellschaft mbH and Hannover Leasing Wachstumswerte Europa VI GmbH & Co KG v HMRC (18 April 2019)), where the court applied section 75A of the Finance Act 2003 to a property-holding SPV sale).
2. Up-to-date EPCs are not required for share sales, which can save money (for sellers) and time (for buyers and sellers) in cases where EPCs are uncommissioned or expired. However, the acquisition of an older building comes with energy efficiency upgrade responsibilities. A prudent buyer needs clarity on necessary environmental improvements and assurance that premises are certified no lower than the April 2023-minimum E EPC rating.
3. The five-year rule for use of ground 30(2) of the Act will not apply to the buyer if the outgoing SPV landlord has sufficient tenure.
• Where premises are multi-let, the buyer may be unable to collapse and merge its own lease. The existing lease may need to remain in place to support the service charge structure.
• More thought will be given to encumbrances which might cause an inconvenience, nuisance or disturbance to the owner-occupier. An investor-buyer is likely to note the monetary value, but be less troubled by the existence of arrangements such as telecommunications wayleaves running through the building. An owner-occupier will be more concerned with the position of equipment and cabling, rights of access and rights of termination/recovery.
• In a multi-let building, an incoming owner should give particular thought to existing arrears and ongoing income streams. A buyer is unlikely to want to take on arrears, particularly where there are potential claims to be carried though to arbitration as a result of the Commercial Rent (Coronavirus) Act 2022.
Increasing costs
Building costs may increase as the property becomes inextricably linked to the owner-occupier, particularly for an ageing, historic or architecturally significant building. In such circumstances, reputational considerations become more important. This may result in repairs, works or improvements to parts of the building which the owner does not occupy, but where failure to do so would adversely impact the company’s reputation among occupational tenants or in the market.
In an older building, inevitable concerns exist over required energy performance improvements as tighter Minimum Energy Efficiency Standards edge closer. Looming net zero targets will require retrofitting of buildings sooner rather than later. Moving into a new building built with environmental efficiency as a primary consideration comes at an upfront premium cost, but taking on older premises requires both short- and long-term investment in energy efficiency. This acceptance of environmental responsibility should be reflected in the purchase price.
Caveat emptor can be the undoing of less diligent, less familiar buyers, but the buyer who already knows the property from the inside out has an immediate advantage. Of course, the advantages and disadvantages of an occupier-led acquisition will differ greatly between organisations, but in an uncertain world, buying the tried and tested building could bring much-needed security and stability.
Stefanie Price is a partner in Baker McKenzie’s real estate department
