Testing the rent review system: report

Chapter 3: Methods of Working and Approach

3.1 Methodology

3.1.1 The methodology of the research was agreed with the Scottish Government at the inception meeting. This confirmed that the main aim of the research should be to find a way of assessing the rent in line with the 2016 Act which is fair to both landlord and tenant and will be both objective and transparent in its application.

3.1.2 Protocols for contacting tenant farmers, confidentiality agreements and dealing with the public were also discussed at this meeting. The Team was provided with a list of possible sample farms which had either been volunteered by the stakeholder groups or selected randomly by Scottish Government (blind farms). The project plan enclosed in Appendix 1 was confirmed and the following protocols agreed:

• Confirmed no conflicts with volunteer sample farms.;
• conflicts with blind farms were noted and these were removed from the sample.;
• contacting sample farms – Scottish Government contacted the four blind farms in the first instance to explain the process and what documentation we required. This was then followed up with a phone call from Savills and a confirmation letter with the time and date of the farm inspection.;
• transparency – Scottish Government confirmed expectations in terms of discussions with sample tenants. It was agreed that we were to adopt a research role rather than an agent role. This meant using the inspections as a means of researching the new process, acting impartially, being completely open with the tenants about conclusions and assumptions to gauge their reactions, understanding why they do what they do and opening up discussions to challenge this rather than just undertaking the reviews.;
• documentation – Research would be based on a standard set of general lease regulations rather than analysing the actual tenant's lease documentation. This was in order to prevent the inspection process being seen as intrusive by the sample farms and allow us to test the new system without actually doing a rent review on the farm as an actual rent review would require access to all documentation associated with the lease. In order to cross check different scenarios we considered how a post-lease agreement would impact on the results. It was concluded that a pre–1948 Act tenancy has the effect of removing the landlord's renewal obligations but the repairing obligations are consistent with 1991 Act tenancies. As such no separate consideration is required to deal with these tenancies as renewal by the tenant would be considered to be a fixture or improvement and not included in the rental calculation anyway. This method ensured minimal exposure to conflict, privacy issues and inefficiency or inaccuracy through incomplete documentation. The only documentation sought from the sample farms was a copy of their IACS plan to define the lease boundary.;
• communication – For the purpose of this study no evidence or documentation was required to establish tenant's improvements, details of grant funding, sub-letting, diversification, residential property occupancy and any other factor relevant to the rental analysis. ;
• representation – Limits to the representativeness of the sample farms were discussed. Despite obvious limitations it was agreed that the samples were representative enough to give the research the scope required. In other words the farms selected had a broad enough scope to raise the issues likely to challenge the approach and assessment taken.;
• project Plan and timeframe was approved.;
• interaction – The procedure for interaction with the Scottish Government, third party advisors and stakeholders was approved and added to the project plan.

3.2 Legal Context – Interpretation of the requirement

3.2.1 A number of areas require secondary legislation and regulation. These include defining how the productive capacity of a farm is to be calculated; the amount of accommodation needed by the farm ( i.e. whether cottages are required for agriculture or are surplus); and how the divisible surplus is to be distributed between rent and return to the tenant. We discussed the review process with our legal consultant Hamish Lean prior to the beginning of the fieldwork, to ensure we had fully understood the implications of the legislation and the areas that need to be assessed. The detail of these discussions is outlined in the table in Appendix 2.

3.2.2 In summary, the table considered in conjunction with Hamish Lean confirms that the following issues cannot be considered as part of this project as they are already confirmed in terms of the legislation as it stands:

• The hypothetical tenant must be considered so the rent cannot be based on 'the actual tenant's' farming system or business;
• accommodation all or part of which is occupied by 'the tenant' must be disregarded when considering whether or not where residential accommodation is deemed as being surplus. It can only be considered in terms of the impact it has on the productive capacity of the farm;
• the actual non-agricultural use cannot be considered. It is what rent would be received on the open market for commercial purposes, based on the same planning use class by any tenant. Importantly this is not restricted to an agricultural tenant;
• standard Labour Requirements ( SLR) are set out in the SAC handbook (based on the University of Nottingham Study issued in 2008) based on work done in 2004-2006. We recommend that they be brought up to date;
• dispute Resolution – we recommend guidance is created to encourage alternative methods of dispute resolution. There is not scope to introduce this within the Act itself. Dispute avoidance should be addressed in secondary legislation/regulation. Best Practice Guidance could promote the establishment of a statement of facts at the outset of a review, agreed by both parties on the physical characteristics of the holding;
• grant aid, where the tenant has carried out an improvement with grant aid this must be disregarded from the rent assessment; and
• grant aid, where the landlord and tenant make a contribution – the amount of grant aid attributable to the improvement should be entirely disregarded. i.e., if a building was put up with 40% grant, 30% tenant contribution and 30% landlord contribution, 30% of that building could be considered in the analysis of the rent. It should be noted that such a definition only applies to improvements, where fixed equipment has been renewed through a landlord's grant. This can be accounted for in the rent review up to the extent that it is a renewal.

3.2.3 The main areas which can be influenced through further regulation are:

• The form and content of a rent review notice and the information that must or may accompany it;
• the means of calculating productive capacity. Investigation into various models and data sets should be undertaken in order to find a workable model. The definition of productive capacity is linked to the output a competent, efficient and experienced tenant would utilise from the farm;
• the means of disregarding or deducting tenants improvements. A black patch approach has been the preferred approach of the Land Court but we believe the legislation should allow in some circumstances for adjustment by other means, particularly land based improvements;
• consideration of the approach to grant aided improvements where the grant covers 100% of the cost;
• consideration of whether marriage value is appropriate when considering the 'hypothetical tenant';
• consideration of whether finance is relevant as a cost when considering the 'hypothetical tenant';
• the application of the divisible surplus between parties and whether it should follow the AHLRG recommendation of 50/50;
• consideration of surplus residential units including when they are seen to be surplus, adjustments for seasonal and retired employees and deduction to make to the market value for tenants improvements, compliance with residential standards and the tenants maintenance obligations; and
• consideration of non-agricultural activities, when they can be rentalised, the issues with disregarding tenant's improvements and the use for commercial purposes.

3.3 Research Context

3.3.1 Desk-top research into the issues arising from productive capacity, labour requirements and tenant improvements were carried out before and after the fieldwork.

3.3.2 A comprehensive library of information on which to base calculations has been assembled and includes:

Productive Capacity

• Macaulay ('The James Hutton Institute') land classification and soil maps for all farms to be inspected;
• the Scottish Agricultural College Farm Management Handbook ( SAC handbook) (yields per enterprise, labour units, pricing data);
• Farm Business Survey ( FBS);
• Savills research on up to date pricing and yield data;
• the Law of Agricultural Holdings in Scotland (Greens Practice Library);
• the Scottish Government's agricultural statistics, including on Scottish farm enterprise performance, harvest summaries and farm business income estimates;
• live data taken from newspapers, the Scottish Farmer, market prices, supplier prices and grain future prices;
• the whole farm reviews target percentages based on Bank Agricultural lending checklist;
• emails from Royal Bank of Scotland, Bank of Scotland and Clydesdale Bank confirming target percentages of gross output for standard costs. These would be the expected percentages for a competent farmer;
• Savills research database of farm rents used to cross check against comparables rents in the areas; and
• additional actual costs where known and disclosed by the parties i.e. Farm Management Accounts.

Residential Surplus

• Prime Location, Right Move and other location specific property rental websites;
• contractor quotes analysed to compile standard costs model;
• cross check with Savills buildings surveyors;
• Mortgage Advice Bureau guidance;
• banks advice on percentage for voids and maintenance for buy to let budgets;
• a Practitioner's Guide to Scottish Agricultural Rent Reviews, CAAV, RICS, SAAVA; and
• additional actual costs where known and disclosed by the parties i.e. invoices from contractors.

Diversification

• Comparable evidence from commercial agents in the local area;
• comparable evidence from the local Councils;
• Rightmove;
• meeting with commercial agents within Savills;
• analysis of Use Classes;
• Council planning websites;
• additional actual costs where known and disclosed i.e. invoices, accounts; and
• analysis of Business Rates criteria.

