Effect of Policy on the UK Commercial Property Sector

This research project intends to assess and critically analyse what the impact, whether positive or negative. ‘The Code for Leasing Business Premises in England and Wales 2007’, has had on the commercial property sector from the standpoint of both the landlords and the tenants. It is designed, using primary research to aid the Government in assessing the level of success the Code has had and whether legislation is required to further enforce the protection of small business tenants. It is an interesting topic as the Government has sought to promote greater choice and flexibility in the property and leasing market for some time, but has been unsuccessful, also due to the fact that there are still very few reviews on the topic. The research, undertaken in July 2009 involves an investigation into leasing practice by small business tenants and their landlords, accompanied by secondary research.

• Structure of the Dissertation:

Chapter 1: Introduction to the subject matter; containing the hypothesis, as well as the goals and objectives of the research.

Chapter 2: Literature Review; sets out to critically analyse the current literature published on the subject and understand currently established views on the topic. A gap in the knowledge is also identified in the existing published literature.

Chapter 3: Research Methodology; provides the methods and an explanation of them, that were used for primary and secondary research in this dissertation.

Chapter 4:Research and Analysis; questionnaires and surveys presented in tables and graphs along with their analysis. Interviews unable to be quantified are scrutinized and compared in full.

Chapter 5: Conclusion; compares the research with the hypothesis. Deducing its limitations and reliability, as well as whom these conclusions will impact, and any potential additional research that could be carried out.

• Hypothesis:

The introduction of ‘The Code for Leasing Business Premises in England and Wales 2007’ has had no influence upon small business properties and their tenants and as a result was unjustifiable.

• Context and Background information:

‘The Code for Leasing Business Premises in England and Wales 2007’ was launched by Yvette Cooper, then Minister for Housing and Planning, on the 28th of March 2007. It set out some key recommendations to those taking or granting new or renewed leases.

The code itself comprises of three sections:

• For the Landlord; a 10 point requirement guide in order for their lease to be compliant.
• For the Tenant; an explanation of the terms and 37 specific tips.
• A Model Heads of Terms, made available online.

‘The Code for Leasing Business Premises in England and Wales 2007’ is the result of collaboration between commercial property professionals and industry bodies representing both owners (Landlords) and occupiers (Tenants).

These include such members as the Association of British Insurers, the British council for offices, the British Property Federation (BPF), the British Retail Consortium, the Federation of small Businesses, The Royal Institution of Chartered Surveyors (RICS), The Law Society of England and Wales, and the Department for Communities and Local Government. It replaced the previous embodiment of the Code, published in April 2002.

The Code is voluntary so occupiers should be aware that not all Landlords will choose to offer Code-compliant leases. The Government has felt the need to promote the Code with a continual threat of legislation if it is not adopted this time by the property industry. However the Government takes a keen interest in ensuring the property industry complies with this voluntary Code.

Larger business operators are expected to conform to the Code as they have the resources to employ property professionals to act on their behalf. The Code appears to be more aimed at small business tenants seeking to offer guidelines, promoting fairness in commercial leases and aiming to protect small businesses, by ensuring they have the information available to negotiate the most suitable deal.

• Goals and objectives:

Objective One: To investigate small business tenants. A number of questions will be put forward in order to gain information into areas such as, lease terms, tenant satisfaction, and tenant awareness of ‘The Code for Leasing Business Premises in England and Wales 2007’.

Objective Two: To investigate landlords, how they operate with regard to small business tenants, and what is their view is on ‘The Code for Leasing Business Premises in England and Wales 2007’.

Objective Three: To gain extensive knowledge into the views of the Chartered Surveyors of The Code, and how The Code for Leasing Business Premises in England and Wales 2007 affects their decisions when advising a client.

Objective Four: To assess the primary research gained in objectives One, Two and Three, and discover how, or if decisions made by a chartered surveyor could indirectly affect a small business tenant.

