Commonhold: what are the opportunities?

(10 min read)

The discussion around the reinvigoration of commonhold is buzzing in England and Wales. But it has been a successful feature of other jurisdictions for years. Here, Jeremy Scott, a partner in our UAE office and New Zealand qualified, with a wealth of experience on strata and commonhold in some of the other jurisdictions, looks at the proposals and the opportunities they bring to us.

You may well ask yourself why an antipodean lawyer based in Dubai might be writing an article about English and Welsh Commonhold. I certainly have.

The genesis of this article is a bit convoluted. Firstly, it arises from the great consternation I noted (on the group emails) amongst my English and Welsh colleagues about the draft Commonhold and Leasehold Reform Bill. To me, this seemed an opportunity, and I had the intrepidity to say so. This was before I had taken the opportunity to look at the draft Bill in any detail, and upon doing so realised that the concept of “commonhold” and leasehold reform had been intertwined. Leasehold reform is a very different issue and naturally one with considerable complexities.

Secondly, I have a positive predisposition towards the concept of commonhold, an area in which I have practiced, in many jurisdictions over my career. My interest started with advising property managers and developers in relation to the New Zealand’s Strata Title Act of 1972, which borrowed heavily from the New South Wales Law Strata Titles Law of 1961. The New Zealand strata law, bumbled along for close to 30 years without too much fuss, finally yielding to a more evolved (though fundamentally the same) law in 2010.

My New Zealand experience brought me to Dubai in 2008, when Dubai was bringing in its own commonhold laws and regulations, borrowing from Australian best practice. Since then, most of the Middle East has adopted similar regulations to those of Dubai (all with some regional twists). Since arriving in the region, I have had the privilege of working with many large developers, internationally reputed consultants, community managers and regional governments. A particular highlight was working with the Bahrain government on the Bahrain commonhold regulations.

Recognising that this article is targeted at an English and Welsh audience, I also practiced for 2 years in England on my OE (overseas experience for the non-antipodeans), primarily doing commercial real estate work, and am familiar with leasehold title developments, which also exist, though are not common, in New Zealand and the Middle East.

Hopefully, my credibility to comment thus established….

So what is the opportunity?

So what is the opportunity for investors and owners?

In simple terms, owners hold freehold title to a unit, with the association owning and managing the common parts. The association operates in a manner not dissimilar to any other corporation and is governed by a constitution, as well as a commonhold community statement which sets out the key rules and regulations specific to the development. The owners, like the shareholder in a corporation elect the directors and have powers by ordinary or special resolutions to grant some approvals and make prescribed changes.

It is a codified arrangement that does away with numerous different schemes that can be assembled in leasehold arrangements each of which is established in contractual manner. There is no need for owners or investors, their banks, surveyors or solicitors to review leases, consider rent review provisions, consider ad hoc committee structures, or consider how the investment may need to be amortised over the term of a lease. An element of diligence is still advisable, but this is greatly reduced.

In commonhold there is no threat of “termination” of the leasehold interest for non-payment of charges or other reasons as exist in leasehold. Termination in the context of leasehold results in the leasehold interest reverting to the landlord, with the resulting complexities ensuing. For those concerned that without a clear sanction for non-payment, service charges will not get paid, commonhold laws usually allow for penalties and in extreme cases, an order for sale of the unit may arise.

Service charges are also secured against and run with the title to the unit so defaulters are usually forced to pay on any transfer of title. Perhaps the most important element however is that the transparent management structure undermines any owner’s excuse not to pay. They have access to information and vote on the budget. If they object to the service charges, they also have the right to be heard at the owners’ meetings and to put themselves forward as a director of the association, which of course they don’t. Simply paying their service charges is easier.

Issues around management of multi-unit properties obviously remain. The White Paper puts a lot of emphasis on the democratic underpinnings of the association, which of itself may concern some investors who would prefer a strong manager, such as a landlord to ensure standards are maintained. Whilst emphasising the democratic nature of the framework is not incorrect, a better analogy would be that of a company and its board, and a company and board that have a narrow constitutional focus on the business of managing a building for the benefit of the owners. I would also emphasise that the day-to-day executive functions of the association and board, other than in the simplest of projects, will inevitably be delegated to professional managers.

Overall, the above results in a far more transparent structure. Concerns have been raised that this may result in various power struggles and complexities, and whilst this can happen, my experience has been that for the most part, people lose interest in the management once they know it is done in a transparent way. People are very interested in what goes on behind closed doors, but rather blasé about what happens in the open. The danger, if anything is a level of apathy by owners, something that should be borne in mind carefully when considering the various voting thresholds required to get things done. The vast majority of people are happy to leave the management to the board and the professional managers and rely on their recommendations.