3.3.3 Following the completion of this report it will be relevant to undertake further research in a number of areas to assist in future rental negotiations. This has been considered and referred to at various times throughout this report.

3.4 Field Work

3.4.1 We carried out a physical inspection of ten sample farms and conducted a rent appraisal for each. The rent appraisal comprised of an assessment of every field and items of fixed equipment, in order to ascertain the most appropriate farming system based on the landlord's fixed equipment. Using this system, farm budgets were then prepared.

3.4.2 The appraisal also identified items of fixed equipment owned by the tenant, and/or erected by the tenant as an improvement or tenant's fixture. These items were then excluded from our farm assessment. In order to compare the findings from each rental appraisal on a consistent basis the following format was used:

Table 1: Appraisal

Introduction	Define the landlord, tenant, address and name of holding, type of lease, entry date, rent review date, last rent review date, current rent, legislation under which the rent will be reviewed
Analysis of lease documentation	The following standard documentation was approved by Hamish Lean and adopted for each of the farms assessed: 1. General Regulations for a 1991 Act tenancy 2. A post-lease agreement Tenants were also questioned about any oddities present within their lease which could give rise to complications in the assessment of their rent.
Farm appraisal	Date of inspection & attendees Field by field description of the land (land classification, quality, topography, soil quality, climate, flood risk, contamination, field size and shape, access, designations, presence of pests, drainage, ditches, services and permissions, current use, fencing, water supply, tenant improvements), description of items of fixed equipment (farm buildings, farmhouse and surplus residential accommodation and their current use and state of repair, identifying any tenant's improvements) Diversification if applicable.
Proposed farming system and budget	To identify what farming system a hypothetical tenant would undertake on the holding. Different models were considered and tested in consultation with our farm management consultants and Watson Bell. Considerations included: labour required for the holding; costs of inputs required for the agricultural holding; restrictions such as NVZ, or other designations specific to the holding; servitudes and wayleaves; public access; standard data versus actual data, costs as a percentage of output or specific to the unit.
Market Commentary	Observation of farming in the general locality to cross-check the proposed farming system.
Comparable evidence	Where available in the locality, analysed as a means of comparing the market rent with a fair rent.
Surplus Accommodation	All residential accommodation was discussed. The SLRs required for the farm were calculated and anything considered to be surplus was assessed on a rental basis except the farmhouse occupied by the tenant.
Non-agricultural Uses	All non-agricultural activity on the farms were discussed. Tenants improvements were identified by the tenant and the commercial use of the area was defined.
Farm Specific Challenges	Farm specific challenges were considered throughout the process and defined as to whether they were specific to the holding or specific to the way 'the tenant' was farming the holding.

3.4.3 The sample farms comprised of 6 volunteer farms supplied by the main stakeholder organisations, and a further group of 4 agricultural holdings supplied by the Scottish Government. The total sample of 10 agricultural holdings represents a fair geographical spread of Scotland including a variety of different types and sizes of farm.

3.4.4 In order to minimise conflict and ensure clarity the sample farms were informed that visits would take 3-4 hours. Each farm visit was documented as soon after the inspection as possible in order to collate the applicable data in a consistent way to ensure budgets could be formed.

3.4.5 The sample farms must remain completely confidential but can be rationalised as follows:

1) A dairy operating in a livestock area

2) A livestock farm

3) A dairy farm

4) An arable farm

5) A mixed arable/livestock farm

6) A pig farm

7) A non- LFA sheep/cattle farm

8) An arable farm with significant non-agricultural/diversified uses

9) A forage farm (small holding)

10) An upland sheep farm (hill farm)

3.4.6 The samples were located from as far north as Inverness to as far south as the Borders. Although they were not considered to be fully representative, they certainly provided the team with examples of different farm types, different sizes of farms, different levels of tenant investment, surplus residential accommodation and various non-agricultural uses.