Ultimately the aim of this research is to establish that the introduction of ‘The Code for Leasing Business Premises in England and Wales 2007’ has had no influence upon small business properties and their tenants and as a result was unjustifiable. While the existing literature discusses the changes in the relatively new Code, there is little information regarding its actual impact upon the industry. Due to the little research done on the new 2007 lease code, this document is intended to gain background information and research on lease practice in the UK, using the Island of Portsea and surrounding areas to determine the amount of business properties and their tenants that have been affected. The only published document comparable to this research is applied to the previous 2002 code and is therefore now outdated.

By gathering data using interviews, questionnaires, and exploring further information written on the topic in journals and articles, my aim is to gather sufficient evidence to establish whether my hypothesis is true or false. It is hoped that the research methodology set out in chapter three is adequate enough so as to create valuable research, which until now has not been documented.

Chapter 2.Literature Review:

• Introduction

A literature review sets out to critically analyse the current literature published on the subject and understand currently established views on the topic. Secondary research also provides direction to the primary research helping to identify further any unanswered questions.

In order to understand the subject, one must first acquire an understanding of the historical nature of business leases in the UK, and why there appears to be a need for market intervention through lease codes.

Lease Structure within the UK and its’ progression.

• Historical Lease Length:

For the purpose of this dissertation, it is necessary to understand the historical nature of a business lease, how they are changing, and what normality in the current marketplace is.

The “institutional lease” also known as the 25 year FRI (full repairing and insuring) lease with upward only rent reviews was standard issue through the 1970’s and 1980’s. The introduction of more volatile economic conditions led to a change as the longevity of the leases was deemed unrealistic (Lizieri, C., Gibson, V., Crosby, N., Ward, C., 1998). This type of lease has also been described as the “backbone of property investment” (Hamilton, M. Cheng Lim, L. McCluskey, W., 2006).

Whilst the economic climate began to recover in 1995, “the expectation would have been that a recovery in the economy and the property market would precipitate a return to the bargaining strengths of landlords and tenants prior to the recession and a return to the terms of occupation which prevailed at that time” (Hamilton, M. Cheng Lim, L. McCluskey, W., 2006). However there was a contrasting view to this expectation and a number of reasons are given (Crosby, N., Gibson, V., Murdoch, S., 2002). Firstly, tenants who, after being introduced to more flexible terms were unwilling to return to the “institutional lease”. Secondly, new accounts procedures forced tenants to show leases on their balance sheet as a liability and therefore highlighted the fact that longer leases financially burdened the tenant in many cases.

Research was conducted in 2006 that showed that occupiers are still shifting toward shorter leases in order to prevent themselves from being overexposed to risk. Shorter leases “tend to meet the needs of occupiers functioning in a rapidly changing economic environment” (Hamilton, M. Cheng Lim, L. McCluskey, W., 2006). 10.93 years was found to be the average lease length from January 2001 to March 2004, among 106 office leases taken in Birmingham, London, Manchester and Belfast. This would appear to prove a large departure from the “institutional lease”.

However, this research does have its limitations. It remains unclear how large the offices used for the survey are. Larger offices are more likely to have tenants that require longer leases, mainly to justify for writing off fit-out and relocation costs (Dickenson, March 2007). If this is applied to this dissertation for example, the focus of the Code for Leasing Business Premises in England and Wales 2007 is upon small business properties and their tenants who are unlikely to have large fit-out costs.

• Upwards-Only Rent Reviews (UORRs):

The UORR is A clause in a lease wherein at a defined given point a rent review will occur. When this arises the rent will either be fixed at either the current rent passing or the open market value, whichever is the highest. As a lease becomes shorter in length, any fluctuations in market conditions are less likely to affect corporate liability. Therefore the lease rent review clauses become increasingly insignificant. A survey conducted in June 2005 by the ODPM (Office of the Deputy Prime Minister) came to conclusion that they had “strongly polarised views about whether or not the Government should legislate against UORRs.” (Office of the Deputy Prime Minister, June 2005) The government has been considering a ban on UORRs for some time but has still not felt the need to act. A further survey conducted in 2007 by GVA Grimley and the CBI focused on the opinions of corporate tenants. “The survey returned only a small majority (57%) in favour of banning them (Cooke, July 2007). Cooke continues to comment that firstly this is not a large enough majority to consider a ban, and secondly, the size and sector spread of the survey was significant and there is a recommendation of further research. Any moves to remove UORRs will have a major effect on the security as property as an investment. Cooke’s view is that as any legislation is unlikely to be retrospective, and therefore a two stage system will be in place, “corporate occupiers would not reap any benefit for some time”. (Cooke, July 2007).

