Bell & Scott

In this month's issue we comment on a rent valuation case in which McDonalds argued that “warehouse” could only mean a bricks and mortar building for storage and not a modern warehouse building which could also be put to retail use.

We also update you on (1) progress on the Merton-plus rule which requires developers to source 10% of a site’s energy requirements from on-site renewables; (2) a global standard for benchmarking a building’s energy use; (3) Tesco’s opposition to the OFT becoming a consultee in the planning process; (4) the Scottish Government’s proposals to combat rogue property managers; and (5) updated SBSA Technical Handbooks.

In the mid–1980s, McDonalds wanted to develop its first

drive–through burger restaurant on Edgware Road in London. There was a disused factory on the site but the owner did not want to sell. He was prepared to lease the land. In 1986, McDonalds took a lease of the site for a term of 50 years. The user clause said that the site could only be used as a restaurant with ancillary accommodation, storage, staff facilities and car–parking space or for such other retail purposes as the landlord might agree to in writing. A rent review clause provided for 5 yearly rent reviews, with the last review to take place in 2030. The reviewed rent was to be the full market rent of the premises, disregarding any restriction to the permitted use and calculated to be the higher of one of two bases; the first basis required the assumption that the premises were as used and occupied by McDonalds; the second basis required the assumption that the premises were “a modern single storey warehouse comprising 20,000 net useable square feet of which 15% in area were useable as ancillary offices and constructed to a high standard". McDonalds got planning permission and built and ran its drive–through.

The Arundel Corporation became McDonalds’ landlord when it bought the site subject to the lease. After that a dispute arose between Arundel and McDonalds as to how the rent was to be assessed at the next rent review. McDonalds contended that in valuing the premises on the basis that a warehouse stood on the site, the word “warehouse” merely described a physical type of building; it did not provide any indication as to the use to which it could be put. Arundel argued that “warehouse” described not only a building type but also the use to which it could be put. Arundel may have been entitled to a higher rent at review if a more modern “retail warehouse” building type could be taken into account. McDonalds would benefit if the rent review was to be carried out on the basis of a lease of a building used as a traditional storage warehouse.

The High Court had to decide what was meant by "warehouse" at the point in time when the lease contract was entered into. In the mid 1980s, “second generation warehouses” had various uses, including cash and carry, storage and distribution, DIY retail, and research and development. These “second generation warehouses” varied from “first generation warehouses” which were the Victorian multi-storey depositories and were much rarer, usually existing on a one-off basis on industrial estates and were not usually visible to passing traffic. The parties' expert witnesses had already agreed that a second generation warehouse was physically capable of being used for retail trade. The court also considered that the rent review provisions required any restriction on use to be disregarded. This suggested that possible uses could be taken into account. In any case, the lease permitted retail use with the landlord's consent, not to be unreasonably withheld or delayed. For these reasons, the Court decided that the term warehouse as used in the rent review clause entitled a rent review surveyor to take retail use into account in his assessment of rent.

Normally rent review provisions in leases are pretty straightforward and do not throw up problems for rent review surveyors when they come to decide on rental uplifts. That is because the hypothetical lease which is to be taken into account at valuation will assume that the imaginary premises used to assess the rent are in fact the actual premises which are let to the tenant at the date of review. The problem for the court in this case was that McDonalds could see a commercial advantage in having the 5 yearly rent increases over a period of 50 years assessed on the basis of the type of storage warehouse prevalent in the market in the early eighties when negotiations for the lease were on going instead of a more modern retail warehouse - and the lease they negotiated in the mid-eighties just used the term “warehouse” in the rent review clause.

The provision in the McDonalds lease which required the premises to be valued as a warehouse at rent review was specific to that lease. However, the fall out over what the word warehouse could mean over the passage of time illustrates the importance of avoiding, where possible, unusual comparables or introducing hypothetical assumptions that have not been commonly used or tested in surveying or valuing practice.

Sometimes, however, it may be necessary to have specific assumptions about the nature and characteristics of the premises to be valued. For example, the area in which the property is located may lack other properties that are similar to the actual premises leased to the tenant and which can be used to provide comparable evidence for the rent review surveyor. The parties may agree to use, as an alternative basis for valuation, an assumption about the premises that brings them in line with available comparables in the area. If that is the case, the parties need to be able to assess how that hypothetical assumption will work in practice and whether it would give a surveyor enough information on which to base his valuation, even if the commercial practices and circumstances change over time.

In the McDonalds case, had the parties given more thought to the definition of the building that the rent review surveyor would have to look at and which, if any, uses for that building he could take into account, the dispute could have been avoided. We can only assume that McDonalds thought that there was scope for a commercial benefit in simply having the hypothetical premises as a "warehouse".

