Rating Manual - Volume 4 - Section 5 - Practice Note 2 : 1995 : 1995 Revaluation Valuation of Space where a Supply/Demand Imbalance exists at AVD

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PRACTICE NOTE 2 : 1995 : 1995 Revaluation Valuation of Space where a Supply/Demand Imbalance exists at AVD

It is clear that, for at least some classes and in some areas, VOs have the involved task of identifying the appropriate levels of value for the 1995 Rating List in market conditions at the valuation date which are rarely encountered. This Practice Note seeks to investigate the "ground rules", outline the options available, and identify the appropriate approach in such circumstances. In paras 1-6 it considers the problem in detail in its constituent parts, and sets out the policy for the 1995 revaluation.

1. The problem

In some areas the development boom of the late 1980s, in combination with the change in the economic climate in the early 1990s, have led to an oversupply of space by comparison with that required by occupiers. The result is that significant parts of the stock lie vacant while some comparable space is fully occupied. An added complication lies in the variety of rental and other evidence available. Many of the current occupiers are locked into long term agreements, with upward only rent reviews at passing levels agreed in better market conditions. Some reviews have been operated, others not. Contrast an analysis of these with those of new lettings, frequently surrounded by incentives and shrouded in confidentiality clauses, which can show a significantly lower level.

The questions which arise are:-

Should we apply differing levels of value to the vacant and occupied space?

Which evidence is to be preferred?

Can a hereditament which is occupied, and for which a rent is being paid sensibly appear in the Rating List with a nominal or nil value?

In seeking these answers other, more fundamental, questions have arisen:

Are similar properties in the locality to be assumed to be available, and if so, on real world terms or only from year to year?

Is it right to assume that there is a hypothetical tenant notwithstanding seeming evidence that all potential occupiers already have their requirements satisfied?

Should the hypothetical landlord also be assumed to be the owner of the adjacent units if in the real world that is the pattern of ownership, and can this influence the level of value?

Given that the legislation envisages a letting, should regard be had to the 'empty rate' provisions faced by some landlords in the real world?

What adjustment, if any, should be made to account for differences in circumstances between the AVD and compilation date of the rating list?

2. The Legislative Framework

Section 41(1) & (2) of LGFA 1988 requires VOs to compile a new rating list on 1 April 1995. The basis of the RVs to be included is determined by Sch.6. The Secretary of State has specified 1 April 1993 as the date by reference to which the RV is to be determined (SI 1992/1643). Sch.6.2(5) requires that the matters mentioned in 2(7) are nevertheless to be taken as they are assumed to be on 1 April 1995.

3. Basic Principles Investigated

3.1 Tenure in the locality

There is a natural tendency in valuations for rating to prefer reality to hypothesis, an approach reinforced many times in judicial pronouncements. The hereditament is real. The landlord, tenant, tenancy and rent of that hereditament are all hypothetical. But what of matters in the locality? Being primarily physical, those matters mentioned in Sch. 6.2(7) (d) & (e), to be taken at the compilation or material day, must be real. The use and occupation of other premises in the locality must therefore be taken as they were at the relevant date.

The tenure of other properties in the locality, and all the other factors, are to be taken as at 1/4/93, but are they real or to be assumed displaced by the hypothesis?

It cannot be justifiable to prefer an assumption to reality unless it is absolutely necessary so to do. The courts have on several occasions had cause to reflect on this subject, most notably in Humber Ltd v Jones (VO) 1960 RIT 293 . Willmer LJ took the matter as far as anyone, before or since (see "Ryde" now E254), but as the commentary at the time records, it is not absolutely clear whether his assertion of the annual tenancy being the only form available to everybody else, referred to a letting of the hereditament or all properties in the locality. Nevertheless in noting the agreement that the hypothetical terms would be so unattractive in the real world that "no sane manufacturer" would offer a rent, and finding no error of law (he said) there must be a strong presumption in favour of the latter interpretation and that all properties might thereby be assumed to be available from time to time on the terms of the hypothetical tenancy. No contradictory authorities have been identified. It is clearly open to VOs to argue such a line, if necessary, but it seems likely to succeed only where it can be justified by the need to avoid an unwanted conclusion (eg Humber).

The learned editors of Ryde on Rating and CT suggest that the above approach is unsound on two grounds. That it would weaken the evidential value of actual rents and that the contractor's basis assumes the possibility of an alternative form of tenure. Although it must be admitted a possibility, it is felt unlikely that the Lands Tribunal will allow the first consideration to disturb its reliance on actual rents without some better evidence to replace it. Members have resisted arguments based on suggested dissimilarities between the real and hypothetical worlds sufficient to negate reliance on evidence from the former in valuations in the latter. The second ground is contrary to CEO policy on the proper approach to the contractor's basis.