• Contingent Liability:

“There was a strong vote in favour of removing contingent liability, with 83% voting for its abolition” (Cooke, July 2007). This high figure suggests that many business occupiers are despondent with their current leases; however they are not forced to sign a lease with this agreement and as the research shows tenants are aware of the liability but appear to do nothing about it.

It should be noted that the size of corporate tenants questioned in the research conducted by GVA Grimley is unknown and therefore may offer a poor sample of information for what is required in my research. The Code is positioned to aid smaller tenants who often are unable to afford professional property services. Cooke describes his opinion that “corporate occupiers regard it as inequitable that, having assigned a lease to a third party and having received the landlord’s approval to the transaction, they are required to step back in because of the “failure” of the assignee several years later”. (Cooke, July 2007) If this is a commonplace problem in the market, then this certainly gives good grounds for a new code.

2002 Code of Practice for Commercial Leases (E2):

The second edition of the Code of Practice for Leases in England and Wales was published in 2002. Philip Freedman, one of the co-contributors to the 2007 code commented that “Although it was felt there had been a significant move toward shorter leases, and lease terms had become more flexible, small business tenants were still poorly informed about property matters and landlords were not offering tenants sufficiently flexible lease terms to match their business needs”(Freedman, 2006). Freedman continues to mention that the government was unsatisfied with the continued prominence of upward only rent reviews (UORRs) in longer leases, and was considering outlawing them.

The Code introduced in 2002 was very different from its predecessor from 1995 that it replaced. There were no objectives or aims set out in the Code, instead, ten key recommendations to business leases were listed. The first three were to promote open negotiation between parties, and to recommend financial advice on costs of occupation. The other seven points cover particular aspects of a commercial lease (Neil Crosby et al. (2005).

The paper “Monitoring the 2002 Code of Practice for Commercial Leases”, co-written by Neil Crosby at Reading University for the UK government was designed to measure in detail the impact of the 2002 Code. It is similar to my piece of research, although it is now outdated and obsolete for professional consultation. It does however show key research that provides evidence that the 2002 Code was unsuccessful and therefore required change. An interview survey was carried out with an extensive number of chartered surveyors, and also with solicitors involved with conveyance and lease contract negotiation.

The perception of property professionals acting for clients in 2005 was noted as follows. Firstly, virtually all interviewees were aware of the 2002 code. Secondly it is clear that larger and institutional landlords are more likely to have knowledge of the code and smaller landlords may not. Thirdly, tenants are perceived to have no knowledge of the code unless they are large tenants with direct access to professional property services advice. The conclusion is that “Most consider that the Code is having no influence at all on lease negotiations, although some of the agent interviewees regard it as having some small, indirect, influence. Only two interviewees, one surveyor and one solicitor, are actively and regularly using the Code when negotiating on behalf of tenants.”

The paper concludes that there is the perception among large commercial tenants that the lease structure system is unsatisfactory in the UK, even if they are unaware of the Code. International tenants appear to be more dissatisfied than their UK counterparts. The main reasons cited for dissatisfaction are the lease lengths, and the tenant’s lack of break clauses.

The research methods used in this paper hold credit as the results were a catalyst for a code reform. It is highlighted that the Code is underperforming, and holds no or very little influence. The paper has been useful in developing my hypothesis as it gives a benchmark for success for the 2007 Code.