The case serves as a good reminder that even a straightforward description of the physical nature of a building like a “warehouse” may not, for certain types of building, be sufficient to define it with enough precision for rent review purposes. It may need to be defined more clearly by reference to its actual or potential uses. This is all the more likely if a particular type of building had more than one, or even many, possible uses at the time the lease was entered into, as with warehouses in the 1980s.

If the parties agree that a hypothetical assumption for rent review will differ from the commercial reality at the time the lease was entered into, it is a good idea to ask an experienced rent review surveyor to consider any unusual drafting that may determine valuation at rent review. Although the surveyor cannot anticipate changes in commercial practice and circumstances with precision, he may be able to point out obvious problems with applying a clause in practice which may not have occurred to the parties.

Case referred to McDonalds Real Estate LLP v Arundel Corporation [2008] EWHC 377 (Ch),

The Planning and Energy Bill in England & Wales has passed all the various stages of the House of Commons and is scheduled to receive its third reading in the House of Lords at the end of July 2008. The Bill would allow local councils to set targets in their areas for on-site renewable energy, on-site low carbon electricity and energy efficiency standards in addition to national requirements. It would also require developers to source at least 10 per cent of any new building’s energy from renewable sources, implementing nationwide the so-called ‘Merton Rule’, named after the sustainable planning policy first adopted by the London Borough of Merton.

It remains to be seen whether there will be a similar legislative move in this direction in Scotland.

In response to the changing climate and pressure from consumers and environmental bodies, IPD Occupiers (experts in independent property performance measurement) has created a global standard for measuring the environmental impacts of corporate property.

The code aims to provide businesses with a method of reducing their carbon emissions thus increasing the energy efficiency of their buildings whilst substantially cutting energy bills.

The IPD Environment Code is a template for the collection, measurement and analysis of environmental information (which can be applied to buildings anywhere in the world) with the ultimate aim of reducing carbon emissions. This is done by laying out a clear approach to the collection of environmental data.

It is applicable to a broad range of property types from retail shops and offices to hospitals, universities, hotels and airports.

Tesco is to challenge the recommendation made by the Competition Commission in its final report on the market investigation into the supply of groceries that a competition test be included in the planning system. The Commission is keen on the test to address the adverse effect on competition resulting from local market concentration and barriers to entry resulting from the planning system.

Earlier this year the OFT concluded that there are various features of local markets, in particular, for larger and mid-sized grocery stores, that are preventing, restricting or distorting competition in a number of local markets.

To counter the adverse effect on competition resulting from high local concentration levels and planning issues, the Competition Commission has decided to recommend that the Department of Communities and Local Government, the Scottish Executive, the Welsh Assembly and the Northern Ireland Executive should take necessary steps to make the OFT a statutory consultee to local planning authorities on all applications for planning permission for the development of a grocery store which will have a net sales area in excess of 1,000 square metres.

The OFT, as a consultee, would provide advice to the local planning authority on whether a particular retailer has passed or failed a competition test. This competition test will be passed where, within a 10-minute drive time of the developed store:

The retailer would operate as a new comer in the local area; or
There are four or more retailers (including full-range national or regional grocery retailers and symbol groups (such as Spar) operating larger grocery retail stores in the local area; or
The total number of stores is four or fewer and the proposed grocery retail unit would operate less than 60% of the groceries sales area (including the new or extended store).

The Report by the Competition Commission into the UK Groceries market can be accessed here

The Scottish Government has announced measures to improve standards in property management. It will establish an accreditation scheme to give house owners peace of mind when choosing a property manager.

To achieve accreditation, property managers will have to meet high standards of service and a robust complaints procedure will be put in place if the service is unacceptable.

The accreditation requirements will include obligations on the property managers:

to produce clear written contracts for every client including an explicit complaints procedure.
to obtain quotations from a range of contractors.
to show transparent accounting and billing systems, clearly highlighting all management income being received.

Accreditation could be taken away if standards are not met and the government has promised that tougher regulation would follow if unacceptable practices persist.

The industry-led accreditation body will be made up of representatives from a wide spectrum of housing interests, including consumers.

Details of the proposals are available on the Scottish Government’s website accessible here

The Technical Handbooks provide guidance on achieving the standards set in the Building (Scotland) Regulations 2004 and are available in two volumes, for Domestic buildings and for Non-domestic buildings. The revised editions of the Technical Handbooks came into force on 1 June 2008. While there are no technical revisions, corrections have been made in sections 1, 2, 3 and 6.

A summary of the corrections that have been identified between 1 May 2007 and 30 April 2008 can be accessed here.