Charity trustees must consider the financial, legal and tax implications of acquiring, occupying and disposing of property. Surveyor Andrew Morgan and lawyer Jeremy Wakeham advise on making the most of bricks and mortar.
Property is usually the second-largest expense charities have after people, but many of them tend to handle it passively, giving priority to budget control and the management of day-to-day issues. By contrast, organisations that have taken a proactive approach and successfully invested in property have enjoyed returns that match or exceed those from other types of asset.
The lesson is that the third sector needs to take a balanced and strategic approach to property, both as an investment and a resource, and manage it according to separate and clear criteria. Those with direct responsibility for property should continually ask themselves what their organisation's aims are and how they can help to achieve them.
This article touches on investing in property, then looks at charities' obligations as owners, occupiers, landlords and taxpayers.
Trustees have a duty to protect the charity's assets and, if the charity has surplus funds, it should consider investing them to generate income.
Property as an investment asset has been a strong performer and deserves its place in a balanced portfolio. Although it is attractive as a hedge against inflation, property's lack of liquidity and high dealing expenses mean careful selection is key. A prudent approach is needed to balance income, capital growth and diversification.
Regular reviews will help identify and weigh those risks against the potential returns from particular investments. The Charity Commission recommends that such a review should be carried out at least once a year.
As occupiers, charities rarely address sufficient scrutiny to their operating properties. In common with many others, their approach to property issues is probably reactive. Research carried out by property consultancy Donaldsons in association with the Charity Finance Directors' Group suggests more than half of finance directors in UK charities may not have property strategies in place and are in danger of missing out on the savings more strategic approaches can bring.
So how should the charity as occupier deal with factors that underpin a property's status as a prized investment, such as rent reviews and repair liabilities? Various strategic options are available to help trustees make more of their property assets.
As with any investment, a charity must understand how its property decisions meet its objectives. The impact of a rent hike or a surplus or shortage of space, for example, must all be managed within a considered property strategy.
Fortunately, charities usually hold good information because their reporting regime under Sorp demands it. But they must know how to interpret it and set performance targets with it.
Property audits often reveal new solutions to reducing cost and unlocking precious capital. In the case of care homes, for example, many operators are selling off older, inefficient units for conversion back into residential use, then using the proceeds to fund the construction of modern, bespoke facilities that better fit patient need.
Points to consider
The need for scrutiny is particularly important when the building occupied by the charity is its sole property investment.
In some cases, these buildings may be 'heritage assets' of historical, artistic or scientific importance that advance the preservation and conservation objectives of the charity. For most, however, the historic connection with the property will simply be because of its occupation over time.
It might be that property investment is the right option, but it's not the only consideration. The charity needs to be sure it is based in the best environment it can afford, in a space appropriate for users' needs and one that helps recruit and retain good people.
A decision to acquire property will give rise to a number of legal issues, some general and others particular to charities. It is therefore crucial that specialist legal advice is sought when considering property matters.
The first step is to ensure that trustees have the necessary powers to acquire, hold and dispose of property. Where no power can be found or implied in the charity's governing instrument, the charity will need to obtain an order or scheme from the Charity Commission.
Stamp Duty Land Tax
A charity can claim relief from SDLT when it buys land (freehold or leasehold) either for charitable purposes or as an investment to produce profits for its purposes. The purchase must not have been made in order to avoid tax.
To prevent abuse of this relief, the legislation incorporates clawback provisions defined in precise legal terms. SDLT will become payable if, within three years of the purchase, the purchaser ceases to be established only for "qualifying charitable purposes", the subject of the transaction ceases to be held for "qualifying charitable purposes", or arrangements are made in the three-year period to this effect. To avoid inadvertently falling within these provisions, trustees should ensure they keep accurate records.
Following the grant of the lease, any later assignment of it by the charity to a non-charitable entity will be treated as the grant of a new lease for the remainder of the unexpired term. This applies even if the assignment is more than three years after the initial grant. The assignee will then be liable to SDLT - something that would not happen if it acquired the lease from a non-charitable entity. This clearly has an impact on a charity's ability to assign leases.
Conditional break clauses
Landlords will often require that any break clause - the automatic right to terminate the lease at one or more specified dates - is conditional on there being no 'material' breach of the tenant's obligations. Conditions such as this make the use of a break clause uncertain for a tenant who has an obligation to hand premises back to a landlord in good repair.
The Court of Appeal recently considered a claim by a landlord that a tenant had materially failed to comply with its repairing obligations in Fitzroy House Epworth Street (No 1) Ltd v the Financial Times. On the facts of the case, the tenant had taken all reasonable care to return the property to the landlord in good repair, made reasonable efforts to involve the landlord and ensured the outstanding defects were not substantial.
It was held that, in this context, 'material' meant there was no requirement for absolute compliance with all the covenants in the lease. This decision prevents landlords from blocking the exercise of a break clause by citing minor and inconsequential defects.
Charities are not exempt from VAT, so they should think carefully about whether they need to budget for VAT on a property transaction.
The option to charge VAT on the supply of land and existing buildings will often be exercised, both on freehold and leasehold properties. If a charity buys such a property, it will need to pay VAT on the purchase or rent unless it is going to use the property for non-business charitable purposes.
This is a trap into which charities can easily fall, and HM Revenue & Customs recently showed that it will pursue this issue. In Commissioners of Customs and Excise v St Paul's Community Project Limited, HMRC argued that supplies made by a builder to a charity should not be VAT zero-rated as for a "relevant charitable purpose" because the charity ran a fee-charging creche in the building. After a considerable struggle, the charity succeeded in maintaining that there was a "relevant charitable purpose", but the case shows the need for charities to be aware of the risks. If a charity uses premises only for its administration, this will clearly not be for "relevant charitable purposes".
If a charity cannot benefit from VAT exemption, it might consider whether it should itself charge VAT. For instance, a charity could charge VAT on any sub-lettings, which can then be offset against the VAT that it has paid in respect of the premises.
Disposal of land
Section 36 of the Charities Act 1993 requires the trustees of a non-exempt charity to obtain an order of the Charity Commission or the court to make any disposal of land, unless the disposal satisfies various conditions.
If the terms of this section are not met, it is likely (following the decision of the Court of Appeal in Bayoumi v Women's Total Abstinence Educational Union Ltd) that the contract for a disposal will be void and can be set aside.
In most instances, section 36 will require a surveyor's report. Although the requirements are generally clear, matters can become complicated if the property has been left to the charity in a will. In this case, section 36 will apply when the personal representatives have appointed the property to the charity and they sell the property at the direction of the charity; or the personal representatives have not appointed the property to the charity but consider the administration of the estate to be at an end.
Section 36 will not apply when the personal representatives dispose of the property in the normal course of administering an estate, or if there are multiple residuary legatees but no appropriation, even if all the legatees are charitable.
- Andrew Morgan is a partner in the corporate real estate consulting team at chartered surveyors Donaldsons LLP. He advises a number of charities on property strategies and relocations.
- Jeremy Wakeham is a principal at Withers LLP. He advises charities and other not-for-profit bodies on property law issues and on the use of grant funding for property development projects.
For more about property strategy for charities
- Charities' Property Association: www.charity-property.org
- Charity Finance Directors' Group: www.cfdg.org.uk
- Royal Institution of Chartered Surveyors: www.rics.org
- Charity Commission operational guidance on property disposals: www.charity-commission.gov.uk/supportingcharities/ogs/index054.asp
- For a copy of Donaldsons Occupier Survey 2006 in association with the Charity Finance Directors' Group, register at www.donaldsons.co.uk.