In the wake of the COVID-19 pandemic, UK businesses and government alike have been operating in unprecedented times, with owners and occupiers of commercial property continuing to deal with a unique set of challenges.
In addition to contending with lengthy lockdowns and macro-economic volatility, retail occupiers still face the seemingly inexorable rise of internet shopping and the relentless fall of high-street sales, which saw net closures running at 3% in the first half of 2021 and 1.4% in the corresponding six months of 2022.
At the same time, office-based businesses have been wrestling with expensive questions about how to use their existing assets to meet the changing demands of an increasingly hybrid workforce.
Against this backdrop, the government has been consulting on the future of business rates. In October 2021, it published the Business Rates Review: Final Report stating that while several measures are in place to help businesses, there is no intention of abolishing these rates entirely.
But only a year later, legislative developments and a host of unforeseen macro-economic factors look set to make business rates liability one of the key commercial property concerns in early 2023. Therefore, surveyors must be aware of the critical issues and potential impacts on their clients.
For commercial property occupiers, one of the government's most significant decisions has been to confirm that there would be a full revaluation of business rates on 1 April 2023 – the first revaluation since 2017. This will be based on property values as of 1 April 2021 – a year into the COVID-19 pandemic.
The decision to revalue on 1 April 2023 was announced on 21 July 2020 as part of the foreword to the Call for Evidence as part of a consultation into the future of business rates. The decision to defer the revaluation was due to the ongoing impact of the pandemic and the likely impact on rental valuations.
This was supported by stakeholders who wanted rateable values to reflect the impact of the pandemic, with a revaluation of the tax base distributive, so that if business rates raised £25bn before the revaluation, the idea is that they raise £25bn after the revaluation. What changes is that those sectors and properties that have fared better than average pay more, and those that have fared worse pay less than they did before.
However, it is conceivable that this revaluation will lead to unexpected outcomes for ratepayers, with some facing significant increases in their liability. For many businesses, this will represent another hit to profitability. For those who have struggled through the past few years, it may be the final straw. It would therefore be prudent for surveyors to give their occupier clients a warning well before next April, so they have sufficient time to take steps to factor a potential rate rise into their future financial modelling.
Meanwhile, the Bank of England forecast in its Monetary Policy Report, published on 4 August 2022, that the UK was projected to enter recession from the final quarter of 2022. It then went on to vote on 22 September 2022 to raise the base rate to 2.25% and announce that it believed the UK economy was already in recession with a forecast contraction of 0.1% in the third quarter of 2022.
This presents a bleak outlook for commercial landlords and tenants alike. The most vulnerable tenants will inevitably fold, leaving landlords without a rental income stream.
In a better trading environment, landlords faced with such a situation would forfeit the defaulting tenant's lease and grant a new one to a new tenant. However, in recession landlords often face difficulties in reletting properties. If a landlord forfeits a lease but cannot find a replacement tenant for the property then it will become liable for business rates, as well as losing its rental income stream.
In previous recessions, landlords often left leases in place long after tenants had stopped paying rent or even after they had gone bust to avoid business rates liability. However, as we enter a recession, landlords' advisers need to be aware of the risks of forfeiture in a poor trading environment.
Another factor that will affect commercial property landlords are the Minimum Energy Efficiency Standards (MEES), introduced in 2015 to tackle the poor energy performance of the UK's building stock. These currently prevent the grant of new leases on commercial spaces where the energy performance certificate (EPC) rating is F or G.
From April 2023, these regulations will become even stricter, with landlords being required to cease letting properties with grade F and G ratings unless they can claim (and register) an exemption under the regulations. Those who breach the MEES regulations will face financial penalties equivalent to 10% of the property's rateable value – from a minimum of £5,000 up to a maximum of £50,000 – for less than three months in breach. This rises to 20% of the property's rateable value – from a minimum of £10,000 up to a maximum of £150,000 – after three months in breach.
Consequently, MEES will have a stark impact for owners of properties with a poor EPC rating. To avoid a fine, they can either incur the potentially significant cost of improving a building's energy performance or be left with an unlettable property (if they are unable to grant new tenancies at the property due to the EPC rating). Where a property is unlet, landlords become liable for business rates on it, as noted above.
Those advising landlords on strategies to address the impact of the MEES regulations must make them aware that any liability for business rates on empty units will sit with them, so they need to factor this into their decision-making.
While this all paints a rather worrying picture for ratepayers, they are not without recourse.
When a commercial property becomes vacant, for instance, the owner can apply to the local authority for empty rates relief, which gives them 100% business rates relief for the first three months that the building is empty, or six months in the case of warehouses or industrial premises.
Where a property is being substantially redeveloped or refurbished, it could also be classified as incapable of beneficial occupation and therefore not subject to rates liability. This could conceivably include work undertaken to comply with the MEES regulations.
However, advisers should note that properties have to be genuinely incapable of occupation; the courts have made clear that properties being repaired rather than undergoing redevelopment will not qualify for relief, because they are still available for beneficial occupation.
Furthermore, despite the tightening of MEES regulations, the prohibition on new or continued lettings from 2023 will not apply to leases of less than six months, unless at the time of letting the tenant has already been in occupation for more than 12 months.
Accordingly, owners of properties with a low EPC rating can avoid upgrading costs and rates liability while maintaining an income stream by repeatedly letting non-compliant premises for leases of less than six months.
Meanwhile, there are schemes that can mitigate a property owner's rates liability – even if the courts in recent years have outlawed several of these so that only two remain current and viable in England (with the rules being different in Wales).
Makro schemes: after an initial 100% empty rates relief expires, owners can let the property on a short term of six weeks or more, meeting the requirements for rateable occupation that, on expiry, entitles them to a further three-month period of 100% relief. There is no statutory limit on the number of times the makro scheme can be used, so in principle a property owner could repeat the process indefinitely. This approach would also avoid being subject to the MEES regulations.
Bluetooth schemes: where a landlord lets a property to a tenant that installs the bare minimum of apparatus – typically, wi-fi equipment – in an otherwise unoccupied building, this counts as beneficial occupation for business rates purposes. As a result, when the tenant vacates the property the owner is entitled to empty rates relief. The fact that such occupation is so minimal and the use is in reality different from that described in the rating list is irrelevant. However, this has been heavily scrutinised by the courts, so there is a risk that there could be a successful legal challenge to such schemes in future.
As we enter a time of increasing financial difficulties, it is unsurprising that local authorities and landlords are at loggerheads over attempts to limit liability for business rates. With the impending revaluation and regulatory changes added to the mix, those traditional tensions will remain.
Therefore, surveyors should be speaking to their clients now so they can take steps to mitigate their position, ahead of the changes coming in 2023.
13 – 14 December | 8:30 – 13:45 GMT | Online
The RICS UK Commercial Property Conference returns online this year to close out 2022 and will be delivered over two consecutive half-days.
Hear from key-industry speakers giving practical advice to surveyors in tackling the issues of the ongoing cost of living crisis, rising interest rates and how to prepare for a sustainable future in the post-covid recovery. See here for further details.
Professor Sara Wilkinson FRICS, Dr Gillian Armstrong and Professor Jua Cilliers 11 November 2022