Testing the rent review system: report

Chapter 4: Stakeholder Feedback

4.1 Summary of Stakeholder Responses

4.1.1 A meeting with the following stakeholder groups was held to discuss findings reported in the Interim Report:

• National Farmers Union Scotland ( NFUS);
• Scottish Tenant Farmers Association ( STFA);
• Scottish Land and Estates ( SL&E);
• Scottish Agricultural Arbiters & Valuers Association ( SAAVA);
• Royal Institution of Chartered Surveyors, Scotland ( RICS Scotland);
• Scottish Government Rural Payments and Inspections Directorate ( SGRPID).

4.1.2 Formal written responses were requested from the stakeholders by the Scottish Government to inform the this Report. NFUS, STFA, SAAVA in conjunction with CAAV and SL&E all submitted a formal response. A summary of the points raised within each response has been outlined below.

4.2 NFUS Response Summary

4.2.1 General

• Figures should be provided as an Appendix to the next report so recommendations can be cross checked.;
• want further detail in the pros and cons of each model.;
• gaps in available datasets should be highlighted in the next report.

4.2.2 Form and Content of Rent Review Notice

• No comments were offered.

4.2.3 Means of Calculating Productive Capacity

• Believe if possible a standard approach should be recommended.;
• concerned the gross output model does not account for location differentials in terms of cost structures.;
• support a budget approach however wants more detail on the pros and cons of past, current and future price data.

4.2.4 Black Patching Tenants Improvements

• Supports the black patch method for accounting for tenants improvements.;
• concerned about cost and deduction method for non black patched improvements and believe more information and examples are needed on this if it is to be implemented.;
• wary of a system being created which could disincentivise tenants from investing.;
• clarification is required to ensure tenants improvements are never written off.;
• clarification is required for accounting for tenants improvements which are outwith the scope of the amnesty.;
• further research into where interest and depreciation should be considered when dealing with tenants improvements.

4.2.5 Grant Funding

• No comments offered.

4.2.6 Sense Checks

• No comments offered.

4.2.7 Splitting the Divisible Surplus

• No comments offered.

4.2.8 Residential Surplus

• Support the recommendation to update Standard Labour Requirements ( SLR) data to reflect modern farming practices.

4.2.9 Non-agricultural Use

• No comments offered.

4.2.10 Dispute Avoidance

• Agreed that a statement of facts was a positive step. Thought this should be encouraged alongside completion of the tenant's amnesty.;
• supports proposal that no documents are marked 'without prejudice'.

4.3 CAAV Response Summary

4.3.1 General

• Agree agree that much further work will be needed to develop and implement such approaches to rent review.;
• The the issues in defining "fair rent".";
• What what is to be taken into account with the findings on the three statutory factors and other circumstances in then finally arriving at that fair rent.;
• The the problems of forcing individual farms to fit models with issues over the use of inappropriate, standardised and retrospective data, especially in a time of change. ;
• The the financial assessment under any of the first three models is separate from and consequent to the appraisal of the physical productive capacity rather than fully encapsulating it.;
• The the need for more thought as how a divisible surplus is to be divided.;
• The the need to understand the sensitivities in outcomes stemming from variations in the figures and assumptions used. The more links there are in any chain of valuation analysis the more likely the answer is to be wrong.;
• Desirability desirability of a sense check against actual behaviour by 1991 Act tenants, not further standard figures, if fairness is to be judged. ;
• That that tenant's improvements should be understood more broadly than by the 1991 Act or the Amnesty and then disregarded on the basis of value not cost, whether, as appropriate, by the black patch approach or valuing out.;
• The the issues around housing which may be resolved by answers within productive capacity or other circumstances.;
• The the current SLR figures are outdated and will become more so with increasing automation and economic change. ;
• That that more opportunity for final and binding expert determination (Lord Gill suggest this may anyway be possible now) and arbitration would offer the flexibility that businesses need.;
• Barring barring the safe space for negotiations offered by "without prejudice" correspondence will create more problems.;
• Fundamentallyfundamentally, what will best produce the outcome of a "fair rent" that is sought and do so within the wording of the 2016 statute?

4.3.2 Form and Content of Rent Review Notice

• Strongly agree with that specifying a proposed rent over 12 months in advance is impractical and, because of its unreality, more likely to cause problems than reduce them. ;
• a 4 to 6 month horizon would be much more realistic both on whether a rent review is intended rather being provided for and the economic context for that review. ;
• approve of the concern to retain practical flexibility over the timetable.

