The risks and pitfalls of property investment schemes

This article was originally published in Finance Monthly and can be accessed here. 

Investing in a commercial property development scheme has a number of risks associated with it. Some of these are illustrated by the problems being encountered by private investors in a student housing project in Stoke-on-Trent[1].

The scheme involved the developer selling long leases of individual rooms in student accommodation for capital sums and relatively high ground rents subject to review at five-yearly intervals throughout the term of the lease. Each investor then granted a sub-lease of his or her room to the management company (which appears to have been connected to the developer)[2].

The grant of nearly 200 leases on this basis generated for the developer [3] :

• capital receipts of several millions of pounds; and
• an annual ground rent income stream of nearly £150,000 which allowed the developer to sell the freehold for over £2.8 million.

In October 2018, investors failed to receive from the sub-tenant company the “additional rent” due to them under the sub-leases that they had granted. After a further default in making these payments, the sub-tenant company was put into administration[4].

The administrators subsequently advised investors that[5]:

• the management company had not generated enough income to pay the additional rents representing the returns to investors under the sub-leases;
• investors would have to fund payment of the rent and service charge payable under their own leases; and
• to enable the administrators to continue the process of administration the investors would have to waive their right to receive “additional rent” until all other necessary expenses of the administration had been paid.

This has frozen returns on the investments made in the scheme, at least, until the scheme is re-structured to generate an appropriate level of income.

In order to minimise the inherent risk of collective investment of this type, an investor should understand:

• the criteria for making the project a success (in a student housing scheme the criticality of opening at the beginning of the academic year); and
• the process of realisation of the project and the associated risks.

Buying into such a scheme ‘off plan’ is speculative and, therefore, has a higher than normal level of risk. In particular:

• a number of individual units will need to be completed (on time and within budget) to make the whole development viable;
• a lease is both a wasting and, potentially because of the landlord’s right to forfeit for non-payment of rent/service charge, vulnerable asset; and
• there are cost, timing and quality issues, particularly in a specialist sector such as student accommodation.

Engagement of appropriately experienced professionals to advise on making such an investment is a key part of a successful strategy for investing in such a scheme.

The benefits of such engagement in managing the inherent risks are:

• The standards which a professional must meet in order to have satisfied the duty of care owed to a client are high and, not meeting those standards would lead to the client having a claim for negligence against that professional; and
• A good and experienced solicitor/surveyor should be capable of identifying and advising on the potential risks of the scheme and, most importantly, be capable of advising the client not to proceed with the investment or, at least, not on the terms offered.

Informal collective investment property schemes are currently only loosely regulated and disaffected investors will, generally, not be able to obtain redress for lost or impaired investment from the state. Prudence, research and preparation before investing is such schemes is, therefore, imperative.

[1] “How a £100m student accommodation scheme went wrong. Thomas Hale – July 3 2019 – FT Alphaville : https://ftaphalphaville.ft.com/2019/07/03/15562130014000/How-a–100m-student- accommodation-scheme-went-wrong/

[2]  Paragraph 3 of A1 Properties (Leicester) Limited (In administration) Statement of Joint Administrators’ Proposals Pursuant to Schedule B1 of the Insolvency Act 1986 of 23rd April 2019 – Companies House.

[3] Register entries for HM Land Registry Title Number SF514607

[4] Paragraph 3 of A1 Properties (Leicester) Limited (In administration) Statement of Joint Administrators’ Proposals Pursuant to Schedule B1 of the Insolvency Act 1986 of 23rd April 2019 – Companies House.

[5] Paragraph 5 of A1 Properties (Leicester) Limited (In administration) Statement of Joint Administrators’ Proposals Pursuant to Schedule B1 of the Insolvency Act 1986 of 23rd April 2019 – Companies House.