3.4.7 The main restrictions to the samples can be highlighted as follows:

• No islands were assessed.;
• specialist farms were difficult to find and perhaps this indicates that the level of investment for a specialist farm suits an owner occupier model rather than a tenant farm model. Fully functioning fruit farm, pig farm, vegetable farm, pedigree breeding farms were not assessed. Although it was considered that examples of such farms would more than likely be considered as high farming (not what a hypothetical tenant would do) and result in the rent assessment assuming a more general farm type.;
• lease documentation was not looked at. Instead standard leases were assumed and the tenant's comments on improvements and landlord consent to activities were relied upon.;
• the sample was representative of holdings which were made up of a high level of tenant investment. None of the holdings assessed composed of only landlord fixed equipment so generally rents were based on low intensity farming systems, which was not always the case in practise.

3.4.8 The diversity of farm type, size and location, although not without limitation, was considered to be adequate for the testing of the new system.

3.5 Interim Report

3.5.1 Following the completion of the fieldwork, each rent appraisal and model was analysed in collaboration with Watson Bell. Hamish Lean and Watson Bell independently reviewed the method used, identified where the methodology could be challenged and commented on any further work required including suggesting alternative models. The findings within the Interim Report generally outlined several options which could be refined via stakeholder input prior to the submission of the this Report and Presentations.

3.6 Stakeholder Input

3.6.1 The main stakeholders comprising NFUS, STFA, SL&E, SAAVA, RICS and the Scottish Government were represented at a stakeholders meeting to discuss the Interim Report. Written comments were received on 28 August 2017 and are summarised in Chapter 4.

3.6.2 The main points taken from this meeting related to the need for a Statement of Facts to be encouraged potentially via the amnesty, the need for a budget approach to be assessed, the acceptance that sense checks using an output type model or a Macaulay land classification model was sensible, the need for further justification on valuing out non black patched tenants improvements and the acceptance that the surplus being split 50/50 was the only fair option.

3.6.3 Further research was required into likely variations in output depending on farm type and how the existence of unusual lease terms or post-lease agreements would impact the rent.

3.7 Report & Presentations

3.7.1 This Report and planned presentations take account of the full process from the instruction right through to the stakeholder's feedback. The report makes recommendations based on making the existing legislation workable in practice in order to produce a result which benefits all parties equally in order to meet the main objective of 'fairness'.

3.8 Analysis of Barriers: Challenges & Mitigation

3.8.1 Interpretation of the 2016 Act

A number of challenges and barriers have been identified throughout the course of the research to date. Where possible these barriers have been mitigated through further research or the creation of alternative options. The main challenges which will be expanded on throughout the report can be summarised as follows:

Challenge: Work carried out as part of the research must be based on a sound interpretation of the Act in the absence of case law.

Mitigation: As one of Scotland's leading lawyers specialising in agricultural landlord & tenant issues, Hamish Lean has audited the procedures put in place and the rationale of the models applied to ensure consistency with the 2016 Act. He has been consulted throughout the review process through formal meetings and regular email updates. In order to cross check the research reference, comparisons have also been made with the Agricultural Holdings Act 1986 which added a productive capacity element to the rent review process in England.

3.8.2 Potential for Conflict

Challenge: Potential for conflict arising from calculations based on a hypothetical tenant and the proposed farming system could result in the new system increasing rather than decreasing the number of Land Court applications.

Mitigation: We have monitored tenant farmers' reactions to the assumptions we make about the hypothetical tenant. Several meetings and models have been assessed in conjunction with Watson Bell in order to find a model which is least susceptible to conflict. We anticipate dispute is most likely to relate to the farming system applied, the output possible ( i.e. the yield or stocking density possible) and the costs required. A process of coming to agreement on these factors prior to the creation of budgets is the best means of offsetting this issue, although not always possible.

Possible alternatives: Alternatives have also been analysed in order to determine whether or not there is a system which could be adopted using the current legislation as an alternative which could give rise to less conflict.

3.8.3 Budget Issues

Challenge: Creating a hypothetical farm budget has presented the following challenges:

• compiling accurate current, forward and past data;
• finding a model to fit all circumstances, reducing the need for interpretation and minimising complexity; and
• agreeing a fair divisible surplus which is acceptable to all stakeholder groups.

Mitigation: Analysis of extensive data on current, forward and past rental values, commodity costs, average yields by location, grain/livestock values, rental trends and other factors relevant to the rental analysis of farms. Various models using various data sets have been tested for the sample farms.