4.3.3 Means of Calculating Productive Capacity

• Do not agree with the use of standardised data used in models 1 & 2. ;
• believe that the physical data is better drawn from knowledge of the holding and neighbouring units and should be assessed over a period such as a three or five year rolling yield to stabilise it.;
• do not think forcing farms into standard farm types is fair.;
• issues with identifying all relevant costs to be taken into consideration.;
• issues with identifying which data sets are applicable, past, present or future.;
• in working directly from the gross output to identify the productive capacity, it allows the whole issue of overheads and marriage value to be bypassed (and also how to judge when to use contractors' costs), so allowing some realism about current farming circumstances and approaches to business adaptability. In that, it also removes the potential for the subsequent calculations to yield a nil or negative rent which is, for some, a potential objection to the budget models. ;
• prescriptive approaches, such as the conversion ratio used for stocking rates, should not be imposed.;
• clarity is required on whether the assessment of the output over a period of years refers solely to the physical output or also to prices.;
• further justification of 30% used in the gross output model should be explored and whether this should be set in regulation or open to variance depending on the holding.;
• clarification on how to deal with Basic Payment, Greening and agri-environment schemes.

4.3.4 Black Patching Tenants Improvements

• Concern over confusion of cost and value as the cost of the works (even in current terms) may bear little relation to its value to a hypothetical user. ;
• two accepted ways of dealing with tenant's improvements:
  • the more fundamental "black patch" approach saying that the item of work is not there at all. This allows the productive capacity to be assessed without taking account of the latent value of the opportunity to make the improvement.;
  • valuing the improvement out for the value it offers as at the rent review date, usually with a deduction of the result from the landlord's share of the divisible surplus. ;
• the improvement's cost is of no relevance and may be only the same as its value by coincidence. ;
• agree that the black patch approach is more likely to be appropriate for larger improvements made solely by the tenant but that a value based approach may be more relevant to smaller or more incremental improvements. ;
• agree that the Amnesty offers an opportunity for parties to agree on a full record of fixed equipment whether or not it is compensable but that is not what the Land Reform (Scotland) Act actually provides for.

4.3.5 Grant Funding

• Further clarification from Hamish Lean is required on how to deal with grant funding and if the 2016 Act has changed the procedure from that undertaken under section 13 of the 1991 Act.

4.3.6 Sense Checks

• Do not think the Macaulay land classification model makes sense as a method of valuation. The range of factors relevant to productive capacity point to land classification as being too simplistic to be fair.

4.3.7 Splitting the Divisible Surplus

• When budgets for comparables have been analysed, they often show the rent to be at a significantly varying percentage of the divisible sum with, for example, dairy holdings often being lower. ;
• relevant issues could be:;
  • varying levels of risk
  • varying levels of working capital
  • repairing and other obligations of the tenant
• the approaches to the way the divisible sum may be divided need to be more closely considered and argued. A default or prescriptive assumption of an equal split may be ignoring real issues of fairness.

4.3.8 Residential Surplus

• Agree with approach of where the SLRs suggest that 1.2 dwellings are needed, then 80 per cent of the value of the second cottage should be brought into account but suggest clarification is required to conclude this is legally permissible.
• agree where a cottage is being sub-let it should be taken into account. Again clarification is needed on whether this is legally permissible.
• suggest approach to seasonal labour needs further explored.
• consider how the farmhouse occupied by the tenant is assessed when calculating the fair rent.
• we are conscious in looking at this issue of the interaction with the Land Reform Act's proposals for relinquishment and assignation. Where the value of housing is disregarded at rent review, the rent will be lower than otherwise and so reduce the investment value of the holding for the relinquishment calculation. As that would not affect the vacant value, this would increase what the landlord would be asked to pay. That appears to add to the pressures leading to that mechanism becoming a vehicle for selling occupancy rights to housing.
• agree employees and relatives are specific to the actual tenant and should be ignored for the purpose of surplus accommodation.
• agree that the current figures for SLRs, based on work in 2004 to 2006 and issued in 2008 by Nottingham University for FBS and then re-used by SAC are no longer descriptive of farming practice and so are not a fair basis for this assessment.
• prefer industry standard method to more scientific approach.
• believe tenants improvements should be black patched where this is possible.

4.3.9 Non-agricultural Use

• Agree accounts-based approaches may be one way to analyse the rent but are only supporting evidence and assumptions as a sense check to the comparable approach.;
• disagree with the proposal that a final divisible surplus be assessed and then split 50/50 to find rent as this does not seem right for business projects only for sub-lettings. Argue the business project may rely so heavily on the tenant's skills, management and endeavours (without which there would be little or no extra value) that they should retain a higher fraction of the surplus where this route is adopted. It will be even more case specific than for farming.;
• again the preference is to black patch tenant's improvements where possible.

