Ground Rents – the Calm Before the Storm.
Looking at the future of ground rents
by Duncan Greenwood, Partner DAC Beachcroft
The topic of ground rents has had a huge amount of attention over the last 12 months, culminating in the government’s consultation paper on leasehold reform launched in July 2017. Reports of block notifications abound across the property professional sector, but are these likely to produce large scale exposures for professionals and their PI (professional indemnity) insurers?
The issue
Historically, ground rents in long leasehold titles were fixed at extremely modest levels, ranging between peppercorn (£1) and £50 per annum. Often, these were not even collected by freeholders due to their low values.
During the last decade, however, new types of ground rent clause began to appear in long leasehold titles of new build residential properties. Not only were higher starting figures introduced (often between £250 and £500 per annum), but they also became the subject of review every 10 or 25 years.
Many of these clauses doubled the ground rent on each review, resulting in shocking growth throughout the overall term of the lease, which is frequently between 125 and 999 years.
As an example, take a £250,000 house purchase with an initial ground rent of £500 per annum and a ‘doubling’ review cycle every 10 years over the 125-year term. What appears to be relatively modest ground rent liability at the outset will soon become significant. By the 50th anniversary, the annual ground rent liability will be £16,000 and by the 100th anniversary an eye-watering £512,000.
The realisation
So, why has this become an issue now, given that initially it appeared that it will take a number of years before the ground rents begin to spiral?
Following the leasehold reform legislation was announced, the right to acquire the freehold interest and/or seek to extend the term of the original lease comes after two years’ ownership. This right was often used as a selling point to those considering leasehold purchase, particularly where houses (rather than flats and apartments) were involved. The media frequently reports that about house purchasers are told they could acquire the freehold for a relatively modest price of around £3,000 to £4,000 after this two-year qualifying period.
However, when the qualifying period ended, homeowners wanting to exercise this right discovered that the cost could be very different to that initially suggested. Media reports started to surface with anecdotal stories of homeowners being quoted figures of anywhere between £25,000 and £75,000 – a far cry from the pre-purchase indications.
Why is this? Although the basis of assessment under the legislation is far from simple, the process considers the investment value of the right to receive ground rent over the term. Rapid ground rent growth significantly increases that investment value while diminishing the leasehold value in equal measure.
The consequences
As news of this problem spread, the lending industry became extremely cautious about accepting leasehold titles of this type as security, due to the obvious dangers posed to a property’s value over the term of the mortgage. This, in turn, caused numbers of ‘subject to contract’ sales to fail, leaving many people with unsaleable properties.
By May 2017, Nationwide Building Society changed its policy to deem all leasehold titles unacceptable, unless the ground rent throughout the term of the lease was reasonable. The bank specified a maximum not exceeding 0.1% of the property’s value. Many other lenders have followed Nationwide’s lead.
A further complication is a rather unintended one. The Housing Act 1988 says that long leases over 21 years, where annual ground rents exceed £1k in London and £250 elsewhere, are assured tenancies. This applies to a very large number of instances. As currently provided for in the Act, rent arrears (including ground rent) provide a mandatory ground for possession.
Political reaction
On 21 July 2017, the government issued Consultation Paper Tackling unfair practices in the leasehold market. The eight-week period for stakeholder response has now closed and the results are under consideration.
The paper noted that there were four million leasehold properties in England in 2014-15 and, of these, 1.2 million were leasehold houses. In 2016, around 10,000 new build leasehold houses were sold, out of around 57,000 sales of leasehold houses in England.
Serious consideration is likely to be given to outlawing the creation of new build leasehold houses and limiting the level of starting ground rents and future escalations on all new residential leases. If this happens it will close the door on future problems but won’t help the many homeowners who currently find themselves with rapidly escalating ground rent clauses.
Even the government seems to accept that retrospective action will be difficult; although one question in the consultation papers did invite responses to “How could the government support existing leaseholders with onerous ground rents?”. In reality, an industry solution appears more likely but even this will not be easy.