• “The Last Chance to Get Things Right”:

The article titled “the last chance to get things right” written by Philip Freedman, comments on the shortcomings of the 2002 Code and gives specific direction as to changes that should be implemented in the new Code. The shortcomings are extremely valuable to my research because it shows direct areas in which the 2002 Code has been considered to fail and these areas should be focused upon when analysing the level of success of the 2007 Code.

Firstly, Freedman sights that restrictions on subletting and assignments have not been relaxed in accordance with the Code. Landlords, familiar with the landlord and tenant act 1995, had in recent years been imposing detailed restrictions on assignments, most notable with the introduction of required authorised guarantee agreements (AGAs). Tenants under such agreements are limited in their possibilities for assignment as it is difficult to find a sufficient tenant. Furthermore, the liability still remains in an event that an assignee defaults on the lease payments. His views are backed up by the research by the 2005 report conducted at Reading University. This research found that most leases that had the option for assignment automatically required the tenant to enter into an AGA.

Secondly, “between the period of 2002 and 2005, the courts upheld a number of landlords’ rights to impose strict enforcement on lease clauses that require subletting to conform to specific requirements on rent or other terms”(Freedman,2006). Freedman sights the case Allied Dunbar Assurance PLC V Homebase LTD [2002]. This would suggest that the courts are not working in unison with the views held by the Government that businesses require further protection from landlords.

Freedman concludes, indicating that this is the last chance for the industry. A study into whether the new Code has influence or not would seem wholly relevant as it would provide knowledge on whether this “last chance” has been successful or not.

Code for Leasing Business Premises in England and Wales 2007:

After Yvette Cooper introduced the Code in March 2007, Geoff Le Pard considered the contents of the new Code. “The new Code is more concise than the 2002 version. It is written in plain English and provides more authoritative guidance on lease terms” (Le Pard (2007).

The article, from which the quote above is taken, was released 3 days after the Code was introduced. While this is time to provide commentary on the new aspects of the Code, it is unable to provide any reliable prediction as to how this will affect the market in the long run.

New aspects of interest that are assessed include firstly pricing options and rent reviews. “Under the 2007 Code, landlords must state whether a choice of lease terms is available and propose rents for different lease terms” (Le Pard (2007).

Secondly, restrictions on assignment are discussed. “One of the government’s principle concerns is the inflexible assignment and subletting provisions in leases” (Le Pard (2007). The article continues by commenting that the Code only allows the provision of an AGA agreement, established problem of the 2002 Code, when the assigned tenant is of a lower financial standing than the outgoing tenant.

Thirdly Le Pard comments that the new Code insists Break Clauses should “not be prevented by conditions that effectively make the break inoperable” (Le Pard (2007).

Certainly the three features of the 2007 Code that are described by Geoff Le Pard can be tested using primary research as to their influence.

• “A Code that Lacks Strength”:

“The reach of the new commercial lease code will be limited by the ability of landlords to opt out selectively” (Martin, 2007). In this article, John Martin explains that the government and BPF believe that landlords who subscribe to the Commercial Landlords Accreditation Scheme (CLAS) will gain marketing benefits. Part of the scheme involves the landlords abiding by the 2007 commercial lease code (landlord code). If rules are broken then private and public reprimand can occur however, the landlord code value is “watered down” in the fact that landlords can opt out of any specific requirements of the Code (subject to explanation). The extent to which landlords sign to the CLAS is not described, however is supports the view that landlords do not want to adopt the Code.

Martin also has an interesting view that the new guidance on assignments “appears to be an attempt to revert to the pre-1996 position, without re-instating the concept of privity of contract” (Martin 2007).

The article is however written with an assumption that the Code will be endorsed by property professional and therefore will spread throughout the market quickly.

Gap in the Knowledge:

As previously mentioned, there is a wealth of information published commenting on the Code for Leasing Business Premises in England and Wales 2007. What is unknown is the influence this code is having on the industry if at all. Considering the Code is thought to be the last chance for reform prior to legislation, its performance should be reviewed to show whether legislation is necessary or not. After reviewing the literature in this chapter, a conclusion has been drawn that the Code is unnecessary. There is not sufficient research to prove this and there is therefore a gap in the knowledge. The next chapter sets out the methods in which the hypothesis in Chapter 1 will be tested.

