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UK residential ground rent assets leased directly to consumers could become uninvestable for institutional investors after Railpen, manager of the UK鈥檚 rail transport pension schemes, revealed it is rethinking its strategy for residential investing after becoming embroiled in Britain鈥檚 cladding scandal.

Railpen, through its investment vehicle Grey GR, started acquiring residential ground rent assets in 2017. Out of the 300 or so investments it made in the asset class, 11 tower blocks have been identified as being unsafe and in need of expensive remediation work.

The cladding crisis ensued following the Grenfell Tower fire in London in June 2017, which revealed that large numbers of buildings had been clad in dangerous, combustible materials.

Additionally, many buildings have been found to be non-compliant with other fire-safety building requirements, such as missing fire barriers, which are intended to prevent fires from spreading horizontally and vertically into neighbouring flats.

John Chilman, CEO of Railpen, said: 鈥淭his is one of the few asset classes we鈥檝e invested in where there is a consumer on the far end, which makes [managing the asset] much more difficult. It makes it much more emotive.

鈥淲hen you鈥檝e got an institutional investor on the other side, or a corporate, it鈥檚 easier. Would we invest in this again? I don鈥檛 think so.鈥�

The UK government鈥檚 Department for Levelling Up, Housing and Communities launched legal action against Railpen鈥檚 Grey GR in relation to Vista Tower, a 15-storey tower block in Stevenage with an estimated 拢14.9m (鈧�17.2m) remediation bill 鈥� the highest in the country.

The action follows two years of delays for more than 100 residents living in the tower and the government says it is committed to ensuring building owners, landlords and developers meet their legal obligations and protect tenants in their own homes. The first hearing was held on 14 December.

Levelling Up Secretary of State Simon Clarke said: 鈥淭he lives of over 100 people living in Vista Tower have been put on hold for over two years while they wait for Grey GR to remediate unsafe cladding. Enough is enough.鈥�

鈥淭his legal action should act as a warning to the rest of industry, or legal action will be taken against you.鈥�

Chilman said that, in the future, Railpen would focus its residential investment strategy on opportunities where the leaseholder is a corporate entity such as a local authority or housing association.

He said: 鈥淭his has shown us is we need to be very careful moving forward. We will still invest in residential real estate, but it changes the way we look at things.鈥�

Chilman says that when Railpen invested in ground rents, acquiring Vista Tower and a number of other buildings over 18 metres, the cladding used 鈥渨as acceptable鈥�. He added: 鈥淚 don鈥檛 think cladding as an issue had been thoroughly identified at that point.鈥�

However, the Grenfell investigation revealed that there were issues with the sort of combustible cladding being used across various tall residential towers.

The government set up its 拢5bn Building Safety Fund to provide cash to private landlords such as Railpen, to finance the replacement of dangerous cladding and enable remediation works to proceed.

But Railpen says it has been impossible to access the fund due to changes in legislation since it was launched.

The situation also has consequences for the valuation of the assets within Railpen鈥檚 long-term income fund, within which its affected residential ground lease assets sit.

Chilman said: 鈥淭he members of the pension fund are likely to see a significant writedown in their assets, to be honest. We鈥檙e not sure what the remediation costs are at the moment, so we will take a view at the end of this year about what potential provision we should put in for those remediation costs.

鈥淪o there could be a loss of several 拢100m potentially that will probably be spread across 40 different sections of our schemes.鈥�

In the wake of the potential huge financial fallout across its residential, consumer-facing ground rent assets, Railpen is refocusing its residential investment strategy on opportunities such as Trocoll House in Barking, where it agreed a 拢92m funding deal to develop 198 build to rent apartments, with the local authority as head leaseholder.