Parallel pressures creating pressure for lease conversions
There has been a marked reduction in commercial property use in our town and city centres across the UK, arising from the post-COVID transition to hybrid working and the changing shopping patterns of the public.
Add to this the ongoing housing shortage and increasing residential property demand, and it is easy to see why the conversion of retail space into residential accommodation by commercial landlords seeking to profit from the housing crisis has created approximately 95,962 new homes in England during this period.
But it is not only commercial landlords who are able to unlock value in commercial property. For businesses with long commercial leases that find that the properties they occupy are no longer commercially viable for business occupation, there are ways to unlock value, even where the lease prohibits residential use.
Thackray Williams is currently seeing a notable increase in enquiries from commercial tenants who wish to change the use of their leased premises from commercial to residential, but are prohibited from doing so because of restrictive use clauses.
Commercial landlords, therefore, need to brace for a lease conversion surge in 2026. Understanding the legal options open to tenants and the factors that will influence decisions over whether to grant lease conversions will enable landlords keen to maintain a commercial portfolio to argue their position.
It will also enable landlords to anticipate and plan for how their portfolios might shift in the coming months, and how to turn this challenge into a positive opportunity. And it will allow them to consider their own options for lease conversions and where this might help deliver better returns on their portfolios or increase the value of their stock.
The legal route available for tenants wishing to convert commercial leases
Restrictive covenants, such as those permitting commercial use only, can be released or modified by the Upper Tribunal (Lands Chamber) (the ‘Tribunal’) using the procedure set out in section 84 of the Law of Property Act 1925.
Whilst the Section 84 procedure is usually used to release covenants that restrict the use of freehold land, for example, by modifying restrictions on the number of properties permitted to be built on a particular plot, Section 84 can be applied more widely, and the Tribunal has the power to release or modify restrictions contained in a lease on the application of the tenant.
The qualification to the exercise of the Tribunal’s powers in relation to leasehold land is that the lease in question must have originally been granted for a term exceeding 40 years, and more than 25 years of the term must have expired.
Section 84 of the Law of Property Act 1925 – what you need to know
Section 84 gives the Tribunal the power to discharge or modify restrictive covenants affecting land when certain statutory grounds are met. The key grounds under s.84(1) are:
(a) The restriction has become obsolete due to changes in the character of the property, the neighbourhood, or other material circumstances;
(aa) The restriction impedes some reasonable use of the land, and either (i) does not secure any practical benefits of substantial value or advantage to those entitled to the benefit, or (ii) is contrary to the public interest, provided that money will be adequate compensation for any loss suffered;
(b) The persons entitled to the benefit have agreed, expressly or impliedly, to the discharge or modification;
(c) The proposed discharge or modification will not injure those entitled to the benefit of the restriction.
The procedure involves making an application to the Tribunal, which must be satisfied that at least one of the aforesaid jurisdictional grounds exists before it exercises its discretion to grant the order. Even if a ground is proved, the Tribunal retains a discretion whether or not to grant the application.
In deciding applications, the Tribunal must consider factors such as the development plan, the pattern of planning permissions in the area, the context in which the restriction was imposed, and any other material circumstances. In this regard, expert evidence from surveyors and planning professionals is vital as such reports are required to persuade the Tribunal to exercise its powers.
Legal case sets precedent for commercial tenants
The case of Shaviram Normandy Ltd v Basingstoke and Deane Borough Council [2019] UKUT 256 (LC) was the first case where the Tribunal exercised its jurisdiction under s84 to a leasehold interest.
The Council was the freeholder of a building in Basingstoke, which had been let in 1985 for a term of 150 years with the permitted use being an office building. The building was vacant and in disrepair and the tenant wanted to redevelop the building into a residential apartment block with 114 residential flats to be let on assured shorthold tenancies.
The change of use was permitted for planning purposes; it amounted to a breach of the restriction on use in the lease. The Council refused consent to a change of use under the lease, so the tenant applied to the Tribunal to modify the restriction on use in the lease.
The Tribunal allowed the tenant’s application, concluding that the restriction in the lease impeded the reasonable use of the building for residential purposes and the restriction on use conferred no practical benefit of substantial value on the Council.
Factors influencing the Tribunal’s decision
In reaching its decision, the Tribunal took into account the development plan and the pattern for the grant or refusal of planning permission in the area.
In deciding whether the covenant conferred any practical benefit, the Tribunal scrutinised experts’ opinions of the estimated capital value of the building and the rental income that could be received depending on whether its use was as an office or for residential purposes.
The Tribunal concluded that the capital value of the building would be increased if used for residential purposes but would produce a slightly lower rental figure. As the capital value was the more important consideration, the Tribunal concluded that the restriction requiring office use did not confer a practical benefit on the Council.
The Tribunal also considered whether the restriction on use conferred a wider benefit for the Council and rejected the Council's case that restricting the use of the property to offices would make a significant contribution to the economic wellbeing of the town. It rejected an argument that allowing residential use would be the thin end of the wedge, encouraging further changes of use under leases of office buildings owned by the Council.
What this means for commercial landlords
Whilst the merits of applications to modify restrictions in leases will be fact specific to each case, broadly one must consider the location of a building; the development plan; planning history of the locality; the effect of any change of use on the capital and income values of the building and the impact on the landlord’s interest in other properties in the area.
Understanding the legal framework will enable you to identify where you might be able to apply for a lease conversion for unprofitable commercial properties. It can also help you build your case if you are keen to restrict properties within your portfolio for commercial use.
Your first step in either case will be to check whether the lease exceeds 40 years and more than 25 years of the term have expired; if this criterion is not met, then there is no opportunity to apply to the Tribunal for lease conversion.
If this criterion is met, you will need to provide expert evidence to support the value – economic and social – that either conversion to residential use or maintaining the commercial requirement brings to the area, and the material difference that removal of restrictions would make for you, one way or the other.
However, with the ongoing pressure for housing and reduced demand for commercial space, it’s reasonable that some lease conversions will be successful.
Taking expert advice to understand your likely chances of success – whether you are applying for the removal of restrictions or opposing them – could save you more expense in terms of collating expert evidence to support a case that you are not likely to win. It can also enable you to start planning early for the changes to your portfolio and how you can turn this to your best advantage.
