Farewell freedom of contract? Have your say on capping ground rents in existing leases and leaving landlords entirely uncompensated for the lost income stream

Consultation on restricting ground rent for existing leases

Freedom of contact is no longer king, or at least it won’t be if the Government's move to cap ground rents in existing leases is successful. We have blogged previously about the Leasehold Reform (Ground Rent) Act 2022 and the abolition of ground rents for new leases granted after 30 June 2022. However, the Government has announced a consultation on new proposals which go a step further and would cap ground rents in all existing leases. A retrospective re-writing of the agreement struck between two consenting parties by statutory intervention!

This isn't a new concept and we have seen plenty of it recently in relation to the Building Safety Act 2022. There, the express terms in the lease are overwritten to protect qualifying leaseholders of flats in buildings over 5 storeys high from service charges for costs of remediation works. The policy behind the Act is crystal clear … the safety of residents in buildings at risk of fire or collapse is made paramount. The rationale then being that those residents should not foot the bill for fixing unsafe buildings.  But at that point, the reality of where the cost may fall quickly becomes a complex issue.

The Secretary of State for Levelling Up, Housing and Communities, Michael Gove, believes "it is time to address these unregulated costs once and for all, protecting leaseholders and making not only the dream of home ownership, but everyday household bills, more affordable" (foreword, Consultation on Modern Leasehold: restricting ground rent for existing leases, 9 November 2023).

However, a marginal benefit to those seeking to buy a home or to pay household bills is not even in the same ballpark as the immediate need to prevent injury or loss of life where a previous generation of buildings have proven to contain unsafe structural components. Nonetheless, the government's goal is to "make sure that consumers only pay for services that they gain material benefit from", which is why service charges are to remain. Residential leaseholders enjoy extensive service charges protections under the Landlord and Tenant Act 1985 and therefore have the tools to ensure their payments are going towards maintaining the property or providing services for their benefit. Conversely, ground rent payments do not have to be reasonable, they only need to have been agreed as part of the deal between the landlord and the buyer of the flat, at the point when the commercial terms are agreed.

The consultation, which runs until 21 December 2023, seeks views on 5 different options for overriding lease drafting and capping ground rents. These include:

1. Capping to a peppercorn (effectively nil)
2. Capping to a maximum value*
3. Capping at a percentage of property value*
4. Capping at the original amount of ground rent when the lease was granted*
5. Freezing at current levels*

*These options seek views on whether these caps should be increased over time, and if so, using what method (index-linked, fixed increases, open market review, etc)

Expropriation, daylight robbery or somewhere in-between?

Here is the critical bit of the consultation for landlords and investors:

"Regardless of the option taken forward, we would not expect to compensate freeholders for lost revenue, nor do we expect freeholders would be able to capitalise the lost income stream though other means".

We struggle with this.

Views are requested from Government on whether consultees agree with this position. The consultation quotes some statistics from the Investment Property Forum, which undertook a survey of 42 institutional investors in property in 2014 and 2015. They found the value of residential ground rents held by eight respondents was £1.51 billion and £1.9 billion respectively. That was almost 10 years ago and the landscape for ground rents has changed in the meantime, but even using those values, that is a lot to write-off for investors, including pension funds and local authorities. To quote from our earlier blog in 2021 when this issue raised its head the first time around:

"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"

One point of common sense seems to be missing from the proposed Government thinking.  At the point when the buyer (say) of a new flat acquired it, they were presented with a commercial bargain namely to pay a premium for perhaps a 125-year term and to pay a ground rent on top of that for whatever amount might have been acceptable.  In an open market, the tenant will adjust its bid on the premium (downwards) if it considers that the ground rent makes the overall deal unpalatable. Equally, the landlord seller will have worked up its development appraisal to reflect a total outlay and return.  For the return, both the premium and the entitlement to receive ground rent will be components.  With no ground rent, the landlord seller would have asked for a larger premium to sell the flat.  There will be disquiet amongst real estate investors where one part of the consideration paid for a flat is treated as cancelled, perhaps years after the bargain was agreed.  It is therefore odd to see ground rents being treated as a "free extra" benefiting real estate investors when quite the contrary is the case.  There is no mention of any right for the landlord to revisit the original bargain and claim an addition to the purchase price, or to put it another way, to be compensated for what they have lost.

Tell us your opinion

HSF is preparing a response to the consultation and if you would like to have your say, we invite you to share your thoughts with us. Please click the link below to access our abridged version of the consultation questions.

https://forms.office.com/r/rcHbkA7A9A

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