Fire safety – considerations for real estate finance

Fire safety and cladding issues for "buildings with beds" have very much come to the forefront since Grenfell.  Buildings with beds would include blocks of flats, student residential accommodation, care homes, hotels and hospitals. 

The focus of this article is directed at blocks of flats and the perspective of building owners and lenders.  The article addresses the key areas of concern for these participants in (i) where the financial responsibility and risk for funding cladding and fire safety remediation may fall, and (ii) the impact on saleability of units; and looks ahead to where further developments over the course of the year can be expected.

Who pays?

The cost of cladding and fire safety remediation has been estimated to be £15 billion (June 2020 report of the Housing, Communities and Local Government Committee ("HCLG")).  Who foots this bill is a politically highly charged issue and key concern to both lenders and building owners.  The concern is not purely financial, it is also reputational; expecting flat owners to pay at all, or to add an unaffordable burden, is not palatable.

There have been some significant recent developments.

On 10 February 2021, the Housing Secretary Robert Jenrick unveiled a five-point plan intended to provide reassurance to homeowners and confidence in the housing market.  Two of the key planks are:

• A further £3.5 billion available to replace unsafe cladding for all leaseholders in residential buildings over 18 metres.  (More cash promised for cladding remediation | Fieldfisher)  This is in addition to the £600 million allocated to remediation of highest risk ACM cladding and £1 billion building safety fund for non-ACM.
• A government backed, long-term, low interest financing arrangement to pay for cladding removal on buildings between 11 and 18 metres.  Under the scheme, no leaseholder would pay more than £50 a month towards the removal of unsafe cladding.

The Government has also provided a £30 million "Waking Watch Relief Fund" to cover the costs for the installation of a common alarm system in eligible residential buildings with unsafe cladding systems, thereby enabling costly Waking Watch measures to be reduced or replaced in buildings waiting to have unsafe cladding removed.

Private sector developers have also responded.  On 10 February 2021, Persimmon announced it had made a provision of £75 million to pay for its contribution to any necessary work on 26 identified buildings it built that may be affected by unsafe cladding.  On 2 March 2021, Taylor Wimpey announced £125 million in funding to support fire safety improvements works to bring TW apartment buildings constructed in the last 20 years up to the recently updated RICS EWS1 guidance.
 
These measures go some way to addressing the concern of lenders and building owners as to the source of funds for cladding remediation.  The obvious concern is that they do not go far enough, either in terms of amount or scope.  Whilst the building safety fund covers all works directly related to the removal and replacement of unsafe non-ACM cladding systems in buildings over 18m, it does not address remediation of fire safety defects not directly related to cladding, which have been estimated to be equal to the costs of cladding remediation.  The HCLG's report, published on 29 April 2021 following scrutiny of and evidence on the Housing Secretary's "five point plan":

• Concludes in strong terms that the financing arrangement proposal should be dropped because leaseholders should not have to meet any cost.
• Calls on the Government to establish a Comprehensive Building Safety Fund for full remediation work for all affected buildings that applies irrespective of height and covers all fire safety defects and all associated costs.

A consequential consideration for who foots the bill, is how the Government may look to off-set the costs of the cladding funds through taxes or other measures and whether building owners or lenders would be targeted.   However, the focus in the "five point plan" is directed at developers.  The plan includes:

• The introduction of a "Gateway 2" developer levy which would be targeted and apply when developers seek permission to develop certain high-rise buildings.
• A new tax on the residential property development sector.  HMT announced in March that a consultation is to be published in the coming months for this tax targeted at the largest residential property developers, with the tax to be introduced in 2022 (para 3.6: Tax policies and consultations - Spring 2021 (publishing.service.gov.uk)).  This is expected to raise £2 billion over 10 years.

Saleability

Another major area of concern has been the impact on the saleability of flats within developments; with corresponding impacts on valuations.  Again, there have been some significant recent developments.

There has been concern over rising building insurance costs for residents.  The British Insurance Brokers' Association is exploring a market-based intervention and the Government is actively engaged with insurance and cladding groups to incentivise the market to reduce premiums.

The EWS1 form since its introduction in 2019 has faced criticism with the lack of qualified professionals to complete the form, and the difficultly in valuers obtaining professional indemnity insurance.  The "five point plan" includes a commitment of the Government to work towards a targeted, state-backed indemnity scheme for qualified professionals unable to obtain PI insurance for the completion of EWS1 forms.  The Government is also intending to set up and fund a scheme to increase supply of assessors to conduct EWS1 assessments.  In addition, RICS has published guidance which came into effect at the beginning of April, to support valuers' to understand when an EWS1 form should be required due to visible cladding (the Government's estimate is that 500,000 leaseholders have been taken out of the scope of the EWS1  process) and provides criteria that can be used during a standard valuation inspection to identify where remediation work is likely to be required.

The Government confirmed a commitment in the "five point plan": to work with industry to ensure consistency between the RICS guidance, the forthcoming BSI Publicly Available Specification 9980 for cladding fire risk assessment and also the anticipated guidance on Fire Risk Assessments and revised requirements to be implemented through the Fire Safety Bill and Building Safety Bill. On 27 April, the Ministry of Housing, Communities and Local Government announced that it has commissioned the British Standards Institution (BSI) to draft a new code of practice for assessors when examining external wall systems and cladding to help ensure consistency and clarity on the fire risk of the construction of external walls and risk-based and proportionate advice on whether remediation is necessary. This is open for comment until 20 May and once finalised, will supersede aspects of the January 2020 consolidated advice note.

What's next?

As highlighted in this article, the landscape for cladding and fire safety and those impacted (in particular: valuers, residents, building owners, developers and lenders) has seen impactful change in recent months.  Looking ahead, what areas are likely to develop and what do participants and real estate finance lawyers in the sector need to keep abreast of?  Key aspects are summarised below:

• Comprehensive Building Safety Fund: The HCLG may yet get its way and hold sway for the implementation of a Comprehensive Buildings Safety Fund; or additional Government commitments in addition to the £5 billion already committed.
•  Loan scheme for buildings between 11m and 18m: The Government proposals currently lack much detail.  The stated aim is that the loan sits with the building or flat, rather than the flat owner.  If this develops so that the building owner, or managing agent, takes on the obligation in some form, then consideration will need to be given as to its inter-relationship with financings that the building owner may have. 
• Building Safety Bill and Fire Safety Act: Each of these were published as Bills in early/mid-2020.  The Building Safety Bill is expected to make its way through Parliament this year.  The Building Safety Bill introduces a new Building Safety Regulator (set up under the HSE) with powers to enforce higher standards and introduces new roles of the "Accountable Person" (usually a management company or owner of the building) and "Building Safety Manager" and sets out their duties in relation to the safety risks in their building.  The Fire Safety Act (which received Royal Assent on 29 April) amends the Fire Safety Order 2005 to clarify that the responsible person or duty holder / building owner for multi-occupied, residential buildings must manage and reduce the risk of fire for the structure and external walls of the building, including cladding, balconies and windows and entrance doors to individual flats that open into common parts; thereby empowering fire and rescue services to take enforcement action and holding building owners to account.

The approach that building owners and lenders will take to navigate this developing landscape in transactions is likely to vary depending on whether there is a single building in scope or a substantial portfolio.  However any strategy should have at its core a robust assessment of the risk – taking into account both height of the building and other relevant risk factors – and then planning for tailored and appropriate measures to address that risk, that take into account how the building is managed.