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Publication - Report

Testing the rent review system: report

Published: 26 Jan 2018

Report on secondary legislation needed to bring reforms to landlords and tenants agreeing agricultural rents in a cooperative process.

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Contents
Testing the rent review system: report
Chapter 8: Non-Agricultural Use

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Chapter 8: Non-Agricultural Use

8.1 Description of Model

8.1.1 In terms of the 2016 Act, non-agricultural use is assessed on the basis of what a tenant would pay for the site for commercial purposes. The site is the property, land and/or buildings used by 'the tenant' for the non-agricultural use. Therefore it relates to what 'a tenant' would pay for the use of the site rather than what 'the tenant' is using the site for. If non-agricultural use is taken account of in the rent review process then that would be taken as the landlord granting consent to a diversification from agriculture even if it had not been notified in line with the procedures set out in the 2003 Act. Following the rent review the landlord would be personally barred from objecting to the diversification if it had been taken into account as a non-agricultural use within the assessment of the rent.

8.1.2 The below model outlines the process for considering non-agricultural/diversified activities.

model outlining the process for considering non-agricultural/diversified activities

8.2 Issues arising from the model and proposed solutions

The main elements to be considered prior to determining if a non-agricultural/diversified use is in place are:

8.2.1 Is there land and/or buildings used for a non-agricultural use?

8.2.1.1 Proposed Answer: The first aspect of this is to confirm that an activity being undertaken on farm is considered to be a diversified activity. For something to be considered as a diversified activity it needs to be considered as non-agricultural. To distinguish where this is applicable it is often useful to look at whether a building or site has changed from agricultural use to business use in terms of its planning status or rateable value. However this will not always be an accurate assessment as it is common on farms for non-agricultural/diversified activities to take place without being identified up by the Assessor or Planning Authority. It should also be noted that there are areas where the definition falls within agriculture for the purposes of planning but outwith for the purposes of an agricultural tenancy. In such instances the use can be based on the most likely commercial use or if this is not obvious then it would fall back to being let as part of the farm for agricultural purposes.

8.2.1.2 Recommended Approach: The determination of a diversified use should rely on scale, use, extent and therefore contribution to the tenant's business.

8.2.2 Has the landlord consented to the diversified use?

8.2.2.1 Proposed Answer: As noted previously, consent can be granted by not objecting to a notice under the 2003 Act or it can be implied through the parties attributing a rent to the non-agricultural use at past rent reviews. It is clear that if a landlord does not wish to consent to the non-agricultural use taking place then it should not be considered separately to the farm in the rent assessment. Once a rent has been attributed to a non-agricultural use the landlord would be personally barred from objecting to that use and requiring the tenant revert to the pre-diversified use.

8.2.2.2 Recommended Approach: If rent is attributed to a non-agricultural use, consent to the diversification will be implied and the opportunity to object to the use in the future will not be available.

8.2.3 Rent of the landlords fixed equipment let on the open market for commercial purposes

8.2.3.1 Proposed Answer: Generally speaking, whilst there are a range of factors which influence commercial rental values, the Use Class of the buildings defined in the planning consent is often the starting point. Most diversified commercial use seen on farm (considering only landlord's fixed equipment) would be categorised as small scale general industrial use or storage and distribution in terms of the Use Class. Farm buildings will generally be considered as agricultural unless the tenant has been granted planning permission to change the Use Class. For the use to be valued it must be assumed that the relevant planning permission is in place for the diversified activity for the purposes of the commercial rental valuation.

8.2.3.2 In order to consider the rental value of the diversified use it will be necessary to assume a planning Use Class, even if that planning Use Class is agricultural, in the absence of a specific planning consent. The following table outlines the main general use classes, although it should be noted that all Use Classes subject to planning permission are not necessarily specified within the table i.e. equestrian use and other specialised uses.

Table 21: Use Class Table

Table 21: Use Class Table

(Source: Town and Country Planning Scotland Order 1997)

8.2.3.3 The Scottish Government has developed a useful guide to Farm Diversification and Planning Permission in Scotland. In order to consider what a building would be marketed as on the open market we need to consider what Use Class is permitted (for this we have to assume planning permission is in place for the current use).

