The Great Leasehold Scandal – Is your lease a Fiat or a Porsche?
If the current fervour of consumer-driven criticism is anything to go by – not to mention the number of investigations various quangos are carrying out – leasehold property is close to being outlawed, such is the widespread toxicity of hidden legal traps that apparently cause this wasting asset to depreciate in value faster than the latest Fiat 500L rolling off the forecourt.
Why such negative press for leasehold properties?
The surge of criticism was prompted by attempts from a small group of national builders who chose to create leasehold schemes for new build housing estates that ordinarily would have been sold as freehold properties. Selling these ‘units’ as leasehold properties gave the builders more opportunity to extract further value in the future, beyond the sale price agreed and initially paid – especially if certain provisions in the lease were ‘tweaked.’
Typically extra value was extracted by:
- Consent fees – Creating many covenants in the lease requiring the Landlord’s consent to certain activities that a house owner may routinely carry out during their ownership of the Leasehold Property. These include altering the internal arrangement of the property, laying new wooden flooring, a satellite dish or housing a domestic pet. Every time the Landlord’s ‘consent’ is needed, the Landlord can withhold their consent until their ‘reasonable’ administration fee is paid. Fees can amount to £300 to £500 per consent.
- Ground rent – Setting in the lease a high initial annual ground rent and / or regular intervals at which the level of ground rent is increased. Leases with ground rents that double every 10 years, for example, result in very, very high annual ground rents within 50 to 60 years.
- Low terms – Creating a low lease term of, say, 99 years. While most tenants have a protective statutory right to compel their landlord to grant them a 90 year extension to the existing term (and convert the Ground Rent to the equivalent of £0 per year in doing so) landlords are entitled to compensation. The statutory formula for calculating this is quite complicated requiring expert valuations which are often disputed by landlord and tenant making the process more costly. An additional element in the formula, referred to as the ‘marriage value,’ is triggered when the term of the lease has less than 80 years to run and can result in tens of thousands of pounds being added to the price. The overall cost of a statutory extension to your lease term is likely to be significantly lower if it can be completed before the 80 year milestone, but it is still likely to cost at the very least in the region of £5,000 to £10,000. The windfall due to a landlord is proportionally increased relative to the level of ground rent as part of the compensation paid to the landlord is the amount of ground rent that would have been collected for the remainder of the term before it is extended.
The vast majority of residential leases contain ground rents that can be increased periodically, initial terms of 125 years or less and quite a few covenants that require the landlord’s consent.
Leasehold or freehold for flats?
A leasehold arrangement is still the best arrangement for a block of flats or a house converted into 2-6 leasehold units. It creates a legally enforceable contract to ensure the maintenance and insurance of the building and also sets a minimum level of conduct with all of the other flat owners in the block. The obligations set out in a lease bind whoever owns freehold land (the landlord) and the flat (tenant). It is much more difficult to achieve this minimum level of care and protection in the context of freehold ownership within a building.
Stacking freehold titles one on top of the other within a building creates ‘flying freeholds’, arrangements considered by many mortgage lenders to be defective and by some to be unsaleable. This is mainly because under English law positive obligations in the legal title, say to insure and maintain the building, are not automatically binding on successive owners (as they are in leases) unless there is a direct contractual obligation between the property owner and the person obliged to carry out the maintenance and insurance.
What is the new build leasehold housing scandal?
The new build leasehold housing scandal centred upon house builders opting to create overly complicated leasehold titles for properties that really should have been sold as freeholds. This is because there was nothing to prevent the house’s owner from carrying out maintenance and insurance of the entire property themselves. The underlying motive for doing this was the latent value in high ground rent income and a windfall within the next 15 to 20 years when they were approached by the owners for a lease extension as their lease term had less than 80 years to run.
It’s fair to say that the spotlight is now shining on the existing leasehold system as a result.
Following comments in consultation reports prepared by the Law Commission and The Housing Communities and Local Government Committee, over 45 house builders have committed to an industry wide pledge to exclude onerous ground rent clauses. It is highly likely that legislation implementing leasehold reform will be passed in the near future to correct some of the unfair practices that have emerged within the current patchwork quilt of over 50 Acts of Parliament relating to Leasehold property.
Acceptable lease arrangements
In the meantime, many mortgage lenders have reviewed the reports and have adjusted their minimum requirements with respect to Leasehold Property. The emerging picture of what constitutes an acceptable arrangement is a lease containing the following features:
- Leasehold house – If your lease is of one building with no other flat owners within it, then there is good cause for concern. The terms of your lease should be scrutinised carefully. Ideally, your lease will acknowledge that you are responsible for maintaining and insuring the building, not contain any instances whereby you are required to obtain the landlord’s consent, have a term of 999 years with the ground rent being fixed at no more than £250 per year at any point in the term.
- Ground rent amount – Is less than 0.5% of the market value of the property, although annual rents more than 0.1% of the market value are likely to be referred to the lender’s valuer for their further review.
- Ground rent periodic increases – Doubling ground rents are acceptable provided that the frequency between each increase is over 20 years. Ground rent reviews linked to relative increases in the Retail Prices Index are equally valid, provided that there is a gap of at least 10 years between each review.
- Term – The unexpired term of the lease is at least 55 years (or at least 30 years left to run in addition to the length of the mortgage term), although unexpired terms of less than 85 years are likely to be referred to the lender’s valuer for further review.
The value of your lease
So is your lease a Fiat 500L or is it a Porsche in terms of retaining its market value?
There are some mortgage lenders who set the bar higher but for the moment if your lease meets the above criteria then this is a good indication that your lease is not materially affected by the current wave of criticism levied against the leasehold tenure.
Until legislation is passed setting a minimum cap on ground rent and simplifying tenants’ rights to a lease extension or collective purchase of the freehold with other tenants in the same building, then you should strongly consider lodging a claim with your landlord to obtain an extension of your lease term if there is less than 85-90 years left to run on your lease.
How Rix & Kay can help
Rix & Kay has lawyers accredited with the Association of Leasehold Enfranchisement Practitioners (ALEP), an independent regulator which sets the benchmark for best practice in this area of law.