Office-to-Residential Permitted Developments, an introductory analysis

This research piece examines the current status of Office-to-Residential Permitted Development schemes, and the legislation underpinning them. This article will study the evolution of the Office-to-Residential Permitted Development market since the advent of their rights, the current offering available to developers, and specific challenges such as exit pricing and valuation. It concludes with an evaluation of the efficacy of these rights from an investment perspective.

Since Office-to-Residential Permitted Development rights were first made available in 2013, they have become an increasingly popular tool amongst investors and developers alike. More formally known as ‘Class MA Permitted Development Rights’, this particular legislation offers an alternative to the comparatively lengthy and convoluted process of gaining planning permission. Class MA rights, if present, allow owners to convert any Class E property (commercial) into residential dwellings. They are cheaper to acquire, present fewer hurdles to approval, and can be granted significantly faster than traditional planning rights, with a maximum decision timeline of 56 days.

Not only are Class MA rights cheaper and more time-efficient than traditional planning processes, but they also provide greater flexibility in delivering a targeted conversion. The exemption of Affordable Housing requirements, Section-106 payments and unit mix requirements leaves owners with an unrestricted canvas to develop at their own discretion, within the constraints of the property. The appeal of these rights is clear to see, further being reflected in the available data on Class MA conversions. The graph below depicts the submission numbers of Class MA applications from October 2021 until September 2024. Over this 3-year period, the total volume of applications has increased by a factor of 3.45x, with the fastest growth rates seen in 2022 and 2024.

The sharp increase in both total and granted applications towards the end of 2024 is particularly notable, as it coincides with a period in which a significant amendment to the criteria of Class MA rights was enacted. This amendment included two revisions. Firstly, the vacancy requirements were adjusted from requiring a minimum vacancy period of three months, to permitting works to be carried out on an occupied building. Secondly, the maximum area limit of 1,500 square feet was abolished, allowing for an unrestricted conversion size. It is understandable therefore, that Class MA rights have experienced a recent surge in popularity given the favorability of the current legislation.

Despite the aforementioned advantages of Class MA rights, there do exist some questions regarding their efficacy for maximizing asset performance and asset value. The most directly comparable product to Class MA Permitted Developments, are likely to be Build-to-Rent (BTR) assets, particularly those below 152 units, the average size of a BTR scheme in the UK (British Property Federation, 2024). The reason this comparison is appropriate is because BTR developments are vastly similar operationally, with mostly structural aspects differentiating between the two. BTR developments are typically brand new products, built from the ground up. Therefore, their overall asset value is robustly supported by the quality, newness and overall net value of the physical build. With Permitted Developments, this is not always the case.

One key criteria of Class MA rights is that no external works are covered by them, meaning a brand new interior retrofit is to be conducted within the frame of a years-old building. The overall asset value of this will always be lower than that of a new build, however, given that Permitted Developments are often in areas where rental demand is strong, their key metrics could be painting an inflated picture of asset performance. This in turn could lead to inaccuracies when pricing the exit and valuing the development. Other issues may not be strictly financial, the difficulty of installing a completely new interior within an aged frame can make itself apparent in many ways. Issues with concrete, asbestos and other undiagnosed structural issues can be prevalent. Furthermore, the end quality of the units themselves has been called into question, with a recent government study (UCL, University of Liverpool, Ministry of Housing, 2020) finding that homes created under Class MA and formerly Class O rights, were on average, of a lower quality than those commissioned under regular planning channels.

The distinctions in asset value, quality and performance can be further explored by looking at real world examples, however, finding reliable data can be difficult. A condensed area with multiple BTR and Permitted Development schemes, all with similar unit mixes, specification, and amenities probably doesn’t exist in the UK. Some large variances therefore, in certain parameters, are unavoidable. Looking at the Reading market, there are two suitable buildings within the central business district. Weldale Street is a brand new BTR scheme delivered by Ropemaker Properties, and Dukesbridge Court is a Permitted Development delivered by an undisclosed developer. Both are approximately 500 meters from Reading Station. Below is a table showcasing a set of commonly utilized commercial real estate performance indicators for both properties.

Summarising these measurements, the Permitted Development has a 37% lower value per unit, 50% lower rent per square foot, and a net income yield 205 basis points wider than that of the BTR scheme. Regarding the stated difference in capital values, the real difference may be larger than this. The BTR scheme metrics are derived from its Gross Development Value (GDV), whereas the Permitted Development has traded. Should Ropemaker Properties decide to trade the BTR scheme, it’s listed value could be in excess of this. The economy of Reading itself has seen significant regional growth over the past 5 years, with the introduction of high-specification mixed use schemes such as One Station Hill being an indicator of this. The growth trajectory of Reading economically could be enough to underpin further rental growth, thus a sale price exceeding £42m is absolutely possible, and subsequently higher capital values along with this.

Regarding rental values, there is a strong disparity. The question here, is whether this is a case of the Permitted Development underperforming, or the BTR scheme outperforming. Reading’s first BTR Scheme, Thames Quarter, as of January 2022, was achieving a 20% higher rent than central Reading PRS (Haslams, 2022). Alongside this, notable developments have since either topped out, begun construction, or entered planning. Examples include Berkeley’s Huntley Wharf, of which all 765 homes have sold out, and John Lewis’ £80m Mill Lane site. Not to mention the 598 BTR homes under construction at One Station Hill also. Clearly, BTR in Reading is strong, with rents being supported as described above. However, given that the rent per square foot per annum for general PRS in central Reading is £25, the Permitted Development comes in below this, at only £22 per square foot per annum. Accounting for the above, the range between the two regarding rents appears to be a case of both underperforming, and outperforming assets on both sides.

The Permitted Development may not be achieving optimal rent due to a variety of reasons, in spite of this however, it does have location and amenities on its side. Close proximity to Reading Station, convenience stores, retail stores and other transport links sit firmly in its favour. Regarding the higher yield, one possible explanation for this could be asset quality. It is undeniable that in recent years, efforts by owners and operators to both improve energy efficiency, and achieve net zero carbon emissions have been widespread. They are being driven both by the market and legislation, with the UK requiring private rented homes to be at least an EPC C by 2030. The recent flight to quality will have undoubtedly impacted demand for Permitted Developments such as Dukesbridge Court. Future costs of modernisation are almost guaranteed, which in turn decreases investors’ and developers’ willingness to pay, the subsequent sale price, ultimately widening the yield. There may also be lower liquidity in the market, given that the market for lower quality schemes is declining.

To conclude, Class MA rights do present an opportunity. Their underlying purpose is to ensure Class E properties can be converted into residential with greater flexibility, ultimately reducing local vacancy rates and promoting an efficient allocation of Real Estate use classes across an area. However, from an investment perspective, despite seeming like an initially attractive proposition, unforeseen issues in development and poor liquidity on exit could curtail returns. Basing an entire investment strategy on Class MA conversions will likely provide a return which does not adequately compensate for the risk taken. There is potential for Class MA rights to be used on a case-by-case basis, as the idiosyncratic factors of the building, the area, the local economy for example will heavily influence performance. Reviewing select individual opportunities in detail is likely the best way to utilize Class MA rights as an investor/developer.

Hadie Saleem