The King's Speech last month laid out a number of changes to leasehold property which the government says will "make long-term changes to improve home ownership for millions of leaseholders in England and Wales".
The changes have manifested in two ways: the Leasehold and Freehold Reform Bill
(Bill), which was introduced to Parliament on 27
November, and the Consultation on restricting ground rent for
existing leases (Consultation).
We are tracking the Bill through Parliament and will provide
commentary on the amended/final form in due course.
What is being consulted on?
The Consultation runs until 21 December 2023 and seeks views on five potential options (Options) for retrospectively restricting ground rents in existing leases (being leases granted before 30 June 2022 or before 1 April 2023 for leases of retirement homes). The Options are:
1. Capping at a peppercorn - This would remove the obligation to pay a financial ground rent from a given date.
2. Capping at an absolute maximum value - This would mean that there would be an upper financial value above which ground rents could not rise.
3. Capping at a percentage of the property value - This would be a proportion of the market value of the property, with the Consultation referencing 0.1% as an example.
4. Capping at the original amount of ground rent when the lease was granted - This would provide for ground rents to revert to, or remain at, the initial level provided for in a lease.
5. Freezing at current levels - This would provide for ground rents to remain at the value provided for in the lease at the date that such a measure was implemented.
The Consultation goes on to seek views around uprating of the caps (similar to a rent review) and specifically indicates Options 2 and 3 as potentially being subject to uprating.
Interaction between the Consultation and the Bill
Many of the proposals in the Bill would indicate an acceptance
by the government that the aims of the Consultation, i.e.
restricting the amount of ground rent payable in existing leases,
may not be possible. Certainly, there is an expectation in the Bill
that a premium would still be payable to a freeholder on a lease
extension. This would indicate that Option 1 in the Consultation
(capping existing rents at a peppercorn) is unlikely to
materialise. Much of the drafting of the Bill would be unnecessary
if all ground rents were to become a peppercorn.
Equally, the drafting of the Bill may be an acknowledgement of the
challenges that the government could face from freeholders if a
retrospective ban or cap on existing ground rents was forthcoming.
There are many arguments that could be raised by freeholders around
wealth transfers, the re-writing of the principle of 'freedom
of contract' and potential breaches of Protocol 1, Article 1 of
the European Convention on Human Rights (every natural or legal
person is entitled to the peaceful enjoyment of his possessions),
which applies to the UK in the form of the Human Rights Act
1998.
Are there unintended consequences of capping ground rents
Whether or not the government will be able to proceed with a restriction of existing ground rents remains to be seen and will no doubt be the centre of much challenge and debate throughout the Consultation process. That being said, if a retrospective restriction on ground rents were to be introduced, might there be unintended consequences for long leaseholders, as well as for investors and mortgage lenders?
1. One of the overarching aims of the Consultation is to remove the so-called 'two tier' system of ground rents. By virtue of the Leasehold Reform (Ground Rent) Act 2022, all leases granted on or after 30 June 2022 (1 April 2023 for leases of retirement homes) must have a yearly ground rent of a peppercorn. That legislation does not though extend to existing leases, under which ground rents continue to be payable. Whilst a 'two-tier' system is a generic/simplistic view of the market, many view it as being unfair to leaseholders of existing 'ground rent leases' when compared to leaseholders of new 'peppercorn leases'. Either way, the only Option that would eradicate the two-tier system is Option 1 (the peppercorn cap).
As mentioned, the drafting of the Bill and the likely challenges from freeholders would indicate that Option 1 is unlikely to be forthcoming. On that basis, if any of the other Options were to be introduced, it would still give rise to a two-tier system.
2. All Options essentially operate as a ground rent cap. Freeholders own ground rent properties as investments and many are supported or funded by financial institutions. A cap on ground rents would have a direct impact on the value of the freehold and could materially adversely affect the solvency of the freehold owner, potentially leading to a formal insolvency process (administration, liquidation etc). If, for example, rents were capped at a peppercorn, the freehold would no longer have a material value. A formal insolvency process would ultimately lead to the freehold being disclaimed by a liquidator, meaning it would pass to the Crown through the usual bona vacantia and escheat processes. Such a scenario is likely to make leases in apartment blocks inadequate for security purposes. That in essence means that, whilst on the one hand a long leaseholder may no longer have to pay a ground rent, their lease could end up being unsaleable or unmortgageable; perhaps indefinitely but at least for a material period of time (and cost) until the issue is resolved.
3. Many developers have obtained long leaseholds of development sites from landowners. These are commonly on the basis of a lower premium in exchange for a ground rent on the entire development site. Developers then protect the leasehold structure by creating individual apartment leases with ground rents that cumulatively equated to the headlease ground rent. If apartment ground rents are reduced or capped, there would be insufficient rent available to pay the headlease ground rent. That would ultimately result in the headlease being forfeited for non-payment of rent and, as will any form of forfeiture, all of the apartment leases would be automatically terminated with it. Therefore, in exchange for not having to pay a ground rent, a long leaseholder is at risk of potentially losing their lease. Again, whilst there may be relief available for long leaseholders, the forfeiture would have an immediate impact on them (there would be no lease to sell or mortgage) and it would take material period of time (and cost) to resolve.
4. Not all leases are set up with a management company in place. Many leases place insurance and/or management responsibility with the landlord. Long leaseholders already have the option of the Right to Manage process, yet it is not universally utilised. This might be because, for those blocks where management and/or insurance remains with the landlord, there has to date been little desire for those leaseholders to take on management themselves. Many blocks are well managed by professional landlords and not every leaseholder wants to have the responsibility of being a director or shareholder in a leaseholder management company or to have the responsibility of running a management company. Removing or capping ground rents could essentially force long leaseholders into a Right to Manage process and have to run their own management companies even if they didn't want to be in that position; there would be nobody else to do it. At present, long leaseholders can choose to manage their own building but, importantly, they can choose not to do so. A meaningful ground rent cap could change this. This might have its own potential unintended consequences, such as:
a) an inability to cashflow insurance policies, potentially leaving buildings uninsured;
b) failing to make proper filings at Companies House resulting in management companies being struck off; and
c) the insolvency of the RTM, leaving no formal management or service charge function in place,
the result of which can lead to the apartments becoming unmortgageable and other protracted and costly processes needed to remedy the issue.
5. For many professional landlords the ground rent is the incentive to provide other services, such as lease information packs, confirmation of compliance with lease covenants and the issuing consents and of land registry compliance certificates. Sales processes can be delayed or even frustrated entirely where the landlord is absent or unresponsive. This is likely to become more frequent if there is no financial benefit in the Landlord being engaged. Some lenders confirm in the UK Finance handbook guidance that they will proceed with an absent/unresponsive landlord transaction only if adequate indemnity insurance can be obtained. Others will not proceed. Even if a lender will proceed, indemnity insurance comes at a cost that would need to be paid for by the leaseholder.
The above list is not exhaustive but it serves to demonstrate unintended difficulties and consequences that might arise for long leaseholders and others if a retrospective ground rent restriction is introduced. Whether or not such a restriction can be introduced remains to be seen, but the implications of doing so will be far wider-reaching than a simple financial benefit for leaseholders.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