The difficulties arise because the management of freehold reversionary interests is not seen as a core part of a house builders’ business. This has led to the interests being typically sold to third party investors who specialise in releasing the value in the ground rents.
In light of the escalating ground rents and their impact on the value of the freehold reversion, this has become big business. The Secretariat of the All Party Parliamentary Group for leasehold reform estimated in late 2016 that UK house builders were generating between £300-£500 million a year from these sales.
Industry response
The consultation paper singled out one major house builder for creating a fund to support its customers, noting that “parts of the industry are taking action to support leaseholders with onerous extant ground rents. In April 2017 Taylor Wimpey announced it would set aside £130 million for a Ground Rent Review Assistance Scheme for its customers facing doubling ground rent terms. We welcome this and are keen for others to follow suit“.
Media reports suggest that this scheme, while most welcome, is limited to those customers who remain the owners i.e. those who bought a new build property and have not since sold it on. It is envisaged these people will be compensated through the voluntary scheme. It is understood that most third-party freeholder reversion investors have been brought on board and will permit rectification. It does not, however, appear to assist those who have bought ‘second hand’.
In August 2017, another major house builder announced that it would buy back a large number of freehold reversions from one third party investor in order to rectify the ground rent provisions and limit future escalation to reasonable levels. The levels are likely to be RPI/inflation linked. Similar steps have been announced by at least one third party investor. What the other major players decide to do remains to be seen.
Professional targets
Unsurprisingly, claims firms have started to advertise heavily as they look to sign up home owners who own property on leases with escalating ground rent clauses. The clear aim is to bring claims against the professionals who advised them at the time of purchase. It is also possible, in any case of mortgage default, that lenders will seek to claim if the realisation of their security is affected by the nature of the ground rent clause in the lease.
Solicitors will inevitably be first in the firing line, but lawyers are not themselves valuers. While a failure to mention a rapidly escalating ground rent clause will be a difficult position to defend, mere mention of its terms without advice as to its potential implications (from both a leasehold reform perspective and a future security/investment standpoint) is a different matter.
What about mortgage valuation and homebuyer surveyors? Often, the lease itself is not made available to the surveyor and reports reference this, aside from reference to the term of years left to run, with “it is assumed it contains no onerous conditions”.
A ground rent clause which doubles every 10, 15 or even 20 years may well be regarded as ‘onerous’, but the question is whether the surveying profession will be able to hide behind the assumption. The awareness of those actively engaged in the valuation of new and recently new properties with regard to the widespread use by house builders of escalating ground rent clauses over the last decade or so will affect what happens next.
Estate agents should also be aware of the issue. They must ensure that, when dealing with the marketing of an estate house built since the new millennium, the ground rent clause is checked to determine whether or not it is reasonable or not. The Consumer Protection from Unfair Trading Regulations 2008, which replaced the Property Misdescriptions Act, outlaws not only misleading and untruthful statements but, more significantly, ‘material omissions’. These refer to omitting to mention a known negative, that would likely influence a purchaser’s decision-making process.
Limitation may be a factor and will need to be considered in all cases where the lease purchase occurred more than six years ago. However, the latent damage provisions may be deployed to resist any argument that a claim is time barred, dependent on the circumstances.
What next?
Only time will tell whether what is perceived by many as a ‘housing scandal’ will prove to be a major headache for property professionals and their PI insurers. Claims seem inevitable and clear strategies for dealing with what will be a fast-moving landscape are essential.
The first port of call should be an invitation to the freeholder to rectify the clause to one which is acceptable to both homeowner and lender (if any) alike. After that, it remains to be seen what the government can achieve retrospectively, whether through legislation or industry liaison.
It is clear, that those who were forced to abort sales will probably bring consequential loss claims. If a decision was taken to sell at a discount, these could result in losses in excess of simple wasted costs.
Ultimately the real ‘cost’ may be the time spent administering large numbers of notifications and potential claims which, individually, are of limited real value. A very different picture could emerge if the industry resists government pressure and fails to follow the lead set by the few to date.