The preference will therefore be for tenure in the locality to be taken as it exists in the real world whether at AVD or the material day if changes have occurred between those dates. The extent to which this restricts or facilitates demand is a matter for judgment but the outcome would naturally be reflected in rents paid for new lettings rather than renewals of leases.

3.2 Occupation (or vacancy) in the hereditament and locality

An approach which took the pattern of tenure in the locality as it exists in reality might be argued to lead to a different level of value being attributed to hereditaments which are otherwise identical, purely on the grounds of vacancy or occupation, as the case may be. If, as a matter of fact, all tenants' space requirements are satisfied by their current long-term occupations from where is the perceived demand for any vacant property to come? It could be argued that the need to achieve consistency of vacant/occupied hereditaments requires the assumption that a hypothetical tenant exists. To some extent this would mirror the Landlord & Tenant world, where rent review clauses frequently contain a specific assumption that a willing tenant exists. Such an assumption would however fly in the face of the logic of the LT decisions in Lambeth LBC v English Property Corporation & Shepherd (VO) 1980 RA 297 and Sheil (VO) v Borg-Warner Ltd 1985 RA 36. In both cases it was accepted without question that mere occupation/vacancy cannot be a valid reason for differing values but in each it was found that, because of the specific circumstances, there were no potential tenants willing to take the hereditament and use it to its full potential. Because the assumption of an additional potential tenant is likely to prove unsustainable, it will be necessary to fall back on the possibility that one of the occupiers of other "broadly identical" hereditaments is the likely hypothetical tenant. This will mean taking account of the differing physical attributes and locations of properties in order to judge the rent at which they would attract a tenant.

The extent of normal market fluidity underlies the rental evidence from new lettings but may be at variance with evidence derived from rent reviews. It is more straightforward to propose the direct connection between open market rents and RVs in a hypothetical world with tenure in the locality taken as it exists. An assumption that all properties will become available from time to time on a tenancy from year to year, admits the possibility of a greater fluidity of occupation. When valuing each hereditament, deemed vacant and to let, it would be possible to envisage latent demand from occupiers of similar properties freed from any contractual tie which binds them to their current premises. The advantage of such an approach lies in the ability to defeat arguments for nominal assessments on vacant properties, based on "no letting at any price" evidence, where there is a body of occupiers contentedly occupying broadly identical premises.

Whichever basis is followed arguments for differing assessments founded solely on occupation/vacancy of the hereditament must be strongly resisted. Similarly the hypothesis must not be permitted to extend to a departure from reliance on the rental evidence.

3.3 The hypothetical landlord

In obiter in M&S Leamington Spa v Sanderson (VO) 1992 RA 63 the member reinforced earlier decisions (eg. Coppin (VO) v East Midlands Airport Joint Committee CA 1991 RA 449) in asserting that "it cannot be assumed in the rating hypothesis that there is necessarily only one landlord for the whole development nor can it be assumed that there is necessarily a separate landlord for each hereditament ....... However, the further one strays from reality the less certain is the whole foundation upon which assessments are based." There is clearly significant scope for variations in ownership between these two extremes. The overriding suggestion seems to be that, as in other circumstances, departures from reality should be at the minimum level needed to produce consistent values. It may be necessary to assume that the hypothetical landlord is not the actual landlord to distance the former from the latter's letting policy if it is influenced by the ownership of adjoining premises (S & P Jackson (Manchester) Ltd v Hill (VO) 1980 RA 195). This factor will only be of relevance if the hypothetical landlord is likely to pursue a policy on rents at variance with that of the actual landlord.

The most common instances are shopping centres and industrial estates. If a landlord pursues a policy of keeping property vacant rather than reducing the asking rent, his/her success will probably depend on the level of competition in the area. If, as a matter of fact, there is significant competition from other owners it is unlikely that such a policy will achieve any increased level of rent, which will hopefully be demonstrable by rental evidence. On the other hand, if the landowner enjoys a virtual monopoly, any additional rent secured by limiting the supply may be in doubt once the monopoly is broken by the introduction of the hypothetical landlord.

In some areas of significant oversupply and high value landlords of commercial premises were faced at the AVD with the knowledge that if they failed to achieve a letting they would face a considerable empty-rate liability. This, it is argued, will have influenced them to accept a lower rent than might otherwise have been agreed. Although the hypothesis assumes a letting to take place, effectively removing any liability of the hypothetical landlord for empty-rates, it would be unsound practice to disregard their effect. The landlords of all other similar vacant properties, with whom competition can be envisaged, would be similarly motivated. It is therefore highly unlikely that any higher value could be achieved, and the assertion presupposes a tenant could be found who would be willing to pay a higher rent.

Many landlords in some of the oversupplied markets were faced with severe financial difficulties. If present, by a similar logic, their influence on the market cannot be ignored, although the hypothetical landlord need not be assumed to be in such difficulties. Rents of properties where clearly the wish of the landlord was to escape an empty-rate liability, almost at any price, should be treated with caution and the assessments of such properties should be comparable to the assessments of similar properties.

