Building safety reform brings challenges for real estate funders

A sound understanding of the reforms and how they will impact at each stage of development, or in the context of remedial works, will be vital for real estate funders.

Background

In the aftermath of the fatal fire at Grenfell Tower an independent review led by Dame Judith Hackitt published its findings on fire-safety reforms in buildings. These findings were accepted in full by the UK government and have led to the Building Safety Bill and associated legislation being developed.

The Building Safety Bill is making its way through parliament and is expected to be enacted in the summer and to come into force in stages later in 2022 and 2023. A range of secondary legislation and guidance will also be required to implement the legislation. 

Scope of the reforms

The new legislation applies to new and existing ‘high-risk buildings’ which are classed as those being over 18 metres or seven storeys and containing more than one residential dwelling. This means that mixed-use developments and wholly residential developments are in scope. The legislation will likely be extended to cover smaller buildings over time.

Although the legislation remains subject to amendment it is possible to identify challenges for funders of high-risk buildings and for funders to consider how best to mitigate these issues.

Issues specific to new high-risk buildings

High-risk buildings are likely to take longer to build.

The new regulatory framework imposes a system of three regulatory ‘gateways’ for high-risk buildings. These apply: at the planning stage, which came into force in August 2021; before development works can begin and; before the building can be occupied. The Heath and Safety Executive (HSE), as the new building safety regulator, must be satisfied that the conditions to each gateway have been met before the building can proceed to the next gateway. 

The HSE could take up to three months to approve passage through each gateway from the point at which they have sufficient information from the developer. Funders should factor the resultant delays in getting the building completed and occupied into funding and repayment timetables. They will also need to be mindful of the financial implications of completed buildings potentially standing empty for a longer period of time without income whilst accruing costs, for example with respect to meeting insurance and council tax costs, and ensure that the sponsor’s financial models adequately provide for this.

Issues specific to existing high-risk buildings

Funders will need to consider who will fund any remedial work.

As building owners and landlords prepare for the new building safety regime, they may discover fire and structural safety issues within their buildings which are required to be addressed. If substantial remedial work is required, which is more likely for existing properties than new properties, funders may need to look to additional equity funding from sponsors and the value and saleability of the property will be reduced until such work is completed.

Consideration will need to be given to the availability of funding from the government’s Building Safety Fund, and recovery options which could be pursued. Recent Government amendments to the Bill prevent the costs of remediating cladding being passed on to tenants. The amount which can be recovered for other problems such as fire stopping is likely to be capped, and may also be excluded entirely. This means funders will need to ensure that the cost of any remedial works can be adequately covered by sponsors and/or from any other available sources. 

Issues common to new and existing high-risk buildings

Funders should ensure that property portfolios take account of fire and structural safety risks.

Funders should use valuation covenants in loan agreements to require an assessment of the risk profile of the building. For external wall systems, this is likely to be based on the new PAS 9980 or EWS1 standards. The fire risk assessment should also be considered. This will help them to make informed assessments of the true value of their security, taking account of any remedial works.

Limitation periods for claims will change.

Limitation periods under the Defective Premises Act 1972 relating to buildings built before the Building Safety Bill comes into force will be extended from six years to 30 years, applying retrospectively. As such, funders could find that developers face greater financial pressure from historical claims – including claims against companies they might have acquired. This may affect the progress of ongoing developments as well as corporate banking relationships that funders may have with developers. 

Maintaining the ‘golden thread’ of information will be crucial.

A ‘golden thread’ of building safety information must be gathered and maintained throughout the lifecycle of the building, from initial design through to the end of the occupation phase. This means the golden thread will be relevant to both new and existing high-risk buildings. 

On development financings, funders should consider what access they might require to the golden thread so that they can satisfy themselves the borrower and the development parties have complied with the regulatory regime before releasing each tranche of development funding. The funder must also ensure that it can assess whether all conditions for occupation will be met prior to the development loan repayment date. Access to the golden thread will also be important if the funder requires to exercise step in rights and to facilitate any disposal of the development site.

For existing financings, funders will again want access to the golden thread although existing buildings are unlikely to have a full golden thread. The requirements here remain to be specified by the HSE but due diligence and funding on trade sales and enforcements of existing buildings may become more challenging.

In either case, funders should ensure that information undertakings, conditions precedent and other protections are sufficiently robust to allow them to make a proper assessment of compliance with the new regime. The funder’s reputation may also be damaged if it is perceived to have been lax in scrutinising the developer’s compliance with the regime, or if it is seen to be standing in the way of remediating buildings.

Funders can inadvertently become liable under the new regime.

The dutyholder regime in the legislation for high-risk buildings is onerous and includes criminal sanctions. Where the owner of the development is a dutyholder the funder will take over this role if it takes ownership of the asset as a mortgagee in possession and, as such, would assume responsibility for ensuring the safety of the asset. Funders will therefore want to ensure that any enforcement process minimises the risks of this, for example by enforcing share security rather than asset security, and/or relying on third party receivers.

What the reforms mean for real estate funders

The Building Safety Bill promises the biggest shake-up in the regulatory landscape around fire-safety for high-rise residential developments in more than three decades. Funders will be significantly affected by it, alongside many other stakeholders in the sector.

Funders will need to be sure they understand the timing implications for building-out developments and ensure that they are clear as to what compliance with the regulations looks like at each stage of the development. For existing developments, funders should ensure that they understand any remedial works that might be required and consider from what sources those can best be funded. Funders must also ensure that in enforcing security they do not unknowingly take on statutory obligations and potential criminal sanctions.

Despite the challenges, funders can successfully navigate the new regime if they are vigilant, proactive and prepared.

Co-written by Natalie Harris, Zoe de Courcy Arbiser, Kofi Atta and Chandni Pattani of Pinsent Masons.