Dilapidations – Section 18 (1) and topical diminution in value
issues as we ‘build back better’
As 2021 draws to a close, what are the key forces and drivers that are shaping and determining dilapidations claims right now?
There are a number of important factors. Clearly economic uncertainty and the pandemic are relevant, as are the new permitted development rights that came into force on 31 March 2021. In many cases the repurposing of property, and the imminent extension of the Minimum Energy Efficiency Standards to existing leases on 1 April 2023, have also been important considerations. In some cases the scarcity of labour, and materials, and their increased costs, have been key factors too.
From a legal perspective, in Ashfords’ experience the difference between the cost of the works detailed in the schedule and the Section 18(1) valuation is a frequent issue. More so than ever, landlords will need to be able to prove a loss. In our experience invariably landlords will need to be able to prove not only the breaches of covenant but also that the repair works have been completed, or that that there is a certainty they will be undertaken. Increasingly, compelling and comprehensive supporting evidence is key.
Invariably tenants will question, and scrutinise, their landlord's intentions for the property. The Dilapidations Pre-Action Protocol facilitates this. A superficial Landlord’s Section 18 (1) valuation is unlikely to cut the mustard with any properly advised tenant.
Comparables will be analysed. On account of the pandemic, a lack of contemporaneous comparables can sometimes be a problem, depending on the valuation date. Published promotional and marketing materials for the property, and any investment advice the landlord may have created or received, is likely to be sought out and investigated. More than ever, landlords will need to understand the importance and relevance of supersession. Even if the repair works are carried out, MEES can still be critical a critical issue.
Intervening landlords who don’t own the ultimate freehold reversionary interest need to be careful to ensure they use the correct Section 18 (1) valuation methodology. Invariably legal advice is that landlords' claims must be properly assembled and formulated. From a tenant’s point of view, potentially there are very many ways in which Section 18 (1) can provide a way to challenge and defend landlords' dilapidations claims, in whole or significant part.
Whilst the Dilapidations Protocol sets out the Court’s requirements and expectations in relation to the format of the schedule and the need for a statement that the landlord’s “intentions” for the property have been brought into account, presently there is no established practice and accepted guidance (from the RICS or otherwise) on the contents and format of Section 18(1) valuation evidence. In our view this would now be opportune and welcomed.
From a Section 18 (1) valuer’s perspective in the opinion of Ian MacKie Berkeley Research Group, the changing planning environment mentioned above provides a number of valuation issues related to the selection of appropriate comparable transaction evidence. In order to provide a valuation of any potential diminution, valuers are increasingly required to consider whether a property can be repurposed without significant structural alterations, and if so, will this require changes to the valuation approach adopted, for example whether an income approach or a market comparable approach is more suitable.
In addition, there has been considerable divergence over the last couple of years in the performance of different commercial property asset classes. For instance, whilst certain retail property values have fallen up to 30% from their peak, there has been a considerable increase in the values of warehousing and logistics properties over the same time period. This divergence means that a “one size fits all” valuation approach for Section 18 (1) valuations will not be appropriate, and that the valuer must consider the interaction between the Landlord’s intentions and the wider economic factors applicable to each property when establishing the relevant market value of a property in dilapidations cases.
If you have any questions regarding the blog post above, please contact Warren Reid.