The UK’s residential property shortage is no secret. Add to that a post-pandemic slump in demand for older, inefficient office buildings, and it’s no surprise there’s been a huge spike in commercial-to-residential conversions. Change of use applications rose by a staggering 63% between 2021 and 2023.
So, for freeholders with a vacant commercial property (or those considering a purchase), this route is becoming an increasingly viable option. But before you embark on such a course of action, there are a few legal hurdles and practicalities to be aware of, including the tax implications.
WHY NOW
- Office vacancy rates are up — 9% across London alone.
- Older buildings with low energy efficiency ratings are struggling to attract tenants.
- Refurbishment costs can be off-putting for commercial landlords.
- Meanwhile, the demand for homes continues to rise.
The numbers are starting to make sense. To make the most of the opportunity, it’s important to understand how to navigate planning, leases, and environmental obligations.
planning permisson: what’s the deal?
One of the biggest plus points is that converting from commercial to residential often falls under permitted development rights. That means a full planning application isn’t needed — just a Prior Approval application. Less red tape. Less delay.
Requirements include:
- The building must have been in continuous commercial use for at least two years.
- It can’t be listed or otherwise protected.
- The conversion must be completed within three years of approval.
Prior approval still requires the local planning authority to consider things like transport, flooding risk, noise, and the impact on local infrastructure. But it’s far less onerous than a full-blown application.
Lease Agreements
If the commercial building is currently occupied, things can get more complicated.
- Some tenants may have the right to renew their lease.
- Others may be protected under the Landlord and Tenant Act 1954 (“security of tenure”).
This can lead to costly surrender negotiations or compensation based on the rateable value if the landlord plans redevelopment. The landlord may be forced to pay the tenant compensation based on the rateable value instead of a new lease. These factors can impact the overall return on investment. Even if there’s no formal mention of security of tenure or informal agreement over lease/occupation rights, rights relating to security of tenure can be inadvertently applied.
A solicitor should review the lease at the earliest opportunity to establish any potential issues.
Environmental Considerations
Some landlords may view conversion as a way to avoid the high costs of upgrading energy efficiency in commercial premises. But that isn’t a guaranteed workaround.
- Current proposals would require residential lettings on assured shorthold tenancies (ASTs) to have a minimum EPC rating of C.
- Non-compliance could mean fines and difficulties letting the property.
It’s better to factor in upgrade costs early rather than face penalties later.
That said, conversion can be a strong sustainability move. Conversion isn’t a way to bypass obligations; if anything, it can enhance environmental credentials. Reusing existing structures tends to have a lower carbon impact than demolition and rebuild, which can support ESG and wider corporate objectives.
TAX CONSIDERATIONS
As always, you should not underestimate the complexities that tax can throw at a residential conversion.
From a VAT perspective, when contractors are carrying out the conversion, they are often able to apply a beneficial reduced 5% VAT rate for any qualifying work (subject to meeting some conditions).
This typically covers both labour and materials supplied as part of their service. However, if you purchase materials separately (i.e., supply-only goods bought over the counter), these are usually subject to the standard 20% VAT rate. There are times when we see contractors incorrectly applying a 20% rate here unnecessarily, so it’s important to make sure this is considered and the approach agreed from the outset.
Even if the property has previously been opted to tax, once it has been converted and is let out for short-term residential use, the rental income becomes exempt from VAT.
This maintains the property’s appeal for residential tenants, but the landlord’s input VAT associated with converting the property and operating it is irrecoverable and should be factored into project budgeting. However, depending on the structure of the project, there may be opportunities to mitigate the VAT cost, such as through partial exemption methods or by adopting alternative strategies for property use and ownership.
From a tax relief perspective, although the majority of costs associated with converting a commercial property to residential use do not qualify for Capital Allowances. However, it may be possible to claim for certain items of plant and machinery, particularly where these are installed in communal or retained commercial areas.
There could also be scope to identify tax relief on the original fixtures within the commercial property. This needs to be done prior to the conversion works commencing. And is dependent on prior owner restrictions and the nature of the current owner’s trade.
Conclusions
Converting commercial property to residential can be a smart way to repurpose a building with no commercial future. But it needs careful planning.
There are legal considerations, environmental requirements, and commercial risks that need addressing early on to ensure a smooth and financially viable conversion.
Tax considerations need to be part of your planning. Not just from the immediate project involving conversion, but also how they could impact for the long-term running of the property.
How we can help:
- Review and advise on leases and renewal rights.
- Advise on the implications of informal agreements.
- Guide you through LTA 1954 act implications.
- Carry out due diligence on property purchases.
- Advise on your exit strategy (whether that’s selling or letting). Disposals need to be considered as part of your long-term planning.
- Assist with VAT considerations.
- Prepare Capital Allowance claims.
Early legal advice makes all the difference. Get in touch to find out more.
