Mixed use development and structure (Part 1/2)

Our previous blog post on the topic of mixed use developments: 6 structures for reducing risk in mixed use developments referred to a number of potential issues, including statutory residential rights and service charge difficulties, which can arise when a proposed mixed use development includes a residential element.  Our Practice Note Common structures for leasehold mixed use developments sets out how such issues can be avoided or reduced by careful ownership structuring at the outset.

This two-part blog examines questions that might arise in relation to structuring a mixed use development as a variation on clean freehold investment structure, as outlined below.  In particular we look at whether, for the buffer lease to be effective, the main structure of the building needs to be included in the demise of the management company lease, and if it is not included will the tenants’ right of first refusal still apply?

Putting in place a ‘buffer’ lease

One structure that is commonly used for buildings mixing long residential leases and shorter rack rent commercial leases is the clean freehold investment model.  This structure aims to create a ‘buffer’ lease between the residential leases and the freehold to achieve a clean investment freehold with minimal responsibilities for management of the lease.

A variation on the clean freehold investment structure is for the freeholder to carve out the internal demise of the commercial units from the management lease and to retain direct control of the commercial premises.  The main objective in putting in place some kind of buffer lease(s) is to mitigate the effects of the residential tenants’ right to buy under the Landlord and Tenant Act 1987 and the collective right to manage.

Tenants’ right of first refusal

Part 1 of the Landlord and Tenant Act 1987 gives qualifying tenants of flats a right of first refusal enabling them to purchase the interest of their landlord if and when he proposes to dispose of it.  The right prohibits the landlord from making a relevant disposal without first serving a notice on the qualifying tenants and requiring that the disposal is made in accordance with the statutory requirements.  It applies to the disposal of the interest in reversion to the residential leases, and applies where premises:

• consist of the whole or part of a building;
• contain two or more flats held by qualifying tenants, and
• the number of flats held by qualifying tenants exceeds half of the total number of flats contained in the premises.

Does the main structure need to be included in the demise of the management company lease?

Whilst there appears to be no direct authority on the point, the wording ‘or part’ indicates that part of the structure or indeed an internal long lease may be sufficient and, therefore, there does not seem to be any express requirement for the structure of the building to be included in the management company lease.

As these schemes are usually complex, it is easier to take an example. If you have a multi-tower residential development all situated on a four-storey podium which itself contains the commercial premises and common service facilities for the scheme, it would be possible, for example, to demise the tower structures above podium level and the internal demise of any exclusive residential  service areas and appurtenant facilities but not any structure of the podium,  to the residential management company and retain the main support structures and commercial premises either as part of the freehold or indeed to also carve out the commercial element by way of a further headlease either with or without the podium support structures.

As to whether the tenants’ right of first refusal would still apply if the main structure was not included in the management company lease, from a practical perspective, provided that:

• the lease was for more than seven years; and
• not terminable within the first seven years at the option of the person who is the landlord under the tenancy,

then it should operate as a buffer to triggering the first right of refusal in relation to the disposal of any superior reversionary interest, but not the management lease itself in respect of which the right would apply as it is the interest in reversion to the qualifying leases.

Further reading

For more information in this regard, see our Practice Note Landlord and Tenant Act 1987 – tenants’ right of first refusal and also Halsbury’s Laws of England: Meaning of 'relevant disposal' [1858] and Landlords to whose premises the right of first refusal applies [1855].  These issues are also considered in a LexisPSL Q&A.

Stand by for Part 2, which will deal with splitting the demise of the main structure of the building between a management company lease and a long lease of the commercial element, and how tenants’ rights are affected.