Introduction:

This research was designed to test this hypothesis;

The introduction of The Code for Leasing Business Premises in England and Wales 2007 has improved the position of a tenant when negotiating a new lease.

This chapter discusses the research methods applied and ultimately lead to a comprehensive conclusion that will either reject or confirm the hypothesis.

Research Methods:

Traditionally, there are two different types of research. These are Quantitative research and qualitative research. Miles & Huberman (1994).

• Quantitative Research:

Quantitative Research is normally presented in Data, usually in the form of numbers and statistics.

“There’s no such thing as qualitative data. Everything is either 1 or 0” (Fred Kerlinger).

The aim is to classify what statistics are important, count them and construct statistical models. One can then explain what is observed. Fred Kerlinger considers all research can be ultimately defined as quantitative as one could argue that all information can be displayed through binary (yes or no) questions and answers.

• Qualitative Research:

Qualitative research is based upon alternatives to statistical data such as values and opinions. Donald Campbell holds the view that all research must stem from an initial qualitative theory.

“All research ultimately has a qualitative grounding” (Donald Campbell)

It can be extremely useful when there is little or no previous research on a topic, as it can unearth new views and theories on a subject. Donald Campbell considers all research stems from an initial qualitative study.

Research Strategy:

• Secondary Research:

This type of research relies on the information and research submitted by others. The advantages and disadvantages are shown in table 3.1 above. Before writing this report, many books, internet articles, journals magazine articles were consulted so a thorough understanding of the subject was known. It should be noted that as the Code in question, The Code for Leasing Business Premises in England and Wales 2007, was only introduced at the end of April in 2007 there is therefore limited published material on the subject.

• Literature Review:

The literature used in Chapter 2 for the review is a form of secondary research, and while it shows the current knowledge on a topic, much of it is outdated and therefore unreliable. The literature review also highlighted the lack of material published regarding the lease codes in the UK. There are a number of magazine articles but there is only one academic report (Crosby et al. (2005)) that holds any significant value, but as stated it is outdated. Once the gap in the knowledge was identified from the literature review, it gave direction for a number of research questions to use in my primary research.

• Primary Research:

This is research that compounds new information. The following two types of primary research were used by my study:-

• Small Business Tenant Questionnaire.
• Landlord Questionnaire.
• Semi-structured Interview with Chartered Surveyors.

Tenant and Landlord Questionnaires:

• Target Audience:

The first stage of primary research involved two separate questionnaire studies firstly to tenants, and secondly to landlords. The questions aimed at the subjects were influenced by the report from Reading University “Monitoring the 2002 Code of Practice for Commercial Leases” (Crosby et al. (2005)). Questions were asked with a final goal of contributing to the objectives and aims of the report and testing the validity of the hypothesis.

The questionnaire provides an opportunity to understand the direct influence of the Code for Leasing Business Premises in England and Wales 2007 on tenants and landlords.

Questionnaires were completed in either of two ways. It was established that it would be far easier to gain responses from landlords if it was via email and therefore this is how the 20 landlords were contacted and how they gave response. With regard to the tenant questionnaire, it was decided that a questionnaire would be delivered to a number of tenants. After two days, these would be collected and any uncompleted questionnaires would not be counted. A total of 30 business tenants were visited. Due to the data protection act, names of tenants or landlords remain anonymous and cover notes were addressed to the “Manager”.

• Sample:

Due to the large number of tenants and landlords in England and Wales, it is necessary to sample the respondents. The sample method used is a form of “random” and “cluster sampling” combined. Normal cluster samples are used when the subject research matter is too large to measure. Normally certain areas would be subject to research instead of the whole country for example. Often in cluster sampling, “the total population is divided into these groups (or clusters) and a sample of the groups is selected” (Wikipedia, 2008). In my research, this was further randomised down into sample of particular clusters. Areas used for the research were Windsor, Bracknell and Reading. It was considered that 30 tenants and 12 landlords would be a sufficient sample to gain the required information without mak ng the research excessively impractical.