3.4 Nil or nominal rateable value?

In Black v Oliver (VO) 1978 RA 117 the Court of Appeal reviewed the authorities as to whether it could be correct, as a matter of law, to assess an occupied hereditament at £0 rateable value.

Browne LJ held that "if a tribunal of fact comes to the conclusion that if.......... no one would give any rent for the hereditament, there is in my judgement, no reason in law why it should not find a NIL value." In reviewing British Transport Commission v Hingley (VO) (The Grimsby Docks case) he went on to add "in my judgement, that case is an authority which supports what I think is the right answer in principle, namely that there is no reason in law why in proper circumstances there should not be nil value though the actual occupier is in beneficial occupation." The suggestion that the case be distinguished because the docks had been valued on the profits basis was rejected.

It seems clear therefore that there is no legal bar on entering a nil value in the rating list, but how should we define "in proper circumstances". It must be recognised that Black v Oliver was an exceptional case. The LT found that for personal reasons Black would wish to continue living at the property and paying a rent, but that the hypothetical tenant would not. It is unlikely that such powerful personal reasons could be identified in the non-domestic world. The normal non-domestic premise might be stated as "beneficial occupation implies valuable occupation", but if there is positive evidence that the value at the AVD is NIL then depending on the weight of that evidence that value cannot be ruled out. Nevertheless presentationally it may still be preferable if very nominal values are included in the list. In proper circumstances can therefore be defined as being where there is reliable evidence that NIL is the value of the hereditament even though it is occupied.

4. Reliability of Rents

Rents agreed in the open market will naturally reflect the interaction of supply and demand at the date they were agreed. Changes in these factors and the underlying economic circumstances will occur over time and impact on the rents agreed in the market. In a rapidly changing economic and market climate the further the effective date departs from the AVD the less reliable will it be as a guide to absolute value at that time. Nevertheless it may provide an insight into the rental effect of MCCs providing these can be isolated from other economic trends.

RM : Vol.4 Section 5 Practice Note 1 Para 17 identifies the normally accepted ranking of rental evidence in the order:

New lettings

Lease Renewals

Rent Reviews

Generally those rents agreed between the parties are felt to be more reliable than those determined by an expert, the Courts or an arbitrator. In normal market conditions there is frequently an adequate supply of new letting, renewal and review evidence to permit a judgement to be made of the correct level of value. However as at 1/4/93 there may be a scarcity of the first, and such as it is will sometimes be at odds with the remainder. Where, on analysis, the differences cannot be reconciled the level of assessment adopted will depend on a consideration of the rates which most closely conform to the statutory basis outlined above.

The levels of rent apparently flowing from operated upwards only reviews may show only a marginal increase over the rent previously passing. Agents may attempt to discredit such evidence arguing that it is tantamount to no increase and that the difference did not justify reference to arbitration. Equally it may be open to experts to show that the rent review surveyors relied on an imperfect knowledge of the market evidence because of confidentiality clauses. Such clauses are most likely to occur in markets where landlords hold multiple interests. Resistance to the latter arguments might be fairly based on the assertion that as that evidence was known at the AVD only by the parties to the transaction it would be unreasonable to assume that the hypothetical landlord and tenant had the same knowledge.

Ultimately the levels of value to be applied will depend on the weight to be attached to the range of evidence, and there can be no hard and fast rules as to which type is more reliable. Suffice to say that all evidence must be subjected to the most rigorous scrutiny.

5. The state of the locality at 1/4/93 and 1/4/95

Rating Circs 64 & 96 embody current VO policy on the detailed principles to be applied when valuing properties affected by MCCs. It is vital to differentiate between cause and effect. All MCCs and their economic consequences are to be taken at the compilation date (thereafter the material day). Any economic changes not flowing from MCCs are to be ignored although physical manifestations as a result at the later date will still have to be considered.

It is possible to envisage circumstances where a supply/demand imbalance at AVD will thereafter be influenced by a reducing supply (eg redevelopment) and/or increased levels of occupation by the compilation/material day. Whilst both are factors which are properly to be taken into account the latter is unlikely to impact on rental levels once separated from any underlying economic change which has caused it.

The state of all properties in the locality is relevant. There may be a proportion which at the material day are incomplete. The likelihood (or otherwise) of their being completed is a factor to be taken at the AVD.

