Building safety issues ‘impacting real estate finance’

Katherine Metcalfe and Pippa Whitmore of Pinsent Masons were commenting at a recent Pinsent Masons event at which they explored how building safety compliance is impacting real estate finance in England.

The Building Safety Act 2022 imposes strict requirements on both developers of new ‘higher-risk’ residential buildings and on the owners and managers of existing ‘higher-risk’ residential buildings.

Whitmore told attendees at Pinsent Masons’ event that building safety-related compliance risks are impacting how loan agreements for both new developments and existing buildings are being drafted.

In loan documentation, lenders seek protection against non-repayment of the loan stemming from risks facing borrowers. In the context of building safety, one such risk is where a borrower fails to comply with their legal obligations. That failure can cause reputational harm, lead to delay in development projects and, in the case of existing in-scope buildings, could result in borrowers being required to re-accommodate residents until necessary remediation works are completed – often at significant cost and with a resultant loss of rental income.

Whitmore said that industry body the Loan Market Association (LMA) believes that it is not necessary for loan documentation to make specific reference to compliance with the Building Safety Act 2022 and that lenders can rely on more generic alternative language referencing the need for borrower ‘compliance with laws’. However, she said that position is unpalatable to many lenders.

“The ‘compliance with laws’ drafting typically states that borrowers and guarantors, also known as obligors, will comply in all respects with all laws to which they may be subject if failure so to comply has or is reasonably likely to have a material adverse effect,” Whitmore said. “What constitutes a ‘material adverse effect’ is heavily negotiated on a case-by-case basis. It can cover things that will have a material adverse effect on things like the business operations, property condition, or potentially the prospects of a borrower or guarantor. While that sounds broad, borrowers will often seek to negotiate down that position and there are common limitations, such as around enforceability of security and around remedies open to a lender.”

“What it means in reality is that for a lender to obtain proper protection in relation to building and fire safety, any failure to comply has to be classed as also having this material adverse effect. That is not a given – it completely depends on the drafting and the negotiated position. It is quite common with older loan agreements where, for example, a building needs to pass a safety inspection – if that fails, and the borrower has a strong negotiated position, the lender might find it has little to no teeth in relation to ‘compliance with laws’ drafting,” she said.

According to Whitmore there is no market standard wording that can be applied on an off-the-shelf basis to give lenders more comfort over this issue.

As a result, some lenders are seeking to insert more specific wording on compliance requirements into loan agreements, such as ‘Comply with the Building Safety Act 2022’ or other relevant fire safety legislation, Whitmore said.

Other lenders have also sought to obtain “positive undertakings” from borrowers in relation to disclosure of information pertaining to building safety and fire safety compliance – such as a copy of the ‘golden thread’ of information that duty holders are required to maintain about an in-scope building to support building safety compliance on an ongoing basis, Whitmore said.

However, Metcalfe said that while the regulatory system applicable to new higher-risk buildings means developers compile such a golden thread as their project progresses through the different ‘gateways’ of approval, it has been more challenging for owners and managers of existing properties to compile a golden thread for each relevant property in their portfolio.

“Funders are pretty risk averse when it comes to fire and building safety issues within existing buildings,” Metcalfe said. “The market for anything that does have known defects which are still waiting to be remediated is really quite difficult. They're likely to be subject to some pretty serious price chipping. And even with remediation plans in place, the delay in getting that done, the standard of work that's required, how you're going to protect rental income while the remediation is being done, are all huge issues for negotiation.”

Metcalfe said that borrowers able to compile technical documentation pertaining to fire safety for their property portfolio will be well placed to satisfy lender information requests – and that this can help them negotiate finance agreements or the sale of assets.

“We’re frequently seeing lenders asking for updated EWS1 forms, new PAS9980 assessments that they can have the benefit of, and an up-to-date ‘Type 4 fire risk assessment’ for higher-risk buildings. If those are not already available, it is really tricky to get them at short notice and that's going to delay your deal.”

“We're also seeing lenders and purchasers asking for the full golden thread for higher-risk buildings – safety case reports, resident engagement strategies, and so on. For existing buildings, the obligation is to put those in place as soon as reasonably practicable after the Building Safety Act 2022 came into force. However, many organisations with large portfolios simply don't have all of that in place yet – it's a work in progress to roll that out across their entire stock. So, for those selling an asset, I would say try and prioritise that to make sure that the golden thread is as good as it can be,” she said.

The Building Safety Regulator is taking a phased approach to assessing the compliance of existing buildings. As of July this year, it had assessed 170 applications for a building assessment certificate but rejected 125 of those applications. This is just a small initial sample of the estimated 12,500 buildings thought to constitute higher risk buildings under the Building Safety Act 2022.

Metcalfe said that while the regulator had identified major safety concerns in relation to some of those applications, in many other cases it had simply considered applications to be poor or incomplete. In those cases, she stressed, it does not necessarily mean the buildings are unsafe. However, she said that is not how some conveyancers – and therefore some lenders and insurers – have interpreted things, causing problems for owners and managers seeking finance and insurance for those properties.

Whitmore said: “We would advise borrowers to enter into dialogue with lenders now about the state of the existing buildings that will be called in for review by the Building Safety Regulator over the coming months and years and the compliance process that they're going through, and having some meaningful conversations now about the positioning of each of those buildings and the approval rates of their applications. That will then go some way to protect against difficult conversations further down the line.”