• Design and Content:

Each of the two questionnaires were designed to be as clear as possible for the target individuals, and they also incorporate layman wording as to ensure each question is understood fully. The majority of questions asked utilised a multiple choice answer system. This enabled each paper to be completed with ease and also provide comparable data between different questionnaires. Copies of both Questionnaires including a covering letter for each questionnaire are included in Appendix B and C respectively.

• Pilot:

It was felt necessary for a pilot copy of each questionnaire to be reviewed by a property professional prior to conduction of the survey. This was done for a number of reasons. Firstly the design of the questionnaire is reviewed to ensure it is easy to comprehend. Secondly, the wording is reviewed and changed if necessary. Thirdly organisation and the number of questions are reviewed. The pilot questionnaires were sent to a property professional Nigel Dight (Leslie G. Dight and Partners). It was decided after the pilot that a universal “do you have any other comments to add”, would be incorporated as a final question. This gives the opportunity for landlords or tenants in the subject research to add any qualitative information they feel important to the subject.

• Response Rate:

Before each email was sent to landlords, a telephone call was made to ensure they were comfortable with the questionnaire. This ensured a high response rate. A covering letter (viewable in Appendix B) was also sent to emphasise the importance of the answers and how they help the research project. A response rate of 75% was achieved which was viewed as a success. A much lower response rate was expected from the tenant questionnaires; however, the 60% achieved was largely viewed as a success. It was expected to that ten respondents from each questionnaire would be achieved however this was exceeded. After this initial response it was decided therefore that no new respondents needed to be found as both questionnaires had exceeded response rate expectancy.

Semi-structured Interview:

• Target Audience:

Interviews were carried out with chartered surveyors who have extensive current and previous experience in both tenant and landlord representation during lease negotiations. It is important that each interviewee has experience of the market over the last twenty years in order to have a comprehensive view of how the market has changed, and how this has affected tenants. Appendix D gives a list of interview candidates. A semi-structured interview technique was used to gather information from chartered surveyors because they are likely to have a wealth of experience and knowledge on the topic. The interview provides the opportunity to show the indirect impact of the Code for Leasing Business Premises in England and Wales 2007 because, unlike the questionnaires, the interviewed surveyors are more likely to have a broader understanding of the mechanisms within the market. If the code is found to indirectly affect a business lease tenant, the surveyor is far more likely indicate this than the tenant themselves.

• Sample:

Due to the large number of chartered surveyors in the UK it is not possible to interview them all. A random sample method is used to find suitable candidates for the interview process. It is also important the prospective candidates are vetted prior to the interview to ensure they have the relevant experience to answer the questions. Although only a small number of interviews took place, an attempt to provide a full spectrum of surveyors from the marketplace was achieved. One of the interviewees acts on behalf of large corporate clients, while another acts on behalf of smaller clients for example. It was viewed that only a small number of samples would be required as a predicted response rate was a high percentage.

• Design and Content:

Appendix D includes a list of outline questions that should be posted to interviewees. Although only a guideline, these questions were designed to gain the core information required from the interview. In practice, further questions and discussions took place during the interview. Compared with the questionnaires, this provides further in depth answers and opinions. The estimated time of each interview was intended to be around 15 minutes. This was firstly conceived to be enough time to gain the required information. Secondly it was not so long as to discourage any prospective interviewees from taking part. In practice the interviews lasted for around 25 minutes, due to the expansion of the core questions, however this did not cause a problem. A full transcript of each interview can be viewed in appendix E. Two of the interviews were carried out via telephone interview as this provided the easiest was to lease with surveyors at some distance. One interview was carried out in person due to the close proximity of their office. The interview in person proved to be more successful as the interviewee seemed more focused on the questions.

• Response Rate:

The response rate was 60% which was considered poor under the circumstances. A small number of surveyors were contacted with the initial view that all would provide an interview. The response rate did however fall between 60% and 100% which wa