8.2.3.4 The need for planning permission usually depends on the scale of the operation. Examples of where planning permission would be required for a diversified activity are as follows:

  • Tearoomstearooms;
  • Restaurantsrestaurants;
  • Riding riding schools;
  • Ponypony-trekking centres;
  • Offoff-road driving centres;
  • War war game centres;
  • Food food processing operations that require raw produce to be brought onto the farm for processing, packaging and onward distribution to retailers,;
  • Golf golf course or golf driving ranges.

8.2.3.5 Diversified uses less likely to require planning permission and therefore more difficult to define a use class for are:

  • Small scale educational facilities i.e. demonstrating farm jobs or providing facilities for bird and wildlife watching.;
  • sub-letting of machinery storage space and workshop space.;
  • small processing operations, ancillary to the farm use.;
  • caravan & camping sites. Certain permitted development rights are given particularly if you have a site certified by an organisation such as the Caravan Club. In most other cases planning permission will be needed for caravans.;
  • farm shops: If a farm shop is ancillary to the farm and is in an existing building, planning permission is not normally required. However, if a significant percentage of the goods sold are brought in for sale from off farm, then planning permission will be required. The planning authority's main consideration is likely to be the nature and scale of the shopping activity together with the amount of traffic it will generate.

8.2.3.6 For diversified uses where planning permission would not be required, it may be more difficult to define the commercial use to attribute a rental figure to with reference to the open market. Often due to the scale and extent of the use, it may not be appropriate to attribute a diversified rental against the non-agricultural use as it may be entirely based on tenant endeavour. The rental calculation must consider what a hypothetical commercial tenant would do with the landlord's fixed equipment which may result in no diversified business use being applicable.

8.2.3.7 Recommended Approach: Planning permission must be assumed in line with the tenant's actual non-agricultural use and can be used as a starting point for deciphering what the site would be marketed as commercially. It should be noted that some aspects of non-agricultural use will fall within agriculture from a planning perspective but could still be deemed commercial use in terms of the agricultural holdings legislation, allowing for an open market rent to still be applied i.e. forestry and some types of small scale storage.

8.2.4 What general assumptions need to be made when considering the diversified use?

8.2.4.1 Proposed Answer: Most diversified uses are very specific to the tenant's improvements and therefore the commercial use, if let on the open market only using landlord's fixed equipment, could be different from the actual tenant's use so long as it falls within the same use class. When considering letting on the open market for a commercial purpose the following need to be taken into account:

a) Location of the building - it may sit within the centre of a working farm with the remainder of the farm retaining its agricultural character. The likely restrictions will be related to access to markets and ability to trade from such a location rather than the presence of agricultural activity in close proximity to the use.

b) Access provisions - the tenant can have a non-agricultural use on farm due to the fact they have the right to occupy the whole farm. It is therefore reasonable to presume there are no access difficulties which would prevent the commercial use from taking place and no conflicts with other users.

c) Comparable evidence – needs to be adjusted accordingly. Where possible 'comparable' should reflect only the landlord's fixed equipment, black patching tenant's improvements so far as possible.

d) Terms of the lease – commercial leases are generally use-specific and freedom of contract means they are difficult to standardise. As it is an agricultural tenant, comparable evidence should be based on leases which would have similar terms to that of the agricultural tenancy being reviewed i.e. full repairing and insuring, a long lease term and similar rent review provisions ( i.e. three yearly by open market).

8.2.4.2 The likely open market commercial rent figure for the landlord's site should have necessary deductions for tenant's improvements, voids, management, and maintenance before coming to the likely rent to be charged. When considering a fair rent it would seem appropriate that this is crosschecked against the likely income a hypothetical tenant would achieve from the Use Class as the basis of the residential model. The calculation would be the likely income the tenant would receive minus voids, management and maintenance, minus tenants improvements not black patched with the surplus split 50/50. A cross check with the hypothetical tenant's net enterprise income would promote the assessment of a fair rent. However such an assessment could only be used as a sense check where there is a lack of relevant comparable evidence and not the primary method for assessing the rent.

