25 Feb RICS Dilapidations Forum Annual Conference 2021
Even in the wake of the Covid-19 pandemic the concept of “no market” has little meaning for property in the UK. You can always find someone to take a property off your hands, even if you have to pay them; which occasionally happens, usually in the case of long leases. Whilst the value of a freehold interest might be very low or even nil, there is still a market. What the question is referring to is the situation where the market for a property for its existing use is very weak, or effectively non-existent. That is certainly now true of the market for retail property, in some areas.
How Changes in the Market Affect Diminution?
The effect on diminution due to disrepair is usually relatively unaffected by changes in market circumstances until the value of the property reaches a point where a different type of purchaser enters the market. For example, if the roof of a building is faulty and any likely buyer would retain the roof, the price adjustment that buyer will make will be linked to the cost of repair. Whether the building is worth £10,000,000 or £5,000,000 will not change that. However, if the value drops to a level where a developer who intended to put an additional floor on the building, or even demolish it, would be most likely to pay the highest price, then the condition of the roof is probably will not have any effect on the value. In those circumstances the roof defect does not cause diminution in the value.
When a market is relatively stable or increasing, properties which have a higher alternative use will get identified by developers in a gradual process. However, when there is market disruption and we see significant falls in value over a short period of time, there are likely to be a lot more situations occurring where the value of the property for some alternative use or redevelopment exceeds its existing use.
Diminution in the Context of the Current Retail Market
In some areas the value of vacant retail property will have fallen to its underlying site value for an alternative use. Redevelopment of the site is not inevitable, developers may be unwilling to take the risk until the market improves, but the value buyers are attributing to the building is negligible. This does not automatically imply that there is no diminution. A buyer might only pay site value for a building in disrepair, but conceivably might pay more if it was in good condition and they had some chance, albeit a small one, of letting it to an occupier.
There is quite a lot of property, particularly larger stores, where converting the upper parts to residential accommodation would be problematic and relatively expensive, but where the value of the ground floor retail element has in the past been sufficiently above the underlying site value to make wholesale redevelopment unviable. I expect that to change in quite a few cases and developers will be able to pick up retail properties at prices which allows them to redevelop the site with more efficient use of the upper parts for residential. Where that occurs, the diminution will probably be quite low, or even nil.
Longer term, we need to deal with the problem that, in many areas, the UK has too much retail space. There may be government initiatives to deal with this in a similar way to that where the oversupply of office space was reduced by permitted development rights. However, there will be additional challenges with this approach in retail. Ownership of parades is often fragmented, and many shops already have residential occupiers above. Retail property is also integral to a town centre’s character in a way that offices rarely are. Repurposing much of our redundant retail probably will require wholesale redevelopment rather than conversion and demolishing people’s homes is a political consideration as well as an economic one.
Demonstrating the viability of conversion or redevelopment of an individual retail property is still likely to present a challenge for a diminution valuer even though the market for it may have become very weak.
Diminution Effect on the Office Market
The effect of Covid-19 on demand for offices has certainly been to reduce demand in the short term Most companies and organisations have become more comfortable with remote working but, whilst most people who previously worked in an office five days a week have any desire to return to that, they don’t want to spend all their time at home either. Many organisations will adapt the space they have to permit greater flexibility around desk space and more meeting and socialising areas. Companies may eventually decide they need less space, but that will probably be a gradual process rather than one which leads to a significant and immediate fall in demand.
From 2013 through to 2015, we saw a significant upheaval in the market for offices as developers entered after planning restrictions were relaxed and a lot of office accommodation was converted. In the latter part of the last decade that petered out. Office values, particularly in the London suburbs, increased significantly, purchasing a building for conversion was no longer viable and quite a lot of office accommodation was refurbished. If the demand for offices weakens, the position may reverse itself once more and conversion of former offices accommodation may become viable in many more cases. That will have the effect of reducing a diminution-based dilapidations claim.
Where the effect of any market correction isn’t sufficient to reduce the value for a building’s existing use below it’s value for an alternative one, the valuation impact or disrepair is more likely to be reflected in terms of the timing of an owners’ plans. If the market is uncertain, owners may shelve or moderate plans for refurbishment, preferring to try and relet the space with its existing specification rather than improve it; at least in the short term. That is likely to have the effect of increasing the diminution caused by the disrepair of the existing space and thus the dilapidations claim.
There is always a market, but an event like the pandemic can change the intentions of those in the market for a particular property abruptly. A weak market for a particular type of property can have a dramatic effect on the diminution in value and the amount that can be claimed for dilapidations. However, it isn’t true that a weak market will always lead to a lower claim; it may increase it.
Simon Crust FRICS FNARA