Ground Rents and the impact of Government's proposed changes
By Alexandra Thur
What is a Ground Rent?
A ground rent is created when a freehold owner of land or a building sells one or more long leases for an initial capital sum, such as leases for apartment units. Nearly all apartments in England and Wales, as well as some houses, are owned via these long-term leases. Lease lengths typically range from 99 to 999 years and each lease generally includes a semi-annual or annual ground rent payable to the freeholder for the duration of the lease. Ground rents are attractive, low-yielding investments when the leases are responsibly and sustainably structured, providing freeholders with a safe, long-term and predictable income stream.
Leasehold Houses and Onerous Ground Rents
Leasehold generally applies to flats with shared spaces to make multiple ownership more straightforward. Unfortunately, however, some national housebuilders have increasingly been selling houses, which have traditionally been freehold, on a leasehold basis with onerous ground rents and review structures. In 2016, 16% of new build houses in England and Wales were built as leasehold, compared to less than half of this at 7% in 1995.
Numerous factors have contributed to this being a serious problem that has caught media and government attention, including the fact that these houses a) have no common shared parts to substantiate being leasehold, b) are relatively low value, and c) many of the solicitors that represented the buyers of the leasehold houses did not adequately inform their clients of the ground rent and leasehold aspects of their property purchase. This has made selling and refinancing these houses extremely difficult to impossible. Most mortgage lenders check and highlight onerous ground rents, with Nationwide and RICS highlighting onerous ground rents as those above 0.1% and 0.25% of the unit’s value, respectively.
While most apartment buildings have shared parts that a professional freeholder has a position to manage and insure, some flats have also been subject to onerous ground rents, which include initial ground rents set at a high price compared to the unit value and ground rent review structures that double frequently, such as every 10 years. Sustainable ground rents, on the other hand, will have an initial ground rent proportionate to the unit’s value (such as 0.1%) and review periodically in line with inflation.
The Government’s Response
Spearheaded by the Secretary of State for Communities and Local Government, Sajid Javid, as detailed in the December 2017 white paper, Tackling unfair practices in the leasehold market: Summary of consultation responses and Government response, is proposing numerous changes to the future of the leasehold system. Although these have been rightfully inspired by unjustified ground rent structures imposed on many leasehold houses, the government discussion indicates some potential spill over even to sustainable freehold ground rents on apartments. (Responsible ground rents have sustainable initial ground rents and review patterns, such as initial ground rents of no more than 0.1% of each unit’s value that review in line with the Retail Price Index (RPI) of inflation every 25 years).
Sajid Javid’s December 2017 proposed changes to leasehold include the following:
- Setting ground rents on new long leases, for both houses and apartments, to zero (a “peppercorn”)
- To recoup costs of servicing and managing buildings, however, managing agents may likely increase their fees and associated service charges, particularly when working for leaseholders rather than professional property freeholders knowledgeable of appropriate upkeep costs.
- With the value of the freehold interest often included in order to make new residential development projects viable, this will likely result in reducing development projects, as well as developer motivation for building shared ownership or affordable developments, further segregating the market.
- Land prices and Section 106 contributions may be negotiated more heavily to make new development projects more viable.
- Simplifying and reducing the cost for leaseholders to extend leases and purchase their freehold
- This too will result to the maintenance and upkeep of more buildings being the responsibility of the leaseholders, which frequently leads to either poorly maintained properties and / or inflated costs.
The reformed legislation, once clarified, however, is not expected to apply to existing or new residential buildings that are completed prior to the implementation of the new laws. This new legislation will take time and require substantial new process streamlining, and as such, is not expected prior to late 2018.
The Welsh Government, however, may be leading the way to appropriate and reasonable leasehold reform clarity, as indicated by the recent Written Statement – Leasehold Reform in Wales from Rebecca Evans, the Welsh Minister for Housing and Generation:
"Leasehold does have its place as a tenure (for flats, for example), but I will only support its use where it is appropriate – and this does not apply to new build houses other than in very specific circumstances."
Evans also goes on to say:
"New leasehold flats will have to comply with new minimum standards, including “limiting the starting ground rent to a maximum of 0.1% of the property’s sale value. Any future increases in ground rent will have to be linked to a government recognised inflation index, such as the Retail Price Index. This will put an end to ground rents increasing exponentially and ensure they remain affordable. Leases will also have to run for a minimum of 125 years for flats and 250 years for houses. These minimum terms will provide security to the leaseholder by maintaining the property value…"
Evans also recognises that solicitors representing buyers of leasehold properties, particularly houses, need to be held responsible for ensuring their clients fully understand the leasehold aspect of their purchase.
Leasehold Ground Rents: Now and the Future
This official statement from Evans clearly addresses the issues pertaining to the specific unfair leasehold practices with logic, without suggesting that an all-encompassing blanket also be placed over the responsible practices in the leasehold market. This gives solid hope that the English Government will follow suit in such a manner to continue to allow responsible residential ground rents on flats.
Until new legislation is clarified and implemented, sustainably-priced and structured ground rents still have value. Retrospective action on existing flat ground rents is not expected, so as long as the freehold ground rents exist, they continue to hold value as a secure, inflation-hedged investment.
Alexandra Thur is a residential property investor and the Head of Investment and Development at Castelnau Estates, a nationwide property investment firm. She leads key operations and strategies for company growth while effectively acquiring off-market real estate development opportunities and guiding investment strategy. She is also a Founding Member of Qandor.