8.2.4.3 Alternative Approach: An alternative approach would be to consider the tenant's actual diversification and rentalise it on a net enterprise income basis. This is not in keeping with the Act and is discussed with reference to examples later in this chapter. Where comparable evidence is limited and the tenant's diversification is specialised, but does rely on the provision of land and fixed equipment from the landlord, the enterprise income basis could be justified. Considering the earning capacity of the actual diversification, deducting the tenant's improvements from this, making a deduction for voids, maintenance and management and then splitting the surplus 50/50 could be considered as an alternative calculation method. However this would not be recommended due to the difficulties in ensuring that all tenant's improvements are accounted for and deducted. Where possible it is best to black patch tenant's improvements - which this method does not promote.

8.2.4.4 Recommended Approach: Make general assumptions on the structure of a hypothetical commercial lease based on the actual tenant's obligations in terms of the agricultural lease and value the rent on a comparable basis in the first instance. The net enterprise income method using what a hypothetical commercial tenant would likely achieve from the landlord's fixed equipment could be used as a sense check where there is a lack of relevant comparable evidence. We do not recommend calculating the rent on the basis of the actual tenant's diversification.

8.2.5 Should tenant's improvements be excluded?

8.2.5.1 Proposed Answer: The Act states that the open market rent can only be applied to fixed equipment provided by the landlord or land which is being used for a non-agricultural use. Tenant's improvements must therefore be excluded from the assessment. In order to do this the standard approach is to black patch tenant's improvements where possible and only include improvements which are necessary in order to make valid comparisons with other open market letting evidence. Such improvements would then need to be deducted on the basis of what element of the rent they represent. Ideally this should be done by an analysis of comparables to see how rents vary depending on certain elements or using an annualised cost approach.

8.2.5.2 Alternative Approach: An alternative approach would be to completely black patch the improvements and consider the open market rent without any tenant's improvements. However, in some cases it is impossible to analyse comparables using a black patch approach to tenant's improvements as there are no comparables available. Using this approach would lead to a number of diversified activities being unable to be accounted for in rent reviews. This does not seem to be the intention of the Act and does not meet with the concept of 'fair'.

8.2.5.3 Recommended Approach: Generally improvements should be black patched unless comparable evidence takes account of tenant's improvements such as hard coring for storage. Such improvements should be deducted from the rent either through an analysis of their impact on the rent via comparables or through annualising their current cost and deducting it from the rent. The legislation must allow for improvements to be accounted for on an annualised cost basis.

8.3 Working Examples

8.3.1 Although the model above seems self explanatory, in practice there are a number of issues arising from the calculation of diversified rental income. In order to analyse the calculation for compliance with the legislation we have outlined the results from some of the farm samples we looked at:

8.3.2 Example 1: Dutch barn used for DIY livery

8.3.2.1 In Example 1 the Landlord provided a Dutch barn (500 sq m) (5380 sq ft) constructed of a concrete floor, steel frame, steel sheet walls and roof. The tenant had installed 7 x steel frame stables, the water supply to each stable and renewed the cladding on the roof. Previously the building was used for bale storage with the current use now consisting of ¾ DIY livery and ¼ straw storage for DIY livery. The building was therefore considered to be 100% diversified in terms of its use.

Calculating the Diversified Rent: Comparable Method

8.3.2.2 The comparable method is in-keeping with the legislation as it is the main way of determining the open market rental value of an asset. The difficulty with this method is in finding comparable evidence and then making adjustments in order to make that evidence relevant to the subject being assessed.

8.3.2.3 For a DIY livery, the comparable evidence considered would ideally encompass the following similarities:

1. Location.

2. Lease terms (rent, term, repairs and maintenance obligations, insurance, termination).

3. Scale.

4. Condition of fixed equipment supplied by the landlord i.e. type and quality of stables, condition of main building, water, electric, heating.

