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Cost of office premises are set to soar

publication date: Oct 14, 2008
author/source: Philippa Aldrich and Claire Macdonald
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In the midst of the credit crunch and the turbulence of the economic markets, many commercial tenants are struggling to stay afloat. Whilst survival in the ‘here and now’ is undoubtedly top priority for many UK businesses, it is essential that commercial occupiers also keep one eye on the cost of the future. 

Property costs are often the main expense for UK businesses. On top of rents and service charges, occupiers have to pay what are, essentially, occupier taxes. Known as business rates, compulsory contributions to the cost of local authority services are generally in the region of 40% of the yearly rent. 

Business rates are calculated by multiplying the ‘rateable value’ of each non-domestic property by a multiplier set yearly by the Government in response to inflation. Broadly, the rateable value of premises reflects the annual rent the property could expect to attract on the open market at a specific date. The rateable value is reassessed every 5 years, and business rates are altered accordingly, in order to track changes in the property market. 

In April this year the rateable value of all of the UK’s 1.8 million commercial buildings was re-assessed by the Valuation Office Agency (an agency of the Inland Revenue). In April 2010 this revaluation will be implemented. Although values will not be confirmed until September 2009, based on the open market value of commercial property in April 2008 and the general trend of rising rents since the last revaluation in 2003, it is highly likely that for the majority of occupiers business rates will rise. 

Research has shown that before any appeals, average increases for retailers could be 15% plus. Supermarkets should expect a 20% rise and West End offices a crippling 40% increase in their business rates. Although it is likely that increases will be implemented via a 5 year transitional arrangement, every ratepayer will pay their true rates liability in the fifth year at least, and most will pay it well before. 

When general market trends show rents are rising, payment of rates based on the rental values from at least 2 years previously seems fairly advantageous to occupiers. But unfortunately, rents are no longer rising. In fact, between now and 2010 rents are predicted to fall. 

The current economic slowdown and the negative business performance of many companies, particularly in the retail sector, mean occupiers are hesitant to take on new leases. Developers and landlords are being forced to reduce their rents for retail and office spaces alike. 

The new requirement for buildings to have Energy Performance Certificates and the recent focus upon the environment will also inevitably have an impact. It is expected that buildings with high energy efficiency ratings will become more attractive to occupiers and rents of less efficient buildings will be driven down. 

On top of all of this, legislation abolishing empty property rates relief came into force on April 1 this year. Occupiers with vacant retail or office premises must now pay full business rates on spaces which are empty for more than three months. Previously, after 3 months only 50% rates were payable. Warehouses and factories will benefit from 100% relief for only six months before again facing full business rates. Industrial buildings used to enjoy 100% relief from business rates no matter how long the space stood empty. 

During the economic boom, this sort of encouragement to re-use, sublet or redevelop underutilised properties would arguably have been positive. Through brownfield regeneration, greenfield development could be limited and lower rents would be agreed to avoid high taxes becoming due on empty buildings. 

However, this only works in a booming economy. Clearly, not all landlords are sitting on empty properties because they are unwilling to market the buildings to new tenants or modernise them in order to do so. Some properties are simply harder to let, perhaps due to their age, situation or lack of demand. This is especially true when uncertainty is looming on the economic horizon. 

In fact, even with the threat of high empty business rates, since the abolition of relief was announced in March 2007, there has been a 21% rise in the number of vacant commercial properties. In spite of the Government’s attempts to encourage development and regeneration, energy efficient improvements and speculative development plans have widely been put on hold. In light of full taxation, landlords are not willing to obtain vacant possession to carry out such works and are obviously keen to fill existing properties before building more. 

Whilst it is possible that rents could rise because the cost of rates on empty buildings are after all passed onto tenants, overall, rents are likely to fall. Many businesses are unable to bear the increased costs burden that abolition of the relief has induced. Older properties which cannot be filled, even at a reduced rent, may face demolition as landlords seek to avoid the rates liability. It is yet to be seen whether the Government will take lower rents into account when calculating the new 2010 business rates. If not, occupiers will face inflated rates rises in 2010 at a time when rents have fallen below April 2008 levels. Some have speculated that the coincidence of the implementation on the same day of the new empty rates legislation and the review of rateable values is Government manipulation. Already set to benefit hugely from increased taxes payable on empty buildings (in the region of £1.4bn), the Government can administer a double whammy by raising business rates too. 

And occupiers will face a further blow from April 2010 when local authorities will be allowed to levy a business rate supplement of 2p in the £1. 

So what can occupiers do? In September 2009 the Valuation Office Agency will publish the new rateable values on its website. Before it comes into effect, occupiers will have six months to check that the valuation of their property is based on factually correct information. The rateable value should reflect the net effective rent of a property and take into account any incentives such as rent free periods or cash contributions from landlords. 

It is at this point that occupiers may be able to avoid arbitrary tax by querying or appealing against the rateable value of their property. Any changes to the neighbourhood or the property which may have affected the value of the premises can be reported; the Valuation Office Agency will then investigate further. 

Whilst there has so far been no blanket reduction in business rates to reflect the reduction in rents due to the uncertain economy or the abolition of empty rates relief, it may still be possible to contend, on a case-by-case basis, that the changes to the empty rate relief legislation impact on a property’s rental value. For example, the rateable value of a property could be reduced if it came onto the rental market because of the change in the empty rates legislation. 

If the outcome of any further investigation is still unsatisfactory, an occupier can formally propose to alter their property’s rating. A three month period will then ensue during which most cases are likely to be settled by agreement. However, if no agreement is forthcoming, the case will be automatically referred to the local valuation tribunal where the appeal will be heard. 

Three weeks before the hearing, an appellant will be informed of the rents of similar properties that may be used by the valuation office to justify their valuation. An agreement can still be reached at any time. If a case gets to the hearing stage, the appellant does not have to attend. They can state their case in writing. However, attendance may be wise, just in case any further information is required. 

Business rates must continue to be paid whilst the appeal process is underway and until a decision has been reached. If an appellant is suffering particular hardship there is a chance that the process can be speeded up. Ultimately, if a case is successful, the relevant council will refund any overpayment, with interest. The tribunal is free. Occupiers must however bear in mind that a reduction in rateable value, unfortunately does not always mean a reduction in business rates. 

In order to stand the best chance of paying fair and accurate business rates in the future, it is essential that occupiers start gathering information on the impact of the empty rate legislation and collate records of rental incentives being given locally. It is worth also considering appointing a rating agent who can value the property, identify grounds for a rates reduction, complete the proposal and act as a point of contact with the local valuation office. Any rating agent should have detailed local knowledge of procedures and any local conditions which may affect values. 

Unless the Government is prepared to do a U-turn and reinstate empty property rate relief, it is possible that some businesses won’t even see 2010. However, those that do, need not be punished further through extortionate rates they can ill afford. Advice to occupiers: prepare to appeal. 

Philippa Aldrich is a partner and Claire Macdonald is a trainee solicitor in the Real Estate Group of Shadbolt LLP.