The Dilapidations Disconnect

In this Pandemic world, dilapidations claims are rising sharply in number, and will continue to do so, as more lease expiries and break options turn into exits, than lease renewals.

The ferocity with which they are fought is increasing too, even more so than in the last recession. Landlords angered, and financially weakened, by rental starvation through lockdown, face tenants with businesses similarly struggling to survive. One side desperate to get as much dilapidations cash in as possible, the other determined to minimise what it pays.

For landlord or tenant, there is a risk that the negotiating strength and outcome will be compromised by not employing the two distinct disciplines of chartered surveyor required from the outset. Whilst it is the chartered buildingsurveyor whose expertise is in identifying the breaches of covenants to repair, decorate and reinstate tenant’s alterations, and price their remedies, it is the chartered valuationsurveyor (Valuer) whose expertise is in property valuation and so is the only discipline of surveyor qualified to advise to what extent the law capping damages to the lower of the Cost of Remedial Works, or impact on the Property’s value, affects the outcome.

Section 18 (1) of the Landlord & Tenant Act 1927 provides a statutory cap on repairs, with similar caps applying at common law to both decorations and reinstatement. As such, the ‘Diminished Value (DV) cap’ can, and usually will, impact the entire claim.

For most second-hand commercial & leisure properties, the impact on value is notably less than the total cost to remedy (even on the tenant building surveyor’s figures). Yet whilst this is irrefutably the case, few landlords and tenants obtain the ‘joined up’ advice that is required. That is because there is a disconnect. Building consultancies invariably employ just building surveyors. As such, it is the building surveyor who is wrongly, but commonly, expected to advise to what extent the DV cap is relevant. But the building surveyor is not qualified to make this call, thus mistakes – expensive mistakes – are unavoidable.

For tenants, the risk this disconnect presents is obvious. Settling dilapidations claims solely on a Cost of Works basis recommended by the building surveyor, with no informed advice from the Valuer as to what extent the impact on value is less, inevitably leads to inflated settlements.

For landlords, failing to have the building surveyor and Valuer working together from the outset also creates the likelihood of unwelcome inflation; of expectations. No landlord client is going to thank you for building hopes of a target dilapidations outcome which, on the building surveyor’s Cost of Works assessment is realistic, to later find that when DV principles are applied to it, only a small fraction is achieved.

Hence why we established Dilapsolutions. A collective of the most experienced dilapidations specialists in the Country, both building surveyors and valuers, working together on every case from the outset. This uniquely ensures confidence both for tenants that settlement figures are being minimised, and for landlords, that expectations are being realistically managed, whilst still robustly pursuing maximum settlements.

How does this work in practice?

The Valuer applies two ‘filters’ to the building surveyor’s Costed Schedule of Dilapidations.

The first ‘filter’ requires the Valuer to apply open market transacting experience to, in the absence of knowing the actual landlord’s intentions, make informed conclusions as to how the Property requires The Dilapidations Disconnect 2

to evolve (be ‘repurposed’) going forwards. Commonly, to just ‘do the works’ claimed, would, if true, result in a property in perfect compliance, but for which there is no longer any market. Be it a large shop which needs to be split into marketable smaller units (with upper floors converted to residential), offices requiring gutting and modernising (or converting to residential), a warehouse requiring gutting and modernising to attract the best quality covenant on best terms, or a cinema/NEXTon a retail park being converted to a ‘last mile’ logistics centre, the repurposing of recently vacated properties is all but inevitable and unavoidable. The corollary is of course significant supersession i.e. claimed items being irrelevant, as they will in fact likely be overridden, or destroyed, going forwards.

The second ‘filter’ is to remove items from impacting the reversionary value which are ‘Not Value- Affective’ (‘NVA’) in the context of the ‘age, character and locality’ of the property in question. The law recognises the open market reality that ‘good’ repair does not require ‘perfect’ repair, and that ‘time must be taken into account – an old article is not to be made new’. Within reason, more ‘tattiness’ will be tolerated in the open market without rental adjustment in the older than the newer of two otherwise similar/competing properties on the market.

It is the aggregate of the remedial costs which ‘survive’ these two ‘filters’ which, more or less, is the amount by which the reversionary value is diminished. It is a common misunderstanding that the two valuations, A (In Repair) and B (In Disrepair) reveal the diminution (if any). This would only be the case if each was calculated independent of the other. But as it is near impossible to get comparables of transactions involving properties with exactly the same breaches as the property being valued (in order to calculate valuation B), the practice evolved to one of calculating valuation A, then deducting a cost of works figure (and other items) to get to valuation B. As such, it is the aggregate of those deductions which is the Diminution in Value.

In addition, there could be Loss of Rent, but this is rarely provable. More often than not, the open market generated void period would have been at least as long as that required to do the (surviving) works, and/or the required modernisation repurposing works would take a similar time.

These filters can apply even if the landlord has ‘done the works’, as contrary to what is often suggested, this does not ‘crystallise’, or prove, loss. It simply proves what the landlord chose to spend. The same two filters to remove items of betterment/supersession, and items ‘NVA’, apply. As for the former, it is for the Valuer to advise if replacement being presented as ‘repair’ would likely have been done even if the item was in repair (e.g. rotten softwood windows replaced with uPVC, or corrugated asbestos roof over-sheeted, instead of patch repaired). If so, commonly to ‘future-proof’ so as to improve investment value, then total supersession applies.

Paul J Raeburn

BSc (Hons) DipArb MRICS FCIArb

RICSAccredited Mediator