5. Facilities/opportunities included i.e. hacking, riding schools (outdoor or indoor), DIY/Half or full livery, hay/haylage supply, cleaning facilities, secure tack room, toilets, other high tech facilities such as horse walkers, solariums etc.

6. Presence of other activities i.e. farming, heavy machinery, other animals (risk of disease).

7. Health & Safety i.e. proximity to roads, presence of children, asbestos, security, hygiene.

8. Grazing (ability to have separate grazing, fencing suitability, provision of water supply, age of grass, variety of field sizes to accommodate different horse types).

9. Availability of labour.

8.3.2.4 The comparable evidence method can be difficult in practice as relevant comparable evidence is not always available which means significant adjustments may need to be made. The more adjustments made, the more the rent is open to debate.

8.3.2.5 The following worked example shows how this works in practice.

Comparable Evidence

8.3.2.6 A DIY livery yard with stables within a traditional steading with grazing and a house let under a separate lease is let at £300 per stable per annum. The tenant in this case is responsible for the full repairing and insuring of the unit and has put in the stable kit herself. Essentially the landlord has provided the traditional steading, water supply and electricity supply. Although it is situated in a more affluent location than the subject to be valued, it is similar in most regards. The following differences have been identified and need to be accounted for through adjustments in the rent:

1) Location in terms of proximity to market demand.

2) Consideration of whether a traditional building should be considered differently to a Dutch barn for its ability to facilitate the provision of stabling. May be more open to the elements than a traditional building but probably easier to access.

3) Provision of a secure tack holding facility is included in the comparable evidence but not in the subject farm.

4) Deduction for tenant's improvements in terms of the water supply and roof cladding. Should be done on an annualised cost basis.

8.3.2.7 A worked example of this method would be:

7 x stables let at £300 per stable per annum = £2100

Table 22: Location Analysis

Location

DIY Livery (£/week)

Facilities

Comparable Evidence Location

48

Use of arena, stable, secure tack room and hay, straw and turnout

Subject Location

31

Use of arena, secure tack room & a 12 x 12ft stable

8.3.2.8 The previous table shows that DIY livery does not appear to be hugely location sensitive as the above variations reflect the addition of hay and straw in the comparable evidence example. Bearing in mind the location and tack facilities, it may be necessary to discount the rent slightly per stable per annum.

8.3.2.9 The applicable rent for this would therefore be around £2000 per annum. This would then need to be adjusted to reflect the tenant's investment. Through annualising the likely cost of improvements, a £350 deduction was made to the overall rent. This would leave an open market commercial rent of £1650 per annum.

8.3.2.10 Other comparables looked at included more facilities provided by the landlord and ranged from £520 to £775 per stable per annum. Again once adequate deductions were made to remove the grazing, housing and additional facilities provided by the landlord, most comparables seemed to be in the region of £300 to £350 per stable per annum.

8.3.2.11 In this case what the tenant is doing and what a hypothetical tenant would do are the same. A net enterprise income method in this instance would be based on the income likely to be received from the equestrian use based on the fixed equipment provided by the landlord with cost based deductions for improvements which a tenant would likely make. For example, it would be reasonable to consider a tenant would put in stables and a water supply to operate a DIY livery. It would be unreasonable to consider a tenant to operate a full livery service as this relies on a tenant's specialism and management.

8.3.2.12 The standard method of calculating the net enterprise income has been to start with the income generated from the use, deduct tenant's improvements, allow 33% to be taken off to account for the tenant's management, voids and maintenance then split the surplus 50% to the landlord and 50% to the tenant. There is some evidence of the landlord's share of the surplus rent being between 20 and 40% depending on the level of tenant's endeavour. However the industry practice is to allow for costs, typically 33% and then split the balance 50:50.

8.3.2.13 A worked example of this would be:

7 x stables let at £30 per stable per week = £10,920

Deduction for tenants improvements = £350

Deduct 33% for voids, repairs & management (£3603.6) = £6966.40

Landlord entitled to 50% of the surplus rent = £3483.20

8.3.2.14 The difficulty with this method is determining whether it is supported by the current legislation. It is calculated via the likely earnings of the defined commercial use rather than reference to open market comparables; although in order to derive the income open market comparables are utilised i.e., stable rates for DIY livery. Where there is a lack of relevant comparable evidence it would be appropriate to use this method as a sense check. In the use of this method it is important to take into consideration any relevant operating costs.

