Leasehold Reform: Goodbye to Ground Rents?

Introduction

The 2021 Queen's Speech signalled the start of the UK Government's anticipated plans to change the system of leasehold residential ownership:

"Laws to modernise the planning system, so that more homes can be built, will be brought forward, along with measures to end the practice of ground rents for new leasehold properties."

On 13 May 2021, the Leasehold Reform (Ground Rent) Bill (the Bill) was published and, if passed into law, it will mark a radical shift away from the payment of ground rents for certain leaseholders, a practice which has been in place since Roman times. These changes will not be a surprise for those who caught our earlier blog, published following a statement from the Housing Secretary earlier this year which confirmed long awaited proposals banning leasehold ground rents in England and Wales. While most ground rents are typically low annual payments, the demand for reform came about as a result of controversial "doubler" mechanisms included in some leases. The provisions vary, but in some leases, significant ground rents repeatedly double, say, every five or 10 years. The risk is that this can leave long leaseholders unable to sell or mortgage their properties.  Many have said that they were not fully aware of the potential financial consequences of these provisions when they were granted their lease.

The release of the Bill, which it should be noted may be amended during its passage through Parliament, provides both leaseholders and landowners/developers a valuable opportunity to see what the legislative landscape may look like in future.

Application of the Bill: to which leaseholders will it apply?

The legislation as expected applies to leases of dwellings in England and Wales, which can mean flats or houses. The Bill, if passed, will not have retrospective effect and existing leases will stay as they are. The Bill is intended to restrict the payment of rents in qualifying future residential long leases (eg those granted, after the legislation is enacted, for a term certain exceeding 21 years) such that these leases can then make no financial demand in respect of a ground rent. Instead, a "peppercorn rent" will apply, meaning that nothing more than a literal peppercorn (ie a miniscule amount) can be sought from leaseholders.

As currently drafted, the form of the legislation does not differentiate between ground rent and any other kind of rent: in short, anything reserved as rent (eg service charge, insurance rent) would be cancelled and unenforceable. Similarly, there is no reference to the rent being of the nature of a ground rent, so if the lease exceeds 21 years, there would, as the Bill currently is drafted, be no way of granting a long residential lease without a premium and at a market rent. We expect these points are likely to be addressed as the Bill proceeds through Parliamentary readings.

The provisions of the Bill will regulate future long residential leases (so called regulated leases) which are granted on or after the date on which the Bill comes into force (such date still to be confirmed).

This will also include situations where, by virtue of any variation of a lease, there is a deemed surrender and re-grant after the date the Bill comes into force.  Surrender and re-grants are a frequent problem where a landlord perhaps inadvertently, by variation, extends the term of a lease, or adds to the demise. Surrender and re-grant situations already create problems with land registration, legal charges, and SDLT – so the effect of the legislation to cancel rent will simply add to the list of issues that arise from such an event.

Importantly, a regulated lease which is granted pursuant to an agreement for lease (AfL) which was entered into before the Bill comes into force will not be captured. Therefore, landlord developers are still currently able to enter into an AfL which appends an agreed form lease containing monetary ground rent provisions.  If granted pursuant to the AfL, even after the expected Act comes into force, the ground rent provisions will survive unscathed.

There is a risk that the investor market for new ground rent portfolios, whereby the landlord investor relies on a steady ground rent stream from these leases over the course of many years, may slowly start to dry up if the legislation comes into force and no new leases with ground rent are granted.

However, the background notes to the Queen's Speech suggest that there would be a few limited exemptions to this ban, including: (a) certain parts of the community-led housing sector, so that they can retain the right to levy ground rent to maintain their ability to further promote community activities, (b) certain financial products which depend on leases where rent replaces interest bearing mortgage payments, such as some equity release schemes and the Islamic finance sector and (c) home business leases, where people need to live in the same premises as they work, to allow the parties to agree suitable terms for the tenant's overall occupation. All of these exceptions have made their way into the Bill, in addition to a further exception for leases granted under Part 1 of the Leasehold Reform Act 1967 (ie a tenant of a leasehold house entitled to an extended lease).

How the ban on ground rents would generally work

Under the Bill, a landlord may not require a tenant under a new long residential lease (subject to the above limited exceptions) to make payment of a rent that is more than a peppercorn (ie a prohibited rent).

To the extent that the regulated lease is one of shared ownership between landlord and tenant, the permitted rent in respect of the tenant's share in the demised premises is a peppercorn rent, while the permitted rent in respect of the landlord's share is "any rent". The Bill applies the same principle to scenarios where a tenant under its current lease is granted a new lease in respect of some or all of the same premises, and specifies that such a lease will be similarly regulated by the new legislation.

Where a regulated lease reserves a prohibited rent, the Bill provides a mechanism for replacing the reserved rent with a permitted rent, effectively reducing that rent to a peppercorn.

The Bill envisages civil penalties (ie fines) of up to £5,000 per regulated lease where the landlord asks the tenant for payment of a prohibited rent or where, having received the payment, the landlord fails to refund it to the tenant within 28 days following receipt. Further fines can be imposed if the landlord continues to attempt to demand a prohibited rent. The Bill also gives local authorities the power to require landlords to reimburse tenants for any prohibited rent paid, with an order for interest payable on that sum.

Ground rents in the retirement home sector

On 7 January 2021, the Ministry of Housing, Communities and Local Government reversed the UK Government's previous announcement to exempt the retirement housing industry from this leasehold reform, and the provisions of the Bill do indeed include retirement homes. The Bill states that while its provisions will come into effect on the day on which the Act is passed, in relation to retirement homes the day appointed for the coming into force of the Act will be no earlier than 1 April 2023.

This date will be significant for any investor in the retirement home market: around 90% of the private retirement housing sector uses capitalised ground rents to help pay for the construction costs of its shared spaces. Whether this will have a knock-on impact on the affordability of properties available to older people, and the availability of sites which require capitalised ground rents to be financially viable, is yet to be seen.

Consultation into repeal of section 21 of Housing Act 1988

In relation to further potential leasehold reform, the Queen's Speech also stated that:

"My Government will help more people to own their own home whilst enhancing the rights of those who rent.”

Practically, this is anticipated to mean that the UK Government will publish its consultation response on reforming tenancy law to abolish section 21 evictions and improve security for tenants in the private rented sector, as well as strengthening repossession grounds for landlords when they have valid cause. The consultation occurred in 2019 and focused on (i) the impact of abolishing Assured Shorthold Tenancies and (ii) amendments to the grounds for possession in Schedule 2 of the Housing Act 1988.

The reform package is expected to:

• require all private landlords to belong to a redress scheme, to drive up standards in the private rented sector and ensure that all tenants have a right to redress;
• consider further reforms of the private rented sector enforcement system so it is well targeted, effective and supports improvements in property conditions. This will include a set of measures to hold "bad" landlords to account for delivering safe and decent housing to tenants without penalising "good" landlords; and
• explore improvements and possible efficiencies to the possession process in the courts, to make it quicker and easier for landlords and tenants to use.

What the Bill does not address

The Government has previously made reference to plans to introduce a right for leaseholders of houses and flats to extend their leases up to a maximum of 990 years, with a peppercorn rent. The expected premium payable to the landlord from the tenant for doing so would be based upon a new calculation that would be accessible online. At present, no details have been provided as to the basis of the calculation and the online facility has not emerged.

The second reading of the Bill in the House of Lords is currently scheduled to take place on 24 May 2021, so watch this space!

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