29 January 2018

Leases in the spotlight

Leasehold tenure is currently in the spotlight.  In some cases over the years leasehold tenure has strayed away from the purpose for which it was first introduced, being the sensible use of buildings with a shared fabric and infrastructure, and become a real means of deriving additional investment value from an asset for developers.  The government sought to address this when on 25 July 2017 it published a consultation document on tackling unfair practices in the leasehold market.  The purpose of the document was to seek the public's view on the areas that may be in need of reform.  Two of the key areas highlighted were perceived problems resulting from leasehold houses and ground rent.  Over 6,000 replies were received from members of the public to the questions posed in the consultation. In December 2017 the government issued its findings together with its responses setting out the ways the government intends to act to better safeguard the position of purchasers of leasehold properties.

Leasehold Houses

There has been an increase in the number of new build houses sold as leaseholds over a number of years.  This practice is quite legitimate and, until recently, has been governed by light touch regulation only.  Notwithstanding legal advice taken on their purchase, often the owners of such houses have been unaware of the significance of the costs involved in owning a leasehold interest.  The leases may require the owner to get written consent from their landlord for such things as assignment, underletting or alterations which most freehold house owners can do freely.  Getting these consents can be costly, and a slow process.  A number of leases have been found to have onerous provisions by newly evolving standards and, unless the leases are varied, those onerous provisions will be deemed to be unacceptable to potential buyers and their mortgagees when the properties are sold on.  Such provisions may include the annual ground rent payable under the leases increasing to substantial levels.  A separate but related issue may be the excessive prices charged to leasehold house owners to acquire the freehold interest in their home.  In circumstances where standalone houses have been built that do not benefit from any shared facilities or fabric but have been sold as leasehold houses, it is easy to identify how the original purpose of this form of tenure has been used by some developers to create a reliable income stream at an additional cost to their customers. 

The government has announced its intention to limit the sale of new build leasehold houses.  Whilst the government’s proposal may, once it has been put into effect, address the concerns of future generations of house owners from experiencing the difficulties currently experienced, this will not address the position of those existing homeowners of leasehold houses where the government's strategy has yet to be determined.

Ground Rent

Ground rents apply to both flats and leasehold houses.  Some have escalated from nominal sums to sums which have a far greater significance on the home owner's budget.  In some cases escalating ground rents have caused financial distress to homeowners and made it extremely difficult for homeowners to sell the properties on.  The government’s response to the consultation on this issue is to introduce legislation that will set ground rents on newly created leases of houses and flats at a "peppercorn" (zero financial value).  For homeowners currently experiencing problems with their ground rent, the government would like to extend the compensatory schemes that some developers have introduced to support new homeowners.  The response issued does not however detail how such schemes are to be funded. 

If legislation is passed, the government’s proposals to address the two problems relating to leasehold houses and escalating ground rents will benefit homeowners. However, the implications on ground rent portfolio investors and developers should not be ignored. Developers who use some of the income generated from leasehold houses and ground rents to assist them with funding further developments may possibly seek to recover revenue lost by increasing the purchase prices payable for the new properties to be sold. This has implications for the government's pledge to create more housing. The proposed legislation will have a detrimental effect on ground rent portfolio investors (who are often pension funds and therefore a reduction in whose value would not be in the public interest either), and of course the lenders/mortgagees of such investors whose market will be limited to properties with existing ground rents with no opportunity to invest in buildings with newly granted leases.

Ultimately the government’s responses to the consultation show that the government wants to highlight and address the exploitation of leasehold tenure by unscrupulous developers.  We look forward with interest however to reviewing the legislation actually put in place and advising on the wider effects this may have for our clients and industry in the leasehold market. 

Jacqueline is a senior associate in our Residential Property team.

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