8.3.3 Example 2: Workshop/Storage

8.3.3.1 Another example of diversified income which we came across when looking at the sample farms was sub-letting for storage which would be classed as light industrial use although in terms of scale it may not have required planning permission. With such a use there is a subtle difference as to whether it would be classified as a non-agricultural use or just sub-letting. Sub-letting would be prohibited in most leases and therefore a rent could be agreed via separate agreement but not within the capacity of the rent review. Where sub-letting is ancillary to the tenant's non-agricultural use it can be considered as non-agricultural use for the purposes of the rental calculation. For example in the case of storage, if the tenant is providing a service in terms of security, maintenance etc rather than just sub-letting a shed then the activity can be considered as non-agricultural use. In this example the tenant is operating a storage business and not just sub-letting.

8.3.3.2 This is likely to be a common farm diversification and in terms of the legislation it is reasonably straight forward to find comparables for this type of use on the open market. In terms of the Aberdeenshire area, light industrial use for storage or the letting of a workshop space seems to range from £60 to £750 per month depending on the facilities which are provided. In the case of the comparable the sheds used for diversification were very basic (barely wind and water tight in some cases).

8.3.3.3 In terms of comparable evidence the following information is relevant.

Table 23: Storage Comparables Analysis

Location

Type

Size

Rent (£)

Fraserburgh, Aberdeenshire

Commercial shed complete with racking

742 sq m

1600/month

Oldmeldrum, Aberdeenshire

Garage

1 car

60/month

Buchan Braes Industrial Estate, Peterhead

industrial unit

135 sq m

750/month

Westhill, Aberdeenshire

New Storage container, CCTV security

73 sq m

150/month

Peterhead, Aberdeenshire

Storage containers, secure site

73 sq m

90/month

8.3.3.4 The workshops/storage facilities looked at on the sample farm ranged from 105 to 140 sq m and were located within close proximity to Aberdeen. The most comparable example is probably the container as it provides basic storage although would be smaller than the buildings on the farm. A comparable rent could therefore be £200 per month (£2,400 per annum).

8.3.3.5 In this case, the actual tenant's diversification and what a hypothetical tenant's use of the subjects would be are the same i.e. sub-letting areas within the sheds for the storage of machinery and providing a surveillance service. Due to the amount of comparable evidence available in this case the net enterprise income sense check would not be necessary. However, if it was to be utilised it would calculate the income based on the likely rent a hypothetical commercial tenant would receive for the use of the buildings and the likely service which would be provided with deductions made for management, maintenance and voids. Therefore the surplus rent would be an enhanced rent to the open market comparable rent as it would look at the potential business rather than the commercial rent possible from the landlord's fixed equipment.

8.3.4 Example 3: Specialised Agricultural Processing Operations

8.3.4.1 For specialist agricultural processing, including packing on farm rather than offsite, it is often difficult to decipher whether a diversification exists. This is further complicated by our planning assessment indicating that no consent would be required.

8.3.4.2 When considering whether an additional rent is attributable, it is important to consider what the building/yard space is used for and how much of this is due to the landlord's fixed equipment. For example the following could be considered:

1) Is the barn/store/shed/yard on the farm being used for production and processing rather than purely agriculture?

2) Does the lease specify what type of holding the farm is let as and is the use consistent with this?

3) What elements of the barn/store/shed/yard has the tenant implemented in order for them to undertake the diversified activity?

4) Would the barn/store/shed/yard still be capable of being defined as an agricultural building without the tenant's improvements? For example production/processing activities would fall under agriculture, light industrial use or storage and distribution. Most barns/stores/sheds/yards could be considered under this use class regardless of tenant's improvements.

5) Is the business at a scale of operation whereby a surplus rent is attributable? Would the diversified use be considered as a separate business activity or project which is entirely based around a tenant's interests and endeavours?

