Tue 05 May 2015

Student accommodation and long leases

Student accommodation is an asset class which now comprises a significant part of the investment market.  It also drives a considerable amount of development activity. It's fair to say that it has its own peculiarities, certain restrictions which exist on the grant of long leases in Scotland being one of these.

Scottish residential lease 20 year duration limit

While the maximum duration for which a new commercial lease in Scotland can be granted is 175 years, legislation (dating back to 1974) contains a statutory restriction which effectively prohibits the grant of leases of private dwellinghouses of more than 20 years. 

Why is this relevant to student accommodation one might ask?

The difficulty is that the 1974 Act did not define what was meant by the term "private dwellinghouse" where it appears within the relevant restriction and unfortunately there is no case law concerning student accommodation which makes it clear whether or not it falls within the meaning of "private dwellinghouse". There is a nervousness around this, as there is case law suggesting that a private dwellinghouse can be a nursing home or a place of residence for school children. One can see how this might extend to student residencies. Also, certain types of student accommodation attract reliefs aimed at residential property, such as multiple dwellings relief for LBTT purposes. The generally accepted "safe approach" therefore is to treat student accommodation as comprising "private dwellinghouses" for this purpose.

The two main areas where this potential restriction impacts are on ownership and VAT.

Ground leases are problematic

If title is held on a long ground lease the implications of this are obvious. The danger is that landlords can require that the use ceases, failing which landlords can potentially have the lease declared void. Even in instances where landlords have consented to the use in question, there is an ability on the part of the landlords to reduce the term of the lease to 20 years. 

Quite apart from the impact this could have on investment value, there is also the difficulty that securities may only be granted over leases in excess of 20 years in Scotland which could render a student investment of this type unfundable in practice. There are also statutory restrictions on the ability of funders to charge fees on loans secured over residential leases - and it's not usually possible to contract out of these rules.

Peculiarities of VAT recovery for student accommodation construction

Turning to VAT, in certain circumstances it is only possible for developers to reclaim VAT on construction costs where there is a grant of a "major interest" in land for VAT purposes - which is either a sale or a lease of a minimum duration. For the rest of the UK, the lease element of a major interest is a lease for more than 21 years. VAT legislation in Scotland accommodates the 20 year residential lease limit by providing that a lease of Scottish property for at least 20 years can qualify as the grant of a major interest.

Depending upon how any deal is structured however, this might also create difficulties for funding purposes - either where the funder wishes to take security over the "VAT lease" or where a creditor having security over the ownership interest does not wish to encumber the property with an unsecured lease to (what is generally) a related party.

A change in the law in prospect…?

It is important, therefore, in any student accommodation project, to ensure that appropriate VAT and legal advice is taken. While the courts could yet determine that student use does not qualify as use as a "private dwellinghouse" for the purposes of the 1974 legislation, it is encouraging that the Scottish Government intends to launch a consultation (in the Summer of 2015) which will look at the possibility of amending the 1974 Act in question to exclude student accommodation from its scope.

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