4.3.10 Dispute Avoidance

• Believe "without prejudice" correspondence offers a means for negotiations to happen in a "safe space" where offers can be tested and positions adjusted without making commitments until the matter is agreed. Therefore do not think it should be removed.;
• do not agree that improvements can be limited to those agreed through the amnesty as it does not provide for all improvements to be accounted for.;
• preference to expert determination or arbitration.;
• agree mediation is useful but entails a further round of what is essentially assisted negotiation with no assurance as to achieving an answer.

4.4 STFA Response Summary

4.4.1 General

• We believe the key is a reasoned forward looking farm budget for the 3 years ahead based.;
• believe all tenant's improvements made to the holding should be black patched. Exceptions which may require to be costed out include basic provisions of fixed equipment supplied by the tenant but which should have been supplied by the landlord at the commencement of the lease. These include provision of water, electricity, access and fencing and in some cases drainage works to schemes present at the start of the lease. ;
• want marriage value to be disregarded.;
• want latent value to be disregarded.;
• see finance for tenant's working capital and tenant's improvements as a relevant cost to take account of in the rent test.;
• agree a Statement of Facts is completed and agreed prior to the serving of a rent review notice.

4.4.2 Form and Content of Rent Review Notice

• Believes that the rent notice should be accompanied with a rent proposal showing transparent workings including Statement of Facts and Expert Statement. ;
• suggest it is imperative that a Statement of Fact is completed and agreed prior to the serving of a rent review notice.

4.4.3 Means of Calculating Productive Capacity

• Believe future prices should be used rather than past or current price data;
• concerned over the use of a model based on a criteria used by banks to satisfy lending criteria.;
• there should not be an assumption that any tenant farmer would carry out improvements to crystallise 'latent value'. ;
• believe the individual enterprise model would be more useful if forward looking gross margins and costs were used instead of historic costs. ;
• suggest farm labour should not be excluded from fixed costs. Agree there may be an argument for excluding the tenant's individual labour. Hired labour is a genuine cost to be taken into account when determining the divisible surplus.;
• believe deductions from the landlord's share of divisible surplus for the annualised value of tenant's improvements not black patch requires some agreed methodology with agreed rates of return for the tenant's investment in fixed equipment.;
• adjustments for pre-1948 leases and PLAs will also be significant and require agreed methodology.;
• believe the standard data approach does not take account of the significant area differences which are relevant at rent review.;
• agree the output model could be used as a sense check but think care is needed as it only relates to years of average prices and average profits. ;
• argue different farm types show different ratios for rent and interest and a percentage of gross output. ;
• argues the 30% figure used in the Interim Report may be a banking guideline but it is not representative for actual Scottish farming businesses.

4.4.4 Black Patching Tenant's Improvements

• Believe that the black patch approach should be used for all improvements where possible, being the simplest, fairest, and most transparent method of disregarding improvements. ;
• agree improvements relating to fencing, water supplies, access roads and provision of electricity could be costed out since without them most Scottish farms would be unable to be farmed.

4.4.5 Grant Funding

• Treatment of grant aided landlord improvements has changed from section 13 of the 1991 Act, which is a significant change. Believe the current situation should prevail and this should be clarified through regulation.;
• do not think rent reviews should take account of 100% grant funded improvements done by the landlord.

4.4.6 Sense Checks

• Suggest all models explored as part of the Interim Report, apart from the capital value model, could serve as a good sense check.;
• agree the Land Classification Approach could be an excellent sense check if the industry could agree on a range of rental values for different grades of land. There would need to be adjustments for different areas of Scotland, and the extent of fixed equipment attached to the land would need to be specified.

4.4.7 Splitting the Divisible Surplus

• No specific comments offered.

4.4.8 Residential Surplus

• Care should be taken in making any adjustment to SLR figures so as not to disadvantage tenant farmers on more labour intensive and marginal units;
• believes where possible, the principle of black patching all tenants' improvements should prevail. ;
• agree it is only fair that an allowance for the costs of meeting the repairing standards is also factored into the rent calculation, whether or not the tenant is receiving a rental income from the property.;
• clarity is required where the landlord provision of accommodation is insufficient for the SLR of the holding. Should the extra cost to the tenant of providing alternative accommodation be deducted from the landlord's divisible surplus, or should the productive capacity be based of a different farming system with a lower labour requirement?;
• believe that non-surplus accommodation that is let out should not attract additional rent. ;
• do not agree that specific allowance should not be made for occupation by family members, retired workers or seasonal labour.;
• agree proposed formula to annualise certain improvements such as central heating, double glazing or kitchen and bathroom fittings may be acceptable for analysing comparable evidence if such evidence exists. However more basic tenant's improvements such as provision of electricity, water and sanitation, damp-proofing, housing extensions re-roofing, should be black patched to arrive at the original condition of the property.

