By Linda Kirk, director, Adkirk Law
The Leasehold Reform Bill has passed through its final stages in the House of Commons, and having gained Royal Assent, has now become the Leasehold Reform Act. With the intention of addressing spiralling ground rent rates, the act will, in effect, abolish ground rents for some residential leaseholds in the UK. However, there is a major pitfall in what is, in theory, sound legislation - the key here is that the law will only apply to future leasehold houses. Following a slew of CMA investigations, many of the large developers have already stated their intention to put a halt to ground rents on new leasehold properties. So, a daunting question hovers over the Leasehold Reform Act: is it really needed, and will it make any real impact? In short, probably not.
Traditionally, developers have been able to double down on returns through the practice of selling a house as a leasehold instead of a freehold, and then reaping the financial benefits of both the sale of the lease and collecting annual ground rents thereafter. In some cases, developers hang on to the freehold in order to collect ground rents; in others, the freehold is simply sold to help generate additional returns.
Some developers have relied on a formula that rests on a ‘30 x the annual ground rent’ model to calculate the value of a freehold when looking to sell their freehold. As such, it is in their interest to value the ground rent highly, as this will drive up the calculated price of the freehold. As a result, over the years we have seen ground rents doubling as developers saw an opportunity to maximise the value of freeholds. They have largely seen success in this, and in turn, freeholds have become extremely expensive.
However, such a sharp uptick in valuations inevitably invites unwanted attention from regulators, and such was the case with ground rents. Moreover, the larger developers are typically conscientious about their reputations, and compliance with the consumer code is considered equally important. Following investigations from the Competition and Markets Authority, many of them stopped introducing doubling ground rents in the sale of new build leasehold properties altogether, and they all now sell their houses as freehold. This begs the question, why has the government set their sights on future new build properties from developers with the Leasehold Reform Act, and not on the existing leaseholders still facing spiralling ground rents? It would seem the government is missing the chance to address the issue, and it is aiming at the wrong target altogether.
Whilst the government is looking ahead and seeking to put an end to doubling grounds in the near future, they are overlooking the huge portion of the population who are being plagued by spiralling ground rents right now. Over the past few years, there has been a sharp increase in people re-mortgaging their homes in order to afford lease extensions, and lenders have started to refuse mortgages altogether when ground rents exceed £1,000 in London, and only £250 outside of the capital. Whilst further reform may be planned, the slow progress of the Leasehold Reform Act is not encouraging for those hoping to be relieved of doubling ground rents.
I think it is unlikely that the new legislations will do much to slow the property development market; the large players in this space have essentially beaten the government to the chase, and so any necessary adjustments to their leasehold business practices will be minor as the act comes into effect. Nonetheless, the valuations on freeholds could begin to plateau as ground rents become lawfully controlled, and with the cost of materials on the rise, margins could begin to narrow as a result of the act. Ultimately, however, the government has introduced the act in a bid to halt the doubling ground rent party, only to arrive and find the music has stopped and the lights are turned off.