Ground rent reform shaking the foundations of the leasehold system?

The post below was first published on our Real Estate blog.

On 7 January 2021, the Housing Secretary, Robert Jenrick, confirmed long awaited proposals banning leasehold ground rents in England. This announcement follows the Law Commission’s recommendations last year on residential leasehold reform (see our blog post here) and is expected to benefit up to 4.5 million leaseholders, including retirement properties.

Under these changes, leaseholders of houses and flats will be permitted to extend their leases up to 990 years without needing to pay a ground rent to their landlord. Before this announcement, leaseholders of houses could only extend their term once for 50 years with a ground rent, whereas flat owners were entitled do so multiple times for 90 years with a nil ("peppercorn") rent.

However, what is not currently clear is the basis on which the loss of the value to the landlord of the ground rent income will be compensated. Currently, leaseholders wishing to extend their leases (eg for selling or remortgaging purposes) face payment of a premium to reflect the benefit to them of replacement of a ground rent with a peppercorn rent. Furthermore, there is a complicated valuation process that deals with how “marriage value” (reflecting the increase in value of the property following the lease extension) is calculated and shared with the landlord.

In terms of the various potential ways of carrying out this calculation under these new proposals, it is difficult to imagine how a “one cost fits all” approach would work in practice, given the hugely varying property values across England and the reality that extending a lease by 990 years will turn it into a virtual freehold. This would demote the landlord’s reversionary interest (ie when it could expect to reoccupy the premises when the lease expires) into a mere “paper” freehold title. Perhaps then a sliding costs scale or a re-jigging of the calculation to abolish the “prohibitive cost” (as it is stated to be) of "marriage value" according to the Government? But that simply begs the question of what benefit this will actually give to leaseholders in practice if costs are not significantly reduced by this new calculation which the Government has stated (without providing further detail at this time) will be “fairer, cheaper and more transparent”.

Compensation for landlords … or is this just price inflation for leaseholders?

If there is no compensation built into the calculation, for developer landlords or investors who might be relying on the income stream afforded by ground rents, then there is the argument that this would represent a sequestration/compulsory acquisition of a landlord’s assets without balancing compensation. It is not hard to think of arguments which landlords/developers might raise that without an adequate compensation element then this could be an overreaching breach of Protocol 1, Article 1 of the European Convention on Human Rights (which forms part of our domestic law by virtue of the Human Rights Act 1998). This states that individuals are entitled to peaceful enjoyment of property but it does provide a caveat that any deprivation is allowed if it is “in accordance with the general interest or to secure the payment of taxes or other contributions or penalties”.

Or perhaps the new purchase price/costs for extending the lease to 990 years, rather than 90 years, will simply increase commensurately so as to create a larger financial obligation at the outset. Take for example the Government’s announcement in July 2020 of a residential SDLT holiday until 31 March 2021 for properties worth up to £500,000 in response to the Covid-19 pandemic. Research has already shown that at the end of 2020 there was a national average house price growth of 6.6% compared to 2019. This supports the suggestion that property prices simply increased with sellers recognising that buyers had a bigger budget to play with, whilst the stamp duty holiday was in place, and therefore buyers either haven’t actually been any better off in practice, or have ended up sharing the saving with the seller.

The analogy is easy to make that leaseholders might find that, rather than paying a ground rent to a landlord over the lifetime of their lease term, they will simply have to pay this money (or a proportion of it) to the landlord upfront if they wanted to extend their lease to 990 years. This would not seem to be the policy outcome which the Government was aiming at with this announcement, with it claiming that leaseholders could be “tens of thousands of pounds” better off under the new system when the calculation is eventually revealed. Only time will tell.

Why shake up the historic leasehold system now?

The focus on ground rents has been several years in the making, and the "medieval" system has been on the Law Commission’s radar for some time now. Typically ground rents might be at a low "peppercorn" rate, but more recently there had been the emergence of crippling "doubler" provisions whereby the ground rent doubles, say, every 5 or 10 years. This often leaves these homeowners unable to sell or mortgage their properties after having not been fully aware of the potential financial consequences of these provisions when they were granted their lease. Unfortunately for such leaseholders the Supreme Court has already confirmed back in 2015 (see our blog post here) that it is not the job of the courts to help leaseholders un-do a "bad bargain" in relation to these types of provisions.

Residential leasehold tenure no longer exists in Scotland and the Welsh government has yet to announce its response to the Law Commission’s report, although Welsh and English laws on real estate ownership have the same underlying basis. However, this recent legislative change (which has yet to be put before Parliament) comes in the wake of the Government’s announcement in June 2019 that it would ban the sale of leasehold new-build houses (as opposed to flats) and an announcement in March 2020 that developers would also be unable to charge ground rent on properties sold under the Help to Buy subsidy scheme. In response to this, some UK house builders had already paid heed to this sea change in policy and announced their intention at the end of 2020 to stop ground rents and instead offer 999-year leases with no ground rents on their new build flats.

Commonhold: a fit replacement or an optimistic stop-gap?

The Government is also expected to set up a “Commonhold Council” comprising of industry experts and affected groups in order to pave the way for a move towards commonhold to replace the current leasehold system with freehold ownership.

Commonhold (by which flats within a commonhold scheme are each held, as registered freeholder, by the respective flat/unit holder and with no landlord) has been around in the UK since 2002. Despite being more common in other jurisdictions (where their equivalents tend to be called "condominium" ownership), commonhold has been slow to take root in the UK with developers almost always preferring, often for financing and legal reasons, the traditional route of granting long leasehold interests with an obligation on the flat owners to pay a ground rent.

These “ground rent portfolios” are often then sold to investors who prefer the steady income stream that this model provides. That is now set to change. However, it is unclear whether the Government’s view of an expected uptake on commonhold schemes will bear fruit. Particularly in relation to the increasingly frequent development formulation that is a large mixed use scheme with retail and office elements, where groups of residential unit holders may have different ideas to the landlord developer about standards of repair and control of user in the scheme. The present iteration of commonhold law, now 18 years old, has not attracted the market to shift over to it, so we would expect significant reform before that changes.

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