If you do not come "sweetly to the table" I will destroy you. Michael Gove did not say the last bit but he may as well have done.
The Living Sector has just received its equivalent to a Dear John letter from the Government. A break-up letter that may well end the decades old warm and cosy relationship between residential developers and the Conservative Party.
The Department for Levelling Up, Housing and Communities (DLUHC) has called time on the negotiation of the Developer's Remediation Contract ("DRC") (the contract that signs up developers to billions of pounds in reparations for the cladding scandal) warning developers that they need to sign up to the DRC by 13 March 2023 or else.
In this article we highlight how this letter and the so called "significant consequences" set out in sections 126-129 of the Building Safety Act 2022 (the "BSA") might affect the Living Sector more widely.
- What is the purpose of the DRC and what does it say?
Back in April 2022 49 developers signed a pledge letter setting out the principle that leaseholders (i.e. the owners of flats on long lease) should not have to pay for any costs associated with life-critical fire-safety remediation work arising from the design, construction or refurbishment of residential buildings of 11 metres and above.
A first draft of the DRC was later sent to Developers and has been in discussion with them for some time. The Home Builders Federation initially came out fighting for the industry when it saw an early draft, at one point stating the DRC was "impossible to sign". The comings and goings of various Housing Ministers has hindered the progress on the DRC, with accounts suggesting that Mr Gove pulled previously agreed compromises with the major housebuilders when he was put back in post as Housing Secretary after Simon Clarke his predecessor in the Truss government took a more conciliatory approach.
On 30 January 2023 a new (apparently final) version of the DRC was published and a deadline of 13 March 2023 has been set for the developers to sign up to it or else face "significant consequences". Some of these objections appear to have been dealt with in the latest iteration particularly the requirement that repair obligations must be for "Life-Critical" defects only. In the last 24 hours there have been positive noises from Barratt and Persimmon (being among the biggest house builders) saying they intend to sign up. Developers must confirm their intentions to sign up by 10th February 2023.
What is clear is that there will be vast numbers of Real Estate, regulatory and disputes lawyers poring over the drafting of the DRC ahead of the two deadlines.
- Empty threats? What are the "significant consequences"?
The "Dear Developer letter" confirms DLUHC will implement sections 126-129 of the BSA and to also implement further regulations through a new "Responsible Actor" scheme. In interviews and in Parliament Michael Gove threatened that if the industry did not sign up to the DRC they should "find a new line of work". Exactly how would Gove prohibit trade of the non-compliant?
Sections 126 – 129 of the BSA lay a framework for future intentions in this regard but we await sight of actual draft regulations.
This section is very wide ranging and sets out that the Government may later by regulations, impose a scheme to
a) secure the safety of people in or about buildings in relation to risks arising from buildings, or
b) improve the standard of buildings,
including securing that safety, or improving that standard, by securing that persons in the building industry remedy defects in buildings or contribute to costs associated with remedying defects in buildings.
This section is mainly procedural in nature about the setting up and rules of the scheme that is set up pursuant to section 126 (the "s126 Scheme").
This section details how a developer who is not a member of a s126 Scheme may be prohibited from carrying out development of land in England despite that developer having planning permission. The new regulations could essentially mean that permission is not capable of being implemented by that developer. Note that this refers to all development not just residential development, so putting developers who do not sign up to the DRC out of business entirely.
This section details how a developer who is not a member of a s126 scheme may be prohibited from securing building control approval to their developments.
In short, the Government is willing to hold the industry to ransom and regulate to ban developers from operating in their market if they have not signed the DRC and joined the s126 scheme.
- What will happen in the next 6 weeks?
There will most likely be two camps:
Penitent compliers – Most of the big housebuilders/developers realise that they need to take their medicine. They know that public opinion understandably weighs heavily on the side of the individual leaseholders and they want no further negative PR. Many have made their cladding fund announcements when reporting their financial results and these "losses" are baked into current share values. So, can it get any worse?
Outlier objectors – there is always the possibility that with the Home Builders Federation behind them calling for wider industry reparations ( i.e. throughout the cladding supply chain not just the developers), that a judicial review may be considered when the Responsible Actor regulations come into force. Sections 126-129 set the scene for extremely restrictive curbs on the sector and could be seen as anti-competitive in nature. Michael Gove has recently admitted that the government guidance before Grenfell was "faulty and ambiguous" which may spur some developers on to try to spread the burden wider than just the developer through the Courts.
- And longer term?
In the context of the severe lack of housing in the UK hindered by the seemingly endless roadblocks to delivery of the new housing (even those developments which are consented), the BSA and the prospect of punitive s126 Schemes will no doubt concern investors into the Living sector. Institutional investors have earmarked billions to spend in the UK Living Sector but optimism and sentiment can be dented easily.
Many medium sized and smaller developers will find it hard to bounce back. The "look back" provisions in the BSA are going to be front and centre of developers' risk registers. The new legislative landscape will need advice from lawyers, surveyors and a whole host of other professionals to navigate how the BSA affects risk, funding and delivery timescales.
New entrants may not have legacy remediation costs but they will be entering a highly regulated market and may just settle for lower rise or lower risk developments possibly in sectors other than Living with less regulation. Do we then end up with unimaginative developments in the wrong places which does nothing for the housing crisis? Or no developments at all despite the growing housing need? It is difficult to believe that a government looking for any sort of a growth agenda intends that to be the consequence of this action.
Bizarrely the effects of the stark choice of join the s126 scheme or "find another line of work" may end up playing to the advantage of the big housebuilders. The regulations might inadvertently create the potential to exclude anyone other than the big boys from the high rise market creating a small cartel of those with the largest pockets.
Construction is in itself a strong economic contributor and the new s126 Scheme will undoubtedly depress or diminish high rise activity as a result of rafts of regulations stopping, or at least slowing building in the Living Sector.
Another unintended consequence of this penal approach might be a softening of the Living Sector's resolve to be carbon neutral. The scale of developer's ambitions here may have to be scaled back to try to increase margins on cheaper/ basic schemes.
Another key area which could be affected will be the already scarce provision of affordable homes for a variety of reasons:
- fewer planning permissions will be obtained if not being driven by the larger developers doing schemes over 18m;
- fewer development will be built out now; and
- costs will rise so appraisals will not allow for so many affordable homes
It remains to be seen if the DRC will be signed "sweetly at the table" or whether developers are busy "finding new lines of work" but the Living Sector will be watching the next six weeks with keen interest and a bit of trepidation for what happens next!
Co-head of Housing Sector
Partner, Real Estate