The Team is experienced in representing both landlord and tenants; analysing farm enterprise accounts over a long period; assessing farming alternatives, based on the productive capabilities of the holding; and analysing the economics of farm businesses.

3.8.4 The Transition from Market to Fair Rent

Challenge: The differences between what is considered a 'fair' and 'market' rent. Confirming the arrangement is commercially viable (sustainable) for both landlord and tenant.

Mitigation: We have calculated the fair and (where possible) the market rent for each farm, taking into account the need for both parties to conduct a reasonably competent business from the land asset.

Possible alternatives: The main aim of the project is to produce a workable model under the 2016 Act. We have referred to the current model only to benchmark the effects of the new model and justify conclusions and recommendations.

3.8.5 Labour Units

Challenge: Difficulty in confirming labour units required for a certain farming system and which data source is used for this.

Mitigation: Primarily the SAC handbook has been used to determine the required labour units for the proposed farming system.

Possible alternatives: The SAC handbook model should be updated to reflect modern farming requirements in terms of an appropriate farming system for a hypothetical tenant farmer.

3.8.6 Marriage Value

Challenge: The ability to include marriage value in calculations and whether this is ever appropriate when considering the hypothetical tenant farmer.

Mitigation: We have scrutinised marriage value on a case by case basis to assess whether there are occasions where it should be considered. In terms of how the law is worded, Hamish Lean is of the opinion that it is not applicable. It is also of limited relevance if a focussed approach on Gross Output is taken.

Possible alternatives: The relevance of local practice must be considered. It may be relevant to consider what the hypothetical farmer within the area does, e.g. is it common practice to have a certain size or number of units? Does the tenant have the landlord's permission to sub-let for potatoes?

3.8.7 Tenants' Improvements

Challenge: The range of options available in assessing tenants' improvements is a potential difficulty. Our experience suggests complexities may arise in the analysis of fixed equipment. These relate to the presence of post-lease agreements; improvements which have been undertaken at joint cost; where they have been partly grant funded; whether or not there is landlord consent; and where the tenant owns equipment but the landlord has been insuring and maintaining it or vice versa.

Mitigation: We have assessed this on a case by case basis. Through extensive experience of dealing with issues relating to fixed equipment, the Team are well placed to assess how it affects the functionality of the holding; and whether in view of the lease obligations it should be rentalised. Hamish Lean has been vital in ensuring this is dealt with in line with the Act. We also believe the tenant's amnesty will be an invaluable tool in accounting for tenant's improvements.

3.8.8 Acting Impartially

Challenge: Savills' ability to represent the best interests of all stakeholders may be called into question.

Mitigation: Hamish Lean's involvement throughout the process has ensured all research is carried out in accordance with the correct interpretation of the 2016 Act. This has enabled us to identify any departures from the proposed new system that may be required for practical reasons. Watson Bell as an experienced Agricultural Consultant has ensured all results and models were explored and fully tested.

3.8.9 The Treatment of Surplus Accommodation

Challenge: The difficulty of creating an objective model to determine the level of discount that should apply when taking into account tenants' improvements.

Mitigation: We have drawn upon our knowledge as active residential property letting managers and building surveyors to comment on the additional costs involved in letting houses under the Housing (Scotland) Acts; and the factors to be taken into account when devising an additional rent for surplus residential units.

3.8.10 Timescale for Delivery

Challenge: A tight timetable for completion of the research.

Mitigation: The project plan has been adhered to and regular meetings have been undertaken with Hamish Lean and Watson Bell to ensure the delivery of the research within the timescale.

3.9 Seeking Solutions

3.9.1 There is understandable apprehension that the new method of analysing farm rents could prove to be overly complex, cumbersome or unworkable. Through analysis of the models outlined in this report, input from third party advisors and stakeholders and the implementation of further regulation and best practice guidance we believe a workable, fair solution can be adopted.

3.9.2 It should be stressed that any recommendations made will be subject to the need for further research to improve datasets, further guidance on best practice in terms of communication between parties, procedures to be adopted and the need for alternative methods of dispute resolution to be explored. Workable models need to be based on objectivity and must start from a point where all stakeholders agree on their principals.