Despite appearances, commonhold may offer more avenues to make changes to the project or address structural problems, through the use of owners’ resolutions. There threshold of votes is however a fairly high bar. In appropriate cases, court and other proceedings may be able to have a situation reviewed to ensure that outcomes are appropriate and remove the tyranny of a majority or minority.

Finally, well managed communities also foster a sense of community and engagement that may be lacking in circumstances where the management is externalised and there is limited or no opportunity for engagement.

So, what is the opportunity for developers?

In my experience, the vast majority of professional or institutional developers are not interested in profiting from the ongoing management of their developments once completed. They usually recognise that this would be seen as a conflict of interest in some cases and is generally unwelcome. They are however very concerned to see that their projects are well managed, as their projects are an important part of their image and brand.

What I have seen at times however is ‘a race to the bottom’ type mentality where developers, to stay competitive, engage in practices that they would prefer were not in the industry at all, however, feel compelled to do so to remain competitive.

The White Paper emphasises that the commonhold law is likely to limit the ability for developers to entrench management or any other contracts which should create a level playing field for developers. A level of entrenchment may not be fatal (for example in the context of branded residences) however in such circumstances, and generally speaking, I would recommend the regulations provide for a level of plain English disclosure in order to ensure that investors understand the positioning of the unit and project and any special arrangements that may apply.

Such a level playing field can only be good for the real estate development industry, and the removal of some of the other limitations associated with leasehold should also give comfort to other institutions such as banks and insurers. Most importantly, investors should be able to take comfort from the codified rules and regulations that apply which should be attractive to investors and assist developers with prices and sales.

Contrary to how it may appear, the codified nature of commonhold laws do not limit what can be done from a development perspective. The 2002 law clearly had some limitations in this regard; however, the White Paper indicates a more sophisticated approach will be implemented. This should allow multi-stage and complex, mixed-use projects to be developed, with elaborate shared facilities, the use of which can be game changing for developers.

And the other stakeholders?

Given that commonhold has been around since 2002, why hasn’t it taken off as a concept? The answer will in part be that the leasehold system is familiar and being contractual in nature is flexible and easy to implement. I would speculate moreover that linking leasehold reform to commonhold has meant the overall package has met with a mixed reception. To me, they are fundamentally different arrangements, leasehold in certain contexts makes good sense, and nor when carefully structured would it be inferior.

I will lay down the gauntlet however and argue that commonhold, as multi-unit ownership system, is superior and developers, lawyers, surveyors, property managers and financiers may well be “disrupted” if they don’t prepare. Fundamentally moreover there is enormous potential for the real estate industry.

Banks and financiers stand to benefit as the risk from ill-conceived leasehold schemes is large, whereas the codified commonhold arrangements are far more robust from a title perspective as a commonhold title cannot be terminated. Moreover, the need for a bank to vet and consider leasehold title reports as part of their risk management exercise is greatly reduced.

As outlined above, the transparent structure should also give the banks confidence that the buildings will stay compliant through a centralised management structure, reduced disputes and various legal mechanisms in the case of financial issues or emergencies, including, at the extreme end of the scale, administration type procedures to bring the association back into compliance, (which incidentally, I have never seen used). Moreover, there are prescriptive measures such as sinking funds and insurance obligations.

For the lawyers, there is plenty to do. The fundamentals of planning, development, building management and conveyancing still exist but are run through a different lens. On the non-contentious development side, instead of leases, there are commonhold community statements to be prepared and which in the case of sectioned and mixed-use projects can be quite in-depth. On the day-to-day management side, frequently, the associations or managers may request advice on various matters ranging from the conduct of meetings, interpretation of rules or the code, as well as the range of property management and facilities management type issues that arise in multi-unit projects.

On the contentious side, an association is a very focussed and effective conduit of legal proceedings (architects, engineers and contractors, review your insurance. Developers, you know the drill). Occasionally moreover there can be disputes between stakeholders, which, due to the corporate nature of an association can resemble shareholders disputes.

Perhaps the biggest opportunity however is for the surveying (RICS) community. From a development perspective, the various strata plans will need to be prepared and the method for determining service charges established. The White Paper makes it clear that the commonhold law and regulations should allow for complex mixed-use projects, which can involve a detailed and collaborative approach from architects, surveyors, property managers and legal advisors.

The fundamentals of property (facilities) management do not change, however what does change is that there needs to be a class of property manager which understands the business of running meetings and related administration and dealing with the people side of the association. In addition, these managers need to understand the business of running a building. A challenging but rewarding profession.

And the proof is in the pudding!