4.4.9 Non-agricultural Use

• Believe it is important to note that tenant's will usually have landlord's permission to undertake a non-agricultural activity which will probably already be subject to additional rent. Agreed rent levels should be taken into account before applying a "market rent", especially where the "market rent" may remove any return on the tenant's investment.;
• believe tenant's improvements must be black patched. ;
• believe consideration should be given to the treatment of non-physical tenant's improvements that may be required for diversifications including:
  • planning permission or prior notification;
  • listed building consent;
  • a building warrant;
  • water abstraction license;
  • grid connection consent.

4.4.10 Dispute Avoidance

• Agree with the need for a statement of facts and expert statement.

4.5 SL&E Response Summary

4.5.1 General

• Believe it will be difficult to implement the legislation in a workable way which can be undertaken by Landlords and Tenants rather than third party qualified agents.

4.5.2 Form and Content of Rent Review Notice

• Agree that the rent proposal should not be within the notice as this would be unworkable and costly for the party serving the notice.;
• believe a timeframe for the rent review proposal could be implemented through primary legislation or regulations in line with current best practice guidance i.e. rent review inspection more than 6 months before review date with written proposal 4 months in advance of review date.

4.5.3 Means of Calculating Productive Capacity

• Believe Gross Output approach would be the best means of minimising dispute. ;
• some concerns that the rent review process could be brought to a halt if the parties are not able to reach agreement on the farming policy. However, agree there may be scope for a code of practice to encourage reasonable behaviour. ;
• agree that the "Statement of Fact" to be agreed between the parties should assist in agreeing a realistic farming policy. ;
• believe that the use of a farm budget is likely to result in dispute due to the number of variables involved.

4.5.4 Black Patching Tenant's Improvements

• Concerns were raised over annualising tenant's improvements in a cost and deduction manner and the preference was to black patch tenant's improvements.

4.5.5 Grant Funding

• Believe an improvement undertaken by the landlord which is 100% grant funded needs to factor into the rent calculation as the landlord will have ongoing repair/renewal obligations.

4.5.6 Sense Checks

• Do not agree a sense check using open market rents is appropriate as a new rent review system could not be gauged by checking against the old system. Believe it may be that a sense check against sitting tenant rents would be more appropriate. ;
• concerned that a sense check based on land use class would be too complicated. Adjustments would be required for lease terms, landlord's fixed equipment, tenant's improvements etc.

4.5.7 Splitting the Divisible Surplus

• Concerned that the 50/50 split is arbitrary. Consider that the divisible surplus should be calculated (and defined in regulations) and then divided once each party's costs have been taken into account. The tenant's labour would also need to be factored in, as well as the landlord's repairs and reinvestment. The surplus would then be divided between the parties based on the capital they have in the business and the risk associated with that capital. ;
• appreciate that this may be too complicated to achieve in practice and therefore a 50/50 split with any deviation being justified may be the best alternative.

4.5.8 Residential Surplus

• Support the "recommended approach" and agree that it provides a clear way of calculating what accommodation (or percentage of accommodation) is surplus. It is key that the SLR data produced by the SAC should be updated. ;
• the legislation provides that the overriding assessment is that of a "fair rent". The farmhouse occupied by the tenant is only excluded from the assessment of the open market rent of surplus accommodation. This does not seem to preclude it from being taken into account when assessing what is a "fair rent". Wish for the Team to further consider how this can be applied. ;
• believe surplus properties occupied by seasonal workers, retired employees and family members should be taken into account in the rent calculation (whether or not the tenant receives a rent). Suggest that voids are not relevant where the property is occupied by seasonal workers, retired employees and family member as there is unlikely to be any voids.;
• think tenant's improvements should be black patched where possible as wary of the cost and deduction method for accounting for these.;
• concerned that the scientific approach may be too complicated so the industry standard may be preferable.;
• agree that further clarity is required on accounting for tenants improvements and accounting for compliance with the repairing standard.

