The ripple effect of NHS reform on real estate

Posted: 24/06/2013

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A new NHS structure was born on 1 April 2013, built upon the ashes created from the abolition of all 10 strategic health authorities (SHAs) and around 150 primary care trusts (PCTs). A good part of the estate (up to around 3500 properties) has transferred to the newly incorporated NHS property holding company, NHS Property Services (NHSPS). NHSPS, a government owned limited liability company, is charged with owning and managing the NHS estates and its objectives include disposal of any surplus property and establishing cost effective property solutions.

Effect on landlords

Directly affected are landlords who let to PCTs and SHAs as at 31 March 2013. It is believed that the transfer of these interests to NHSPS had automatic effect under the terms of a transfer order - in effect a statutory instrument. Alienation or assignment restrictions in existing leases did not apply, and the transfers will take place regardless of what they say, leaving landlords unable to object.

A cause of concern may be the issue of NHSPS’ covenant strength, although the Secretary of State has sought to address this, issuing a ‘Letter of Explanation’ for the benefit of landlords' sponsors and/or funders of NHS property schemes. Landlords will also need to ensure that the mechanics for the payment of rent due under leases post 1 April is aligned, and that the new centralised arrangements for making payments on their properties are co-ordinated fully with the relevant estates divisions, to ensure that payments as at and from the March 2013 quarter day have been cross checked to the right properties and made in time.

Effect on tenants and licensees 

Public and private sector tenants of transferred estates will find that they have a new (NHSPS) landlord. Estate management functions will transfer to regional offices, leaving tenants negotiating licenses to alter and rent reviews as at and from 1 April 2013 with new entities - and needing to build new commercial relationships.

The financial position of NHSPS could affect tenants in other ways, because the extent of government funding in the set up period for NHSPS is uncertain. Budgetary constraints could also influence the negotiation stance taken by NHSPS with occupiers. It will be a pleasant surprise if NHSPS approaches real estate matters in any way other than could be expected by a private real estate investor. If one of NHSPS’ objectives is to survive financially by maximising returns on its portfolio, a tougher position on (for example) rent reviews and approvals which are not covered by lease terms could emerge. This may be softened if coffers are replenished through disposals, but only time will tell. Cautious tenants will naturally want to protect themselves with finalising rent reviews as soon as possible, and accelerating requests for consents where advisers believe there could be scope for difficulty.

There is additional confusion around how NHSPS will treat existing concessions personal to tenants (eg rent free periods or capped service charges). They may no longer apply following transfer. Some occupiers who have an undocumented basis of occupation may come under pressure in coming months to sign new leases on less favourable terms.

Occupiers should not underestimate the strength of their bargaining position however, and should always seek appropriate advice. Some PCTs issued occupiers with Heads of Terms and draft leases prior to 1 April, but it is unlikely that those leases were finalised before the transfer date. It is more likely that memoranda of key terms will be presented to occupiers for signature with the effect of fixing, or trying to fix, the commercial understanding between the parties. These can be moved more easily into a binding lease format at a later stage.

Repair obligations in any new leases or memoranda will need careful consideration, and advice should be sought from solicitors and specialist surveyors. NHSPS will be looking to minimise expenditure on its assets and a looming threat of service charge demands in the future exists following the request for a further audit of property portfolios to establish current levels of tenant contribution to buildings in disrepair.

Effect on developers and investors

The opportunity for the private sector to support and work in conjunction with NHSPS in relation to existing estates and future projects is something which developers and investors will need to monitor. Responsibility for Local Improvement Finance Trusts transferred to the CHA as of 1 April and there is speculation that surplus estates will be transferred to the Homes and Communities Agency for resale. There is clearly potential for exciting and innovative property solutions where in the past there has been reluctance. Banks will, however, play a key role in any future success here, as larger projects will rely on the provision of finance, which in recent times has been rather scarce. However, the view banks will take of NHSPS as an investment partner remains to be seen.

Conclusion 

There are still a lot of gaps to be filled and unanswered questions. It would be a foolish landlord, tenant or developer who ignores the future effect of the estate transfer. As the due diligence process proceeds, and the policies of NHSPS are established, all those involved in real estate in the healthcare sector will need to consider their legal positions and be ready to react accordingly.

This article was published in Insight in June 2013.

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