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Commercial property to benefit from permitted development rights?

Henry Lancaster, senior investment analyst at Coutts, provides his take on the introduction of permitted development rights.

UK commercial property could get a lift from government plans to boost new residential construction by removing some restrictions on converting commercial buildings into housing.

The Government today announced new rules to ease planning restriction on converting office premises for residential use. The new rules concentrate on expanding the “Permitted Development Rights” for a narrower target of unused offices. However, local authorities, starting with the City of London, can opt out to prevent disruption to the future development of business districts.

For the commercial property market, the beneficial side effect of these plans to boost the supply of housing would be the conversion of redundant offices to profitable use. But in order for this potential to be realised, property development has to pick up. So the impact will initially be limited outside of the booming Londonmarket.

Why is conversion to residential use significant?

Real rents (adjusted for inflation) on residential property have gone up 80% in the past 25 years, while commercial property rents have only kept pace with inflation over that same time period.

Residential property prices have also outpaced commercial property over the past 50 years, yet planning restrictions mean that there are persistently higher levels of vacancies in commercial than residential property. If conversions to residential use were to absorb surplus commercial property, then the long underperformance of commercial property could reverse.

What will change?

The expansion of Permitted Development Rights would allow commercial propertyto be converted without planning permission from the local council. Other planning restrictions would remain, but it would reduce the cost and risk of the planning process for some developments.

What won’t change?

Local authorities, such as the City of London, can override the Permitted Development Rights, according to press reports on the expected proposals.

More extensive re-developments or re-building would also still be subject to existing planning laws if they change the external size, shape and appearance of the building.

The proposals are confined to commercial office properties. This is a step-back from previous proposals that included industrial property, such as warehouses. Retail remains out-of-bounds, with the focus still on regenerating High Street shops, despite the equally high vacancy rates.

The relatively small size of the office market compared to the housing market means the impact on residential property prices will be more muted, and likely only significant for flats.

Why is the City of London so keen to opt out?

The key concern is that, in the midst of a slump, significant office space could be converted to residential use. This removal of office space could constrain future growth by limiting the City’s ability to expand again when the economy recovers.

A lack of development of an ‘institutional’ market for large blocks of residential rental flats has been the key deterrent to conversion to residential use. Once an office is converted into flats, they are sold to individual owners. This dispersion of ownership rights would make future redevelopment impractical. The introduction of residential areas into business districts could change the nature of the area and impose constraints on commercial development.

What is the immediate impact?

The residual value for office blocks will rise in areas with buoyant residential property markets – currently this means London. However, considerable development has already taken place in the London market. The price of high-endLondon residential property and the well-developed market for flats makes developers willing to accept the costs and constraints of the planning process.

For the rest of the UK, the impact is likely to be more limited. Lower average property prices mean that the cost of conversion is a higher proportion of the value. While the existence of an alternative, residential use may underpin the value of unoccupied office blocks, realising that potential requires investment and a market for flats.

What are the obstacles to further conversion?

The new proposals would reduce the cost and risks of the planning process. However, it does not address the other problems besetting the UK property market, especially outside London.

The aftermath of the property crash has left the commercial property industry with a dearth of capital. Property losses have left many owners with very limited resources, while existing lenders are still seeking to reduce their exposure. That leaves many in the property industry with no appetite for new investment.

New capital and lenders are being attracted to UK property by the potential returns available. But investors are cautious, given the lack of economic growth that limits the market for new tenants and buyers of flats. This has focused investment on cosmopolitan London, which has attracted investors and tenants from around the world.

This was posted in Bdaily's Members' News section by Coutts & Co .