E before Surgery except after DV?

Is there a back-door stealth raid on property asset value taking place in the world of primary care premises?

The march toward integrated care systems, with the traditional GP at the centre of a primary care network that is integrated seamlessly with other outpatient, health and social care services, is driving the need for larger, modern, fit-for-purpose premises. Unfortunately the approvals process is not only hampering delivery but creating some consequences in placemaking which may not have been intended…

Understandably the revised NHS Premises Cost Directions (PCD) issued in May 2024 will have passed unnoticed by many. It only makes a difference to NHS GPs and their landlords. And save for a few relatively minor changes, the underlying principles of the 2013 PCD (and earlier versions) remain the same.?

NHS GP practices, who are regarded as independent private contractors, earn much of their income from the NHS in fees and capitation levies (based on their list size) but they are also entitled to claim reimbursement of their rent and business rates for providing suitable premises.?

Until the last 10-15 years the majority of surgeries were in converted houses, often belonging to the GP, and in these circumstances a ‘notional rent’ would be reimbursed. Occasionally, some practices were set up in rented shop units and in these cases the Current Market Rent (CMR) would be reimbursed by reference to prevailing retail rents in the parade.?

The principles and practices of this reimbursement are enshrined in the PCD, which is mainly referred to at the time of taking a new lease and at rent review. It provides that they should be reimbursed the Current Market Rent (CMR) of suitable leasehold surgery premises.

CMR is typically assessed and/or endorsed by the District Valuer (DV) and, although this can now be any ‘competent’ valuer, DVs have fulfilled the role for many years and they so hold the most comprehensive database of surgery rents and, consequently, a near monopoly on this function.?

Latterly there has been a shift towards purpose built surgeries, occupied leasehold, and in these circumstances the PCD requires the Current Market Rent (CMR) to be assessed. Naturally, DVs have analysed a ‘tone’ of values based on transactions from further afield but, with each surgery being unique, these should approximate to a rental value derived from decapitalising the [actual or] notional replacement cost (NRC) of land and buildings with a suitable margin (IRR) to the developer/investor.

They should approximate to this formula but increasingly they do not tally. Simple construction economics mean that inflated build costs and higher borrowing costs in the market since 2022 have pushed up the notional replacement costs. This, together with ‘softer’ prevailing investment yields (which tend to align with interest rates) mean the decapitalised rents are often way above the ‘tone of value’ DVs have endorsed for other surgeries previously. Sometimes the only way of ‘squaring the circle’ for the DV to endorse the CMR in these circumstances is through a balancing capital contribution from the GP or more usually from the NHS.

But it seems, whether intentional or not, DVs have another way of keeping CMRs lower - by setting an [often artificial] valuation assumption that use is restricted to class E(e) - healthcare. The PCD definition of CMR makes no stipulation about permitted use although Schedule 1 sets out a description of the physical requirements of qualifying surgery premises and, well naturally, they have to be a surgery. But they don’t have to be restricted to this use.

In September 2020 a new planning Use Classes Order reclassified surgeries (formerly D1) as Class E, alongside a very wide selection of uses including retail shops, restaurants, gyms, offices and workshops. The key point of Class E was to make these uses interchangeable, without planning permission, so as to keep commercial areas fluid and vibrant. The Use Classes Order makes no distinction between the uses in Class E, it merely enumerates them with letters for ease of identification but no other purpose.?

There is therefore no longer any value differential of any one of these uses over another. The? rent for a restaurant or catering use may be the same as a gym, office or surgery but the value of retail premises is underpinned by the fact they can now be freely transferred to an alternative trade. While one gym proprietor, restaurateur, dentist or GP practice may still pay a premium on assignment to another for their fixtures, fittings and business (goodwill), or where the passing rent looks low compared to more recent lettings, none of this relates to the relative rental value between uses.

This is particularly so when considering the value of premises let as a shell, perhaps space beneath a residential block, as many now are let like this ready for tenant fit-out. This is no more or less the case for GP surgeries. There is no value premium (or discount) for any specific use within Class E…unless of course it is restricted by the lease. It stands to reason that a tenant would pay less rent for premises when they have less flexibility when it comes to disposal.

So with the construction economics making buildings costlier to build, DVs setting an assumed user restriction to class E(e) in their rental valuations (presumably to maintain parity with their previous class D1 tone of values) is making it more difficult for the NHS to negotiate rents with commercial landlords, particularly for space in new builds.

In fact we have even encountered instances, where the DV has taken a more active role in the lease negotiations on behalf of the NHS as tenant, which have resulted in the class E(e) user restriction being written into the lease (not just? a valuation assumption). In one case the landlord was a local authority who had no reason to accept such a restriction on the value of their asset. In fact, this would seem to contradict their s.123 obligation to obtain best value.

In other circumstances, commercial landlords who have set their own genuine tone of values within their developments through open market lettings, are being forced to accept lower rents if they want the NHS as part of their tenant mix. Ultimately, this forces a downward spiral in their own valuations as asset valuers assume that other tenants could negotiate similar terms.

The net effect is that the NHS finds it harder to find suitable premises, not least because landlords, particularly of new builds, e.g. in regeneration schemes, can only let premises to the NHS if they are prepared to do so at an economic loss. Increasingly, NHS ICBs are having to find ways of closing this funding gap with arbitrary and supplementary capital grants.?

By taking this approach, it could be argued that DVs are overstepping their professional role and actively making the market. This would appear to contradict Schedule 2 to the PCD which clearly states that “valuers must first have regard to the actual terms of the lease” and that the tenant is having their rent reimbursed is expressly to be disregarded.?

Some might see this as a welcome ‘initiative’ to alleviate NHS budgets with subsidies from commercial sector landlords but sometimes these are in fact local authorities. Either way, is this what the Department of Health actually intended?