6. A practical approach

When attempting to quantify the effect (if any) of oversupply at the AVD the following steps are recommended:

  • Identify the type of property for which there is an imbalance between demand and supply. For this purpose "type" must be closely defined. It may be restricted to a specific location (eg shops in a new or existing development) or a type of property defined by reference to a combination of permitted use, location, age, condition, quality and size. VO or BA boundaries will not restrict a consideration of the location.
    It will be necessary to look at the respective physical state ie. type of structure, accommodation layout and state of repair of the vacant and occupied properties to identify any material differences.
  • Consider whether this imbalance resulted at AVD in a substantial stock of accommodation of the type in question standing vacant and to let? Any space reserved for future occupation or held vacant pending redevelopment should be left out of account, but space not being actively marketed because of the state of the market must be included.
  • Assess the prospect as at the AVD of foreseeable changes to either supply or demand which might influence the imbalance. For example the certain prospect of a comprehensive redevelopment might be expected to significantly reduce the supply of a type. Conversely the imminent completion of a new development might equally be expected to increase supply of that space.
  • Conclude whether there was a market in the type at issue at the AVD. In deciding consider:

i) Are units of the type occupied other than for historic reasons? What evidence is there that occupation is only for historic reasons? Is there any real current demand?

ii) Are units of the type being offered on the market, if so on what terms and is this the rent to be expected or near to it?
In considering whether there may or may not be demand valuers should reflect on how long a building of the type in question might reasonably be expected to remain on the market before a tenant is found. In some cases landlords might be content to wait months, if not years, and evidence of no letting at the advertised rent does not mean that there would be no demand at any rent.

iii) Has any new letting of the type taken place around or since the AVD?

iv) Where transactions have taken place showing a positive value does this represent the value to be expected? It will be necessary to identify any factors, post AVD, which affect value but which are not be taken at the compilation/material day.

v) Where transactions have taken place at very low or negative values, have they been abnormally influenced by external factors, such as the circumstances of an individual landlord, the strength of the tenants covenant or the letting being for a short term.

vi) Have any rent reviews been settled for the type at or around AVD showing positive values? Is there any evidence to suggest that these could be impugned.

  • Consider any MCCs which have occurred by the compilation/material day and assess whether they have an impact on the appropriate RV.

7. A possible outcome in a typical locality

7.1 Modern Offices

In many areas of speculative development at the AVD there will be a stock of newly erected offices some of which is vacant (and has been for some time). Most of the vacant buildings will only have been finished to "shell and core" leaving the final fitting to be done by, and to suit, the ingoing tenant. If an incomplete building is subject to a completion notice the assumption that the building is complete will only be of relevance when valuing that property. All other properties in the locality are assumed to be in their physical state at the material day. It would be unusual in the extreme to find no evidence of any demand for the buildings, at the very least in the form of occupation of similar offices. There will almost certainly be a positive value. The difficulty will lie in quantifying that value. Many of the incomplete buildings are likely to be available to let, albeit with various incentives offered. RM4:5 PN1 (Sections 10 and 11) provides advice on the recommended treatment of incentives and improvements. Because deals struck in the open market will reflect the balance of supply and demand at a particular date such evidence close to the AVD will be influential. The drafting of the lease provisions (especially the treatment of improvements on review) will be crucial in determining the period over which to amortise improvements. The effects of incentives and improvements will to some extent be counter-balancing. The actual level of value adopted will depend on the range of evidence but is likely to provide a ceiling on the value of older and poorer quality offices.

7.2 Post-war and 1960's offices

These are likely to encompass a wide variety of buildings in terms of quality both as originally constructed and as subsequently refurbished to a greater or lesser extent. There will also probably be a wide range of condition dependant on the extent to which the buildings have been maintained. In areas where occupiers requirements have progressed it is possible that at least some of these buildings, probably the most basic, may be obsolete in their state at the AVD. To reach this conclusion there would have to be no significant evidence of demand for offices of a similar quality and location in the form either of lettings or continued beneficial occupation. In making these judgements it will be essential to assess the evidence differentiating by location, quality, condition and size. It is possible therefore that a wide range of value conclusions may be drawn for offices within this broad category. Unless there is persuasive evidence of nil or negative rental value (eg. the letting was in those terms) it would be exceptional for occupied buildings to be included in the rating list at £0 rateable value, since the normal expectation is that beneficial occupation will translate into a positive value. Those categories of vacant offices for which there is no evidence of demand should remain in the list for so long as they remain capable of beneficial occupation.

This type of accommodation is the most prone to redevelopment and if this prospect is reflected in either the term available on the rent, or both, it should be ignored, (see Burley (VO) v A & W Birch Ltd 1959 LT 52 RIT 576.)

8. Conclusion

An interpretation of the relevant legislation which results in differences in value of otherwise identical buildings based purely on vacancy or occupation is unsupportable.

It is not possible to draw hard and fast conclusions on which rental evidence will prove the more reliable in any given set of circumstances. Nevertheless there may be reasons why, in a falling market overhung with surplus space, new letting evidence, properly analysed, may be preferred. It will continue to be essential to focus on the physical condition of buildings and identify all facets of the transaction. All assessments must remain firmly based on the rental evidence.

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