4.5.9 Non-agricultural Use

• Believe that whilst the definition of diversification should not be solely restricted to the legislative process, it may be useful to highlight that a diversification may be agreed under the 2003 Act.;
• believe that given the legislation provides for the "open market rent" of non-agricultural use, agree that comparables are a useful starting point. However, given the potential lack of comparables, agree that a "sense check" is required. ;
• feel a sense check against the agricultural value would be useful (as a minimum figure). );
• concerned about the cost and deduction approach regarding tenant's improvements. ;
• disagree with the 50/50 split of divisible surplus methodology here as suggests that the tenant should only pay 50% of the ground rent due to the tenancy being in place (on the basis that there has to be a return for the tenant undertaking a diversification). Believe where the tenant is, for example, carrying out a ground works business, the tenant is obtaining a competitive advantage over competitors because the tenant is not paying a full market rent for the ground.

4.5.10 Dispute Avoidance

• Supports the principle of landlord and tenant agreeing a "Statement of Fact" in respect of a holding but query why some of the information which appears in the "Expert Statement" does not appear in the "Statement of Fact". For example, the residential property on the farm and any basic details of diversifications will be a question of fact. Also believe tenant's improvements need added to the templates.;
• support the use of alternative dispute resolution but have concerns with a code of practice requiring the parties to go to alternative dispute resolution.

4.6 Areas of Agreement

4.6.1 The following concepts were broadly agreed:

1) There was some acceptance of the Output model if further work is done on the percentages to be implemented. At worst this could be used as a sense check to a budgetary approach.

2) Tenant's improvements should mainly be black patched unless for farming and housing they are intrinsic to the system being applied i.e. fencing, access, water and elements of drainage for productive capacity and small improvements taken into account in the assessment of comparables along with the cost of meeting the repairing standard for surplus residential accommodation.

3) A methodology is required for valuing out non black patched improvements.

4) Further clarification is required on grant funded improvements.

4.7 Analysis of Disputed Aspects

Table 2: Analysis of Stakeholder Responses

Disputed Aspect	NFUS	CAAV	STFA	SL&E
Remove reference to rent proposal in RR notice	No comment	Agree	Disagree	Agree
Productive Capacity Budget method	Dispute likely	Preference	Preference	Dispute likely
Productive Capacity Output Model method	Preference	Agree but concern over fairness and adaptability to change	As a sense check	Preference
Output model as sense check	Agree	Agree	Agree	Agree
Macaulay model as a sense check	Agree	Disagree	Agree	Disagree
Sitting Tenant rents as a sense check	No comment	Agree	Agree	Agree
Costing out tenant's improvements not black patched	Prefer black patching	Prefer valuing out	Agree if methodology stated	Prefer black patching
Valuing out tenant's improvements not black patched	Prefer black patching	Agree	Prefer costing out	Prefer black patching
Residential Surplus calculation	No comment	Prefer industry standard approach	Prefer scientific approach	Prefer industry standard approach
Ability to charge where evidence of actual surplus but not surplus in terms of SLR	No comment	Agree	Disagree	Agree
No allowance for relatives or retired employees	No comment	Agree	Disagree	Agree
No allowance for seasonal workers	No comment	Unsure	Disagree	Agree
Cost in requirements for meeting repairing standard	No comment	Unsure	Agree	Agree
Cost and deduction for any improvements taken into account when considering comparable evidence	No comment	Unsure	Agree	Unsure
Ability to charge surplus rent on farmhouse	No comment	Agree this cannot be done on the surplus but feel needs to come into productive capacity	Agree	Agree this cannot be done on the surplus but feel needs to come into productive capacity
Diversification calculation method	No comment	Agree with comparables method	Agree with comparables method	Agree with comparables method
Use of enterprise income method as a sense check	No comment	Agree	Agree	Agree
50/50 split of surplus	No comment	Disagree	No comment	Disagree

4.8 Conclusions drawn from Submissions

4.8.1 From the submissions it was evident further research and justification was required for some of the conclusions drawn in the Interim Report. Very briefly the main areas which were focussed on following the stakeholder submissions can be summarised as follows:

4.8.2 Productive Capacity

• Further work on the Full Budget Model. ;
• further work on the Output Model in examining how the 30% gross profit which was advised to be split 50/50 could range in terms of farm type and economics.;
• further work on how to account for residential accommodation which is not considered to be surplus.;
• further work on determining how to disregard non black patched tenant's improvements.

4.8.3 Residential Surplus

• Further work on determining how to deal with actual sub-letting, housing of relatives, seasonal workers and pensioners.;
• further work on determining how to disregard tenant's improvements.

4.8.4 Non-agricultural Use

• Further work on determining when something would be a non-agricultural use rather than just sub-letting.;
• further work on determining how to disregard non black patched improvements.;
• further work on determining where the comparable method would not work and the net enterprise surplus method would be justified.