Developing Leasehold Property – Don’t be caught out.
In this article we address some of the problems associated with developing leasehold properties that have been highlighted in the media recently. We also present some innovative solutions that may help developers avoid the wrath of the media, leasehold campaigners and possibly the Government!
Developers of Leasehold Flats & Houses have been in the spotlight recently which has culminated in the Government undertaking a number of industry consultations on the Leasehold Property Sector. One of these consultations is specifically aimed at the exploitative nature that development of Leasehold Property can take.
It’s important to emphasise that the majority of Leasehold Property Development is NOT exploitative and in some cases any exploitation is the innocent reliance on bad advice. For example, we recently had an involvement with a Housing Association who had been advised by their solicitors to include ‘doubling ground rents’ to maximise revenue. Obviously, such a tactic is contrary to the objectives of a Housing Association looking to provide affordable home ownership. Once the Housing Association understood the implications the practice was stopped.
The exploitation being complained of, from a developer’s perspective, is the development of leasehold houses and exorbitant ground rents. Both are considered below.
In our opinion the only valid reason for a house to be sold on a Leasehold basis is where the Freehold cannot be conveyed, for example because the development site itself is leased, or there are planning restrictions preventing the disposal of the Freeholds.
Unfortunately, it seems that some developers have built and sold houses on a leasehold basis to enable the sale of the Freehold to third parties who are happy to receive the ground rent. Some will sell the Freehold onto the Leaseholder, but this can be expensive.
The main culprits of this tactic, or at least those identified in reports, are the national house builders.
Our advice to developers considering selling houses on a freehold basis is simple: don’t unless you must!
While the prospect of selling the Freehold may increase the overall yield of a development, a developer might just find themselves a victim of one of the many critical (putting it nicely) websites ran by leasehold campaigners, or even worse, hauled before a Parliamentary Select Committee.
Exorbitant Ground Rents
There are many arguments against ground rents existing at all. Some call them a hangover from feudal times, or an immoral type of investment class. Those arguments aren’t considered as part of this article. Instead we accept that ground rents exist and will probably continue to.
However, the continued existence of ground rents in no way justifies them being exorbitant to the level that has been seen by the ‘doubling ground rents’.
Doubling ground rents refer to ground rents that consistently double over the course of the Lease usually every 10, 20 or 25 years. Therefore, a ground rent that starts at £250 may well become £1000 in 20 years’ time. This not only affects the amount of money a Leaseholder must pay, but it also affects the marketability of the property in the future.
Defenders of this tactic usually cite freedom of contract principles and ‘buyer beware’ to justify the legitimacy of the tactic. Such an argument is flawed owing to the insufficient and poor advice buyers receive when purchasing a property. Yes, we agree that the whole leasehold sector would be much better served if all property owners understood the technicalities intimately, but to expect this is both unreasonable and unrealistic. Moreover, using this as an excuse to justify unscrupulousness is absurd.
Anyway, back on track.
So, what are the answers to exorbitant ground rent?
In our view the answers are simple. Firstly, and obviously, keep the ground rent reasonable. This is usually the case at the start of a lease to prevent the property becoming difficult to market.
Secondly, avoid large periodic hikes in the ground rent. Increases themselves are not unreasonable, but try to limit increases to negating inflationary effects on the value of the ground rent and Freehold interest.
Thirdly, consider passing the Freehold to the property owners upon completion as discussed below.
Our favourite solution to the problems above is to convey the Freehold to the property owners (by setting up and conveying to a Resident’s Management Company) following completion of the development. Not only does this avoid the problems above, it will make the flats more desirable on the open market.
Giving the Freehold away doesn’t have to be for nothing. It can be for valuable consideration. A developer can recover the value of the Freehold in one of two ways.
Firstly, a contribution of the cost can be a condition of the purchase. Thus, each purchaser pays an amount into a fund which is used to purchase the Freehold upon sale of all the units. There are implications with this solution in that some purchases may already be financially stretched through finding a deposit, costs and a mortgage. Depending on the value of the Freehold and the contribution of each purchase, this is a possibility.
Secondly, the developer can retain the Freehold and receive the ground rent with the commitment to convey the Freehold once a certain amount of ground rent has been received. This gets over the problem of purchasers lacking the funds to contribute a lump sum at the point of purchase. However, it does create the problem that someone must keep track of the ground rent receipts and remember to convey the Freehold at the appropriate time.
A combination of the two solutions is also possible.
How can New Estate Management Help?
We are specialists in Leasehold Property and Block Management. We can provide advice on structuring the Freehold ownership or ground rents to ensure that developers do not risk reputational damage from leasehold campaigners or disgruntled purchasers. Additionally, where we are appointed as managers of a development we are happy to provide our advice and expertise to developers free of charge.
So, if you are developing leasehold property please get in touch.