8.3.4.3 In the example we looked at it was considered that the scale of the production and food processing was at a level where it would be considered as a non-agricultural/diversified activity. However, due to the level of tenant investment the comparable evidence utilised was in line with that analysed in the previous example (small scale industrial storage). This meant square foot industrial rental figures were not relevant as they were for industrial buildings which were fully internally fitted with internal walls, flooring, good lighting, spacious accommodation and a clean space to work. Further the building used was split with the diversified use.

8.3.4.4 In terms of small scale storage units, small lockups and container storage were looked at with rents of £135 to £185 per month being applicable. This would give a rental of £1620 to £2220 per year. A deduction would also be made to adjust these comparables as the storage offered would be neither secure nor private.

8.3.4.5 In terms of the net enterprise income method it is unreasonable to base this on what 'the tenant' is doing since it is based so highly on tenant improvement and specialism. In this case it is difficult to come up with a non-agricultural use which a hypothetical commercial tenant would undertake with half a building which makes the net enterprise income method difficult. However, it is fair to assume that a commercial tenant would pay a rent for the building in order to operate a business especially if that business relied on other activities nearby (as the actual tenant's diversification does).

8.3.4.6 A diversified rent of approximately £1,500 to £2,000 per annum could be argued for in this example.

8.3.5 Example 4: Seasonal Farm Shop

8.3.5.1 This example constituted a small redundant building which had been converted by the tenant into a toilet/packaging area/cafe for the sale of fruit grown on the farm and home bakes for a 6 week period every summer. The tenant had put in the water, electric and internal fittings as well as making the building wind and water tight. Due to the use of the buildings for selling farm produce and the nature and scale of the business it would be unlikely that this diversification required planning consent.

8.3.5.2 When considering this it was concluded that the use would still be agriculture in terms of the fixed equipment provided by the landlord, the scale of the activity taking place and the seasonal nature of the business - so no diversified rent was appropriate.

8.3.6 Example 5: Ground lets

8.3.6.1 Finally we found an example where an area of 1440 sq m had been turned into a Dutch barn and hard standing area used for the storage and drying of timber as part of a biomass business. The infrastructure had all been supplied and erected by the tenant which meant that the only element being utilised was the ground.

8.3.6.2 In terms of Use Class the storage of timber for biomass is likely to come under forestry which still comes under the definition of agricultural use. However, since the building and storage space exceeds 465 sq m, planning permission would have been sought for it and the current use could be considered as storage or distribution in terms of the Use Class. An element of diversified use obviously exists over the area despite a proportion still being used for agricultural storage. The shed that now replaces the previous sheds is 720 sq m (half of which is used for drying timber with the other half used for storage of machinery). The 720 sq m of yard space is used for storing timber.

8.3.6.3 It is therefore relevant to consider 1080 sq m as capable of letting on the open market for storage and distribution. As the building fully belongs to the tenant then the whole 1080 sq m should be considered in terms of an unimproved ground let.

8.3.6.4 We have found a number of unimproved ground let comparables in rural locations. These are generally set at £1 to £1.50 per square metre with the most comparable being an area let as a timber stacking area for £1.15 per square metre. These comparables are based on an area which is hard cored so deductions need made to account for the cost of this. From working out the cost of hard coring this area then annualising it by adopting a lifetime for it a discount of £0.2 per square metre was concluded. A diversified rent of approximately £1,080 would be applicable in this instance.

8.3.6.5 This figure feels fair as it does not take the tenant's own use into account and only reflects the increased rental value available to the landlord through the existence of a non-specialised diversified use.

8.4 Recommendations

  • Clarity is required to ensure it is possible to cross check the comparable approach with the hypothetical tenant net enterprise income approach in order to promote a reasonable sense check where there is a lack of comparable evidence to allow for the calculation of a 'fair rent'.
  • The ability to both black patch and deduct tenant's improvements through a cost and deduction method should be clarified in the regulations. The overall basis for the deduction of non black patched improvements should be to reasonably consider how much the improvement adds to the rent and deduct it on that basis.

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