About 20 years ago, Dorrington’s Residential MD Trevor Moross, then President of the British Property Federation (BPF), asked me to his office to discuss the cumbersome sales mechanism for ground rents dictated by the Landlord and Tenant Act 1987.
Basically, landlords wishing to dispose had to offer their interests to their lessees first at a fixed price. If they didn’t want to buy then the landlord was free to go to the wider market – but, for 12 months, couldn’t sell for less than the price at which the interest had been offered to the lessees. The problem was this: set too low a price in your notice and the lessees could snap up a below-market bargain; set too high a price and you risk not selling to anyone for a year. One lawyer quoted Macbeth in describing the dilemma: “It is a tale. Told by an idiot, full of sound and fury. Signifying nothing”.
As an auctioneer, I’m a big fan of using free-market competition to set value. So I suggested using the auction room as the means to set the sale figure to lessees. Go to auction and offer the ground rent investment to set the value. If the lessees like the price, give them the right to be substituted for the auction buyer (provided they have complied with various notices and nominated their purchaser before the sale). The BPF liked the idea and it became Schedule 6 of the Housing Act 1996.
So now there are two methods of selling qualifying ground rent investments. Private treaty is the original route under s.5A and the alternative auction method is covered by s.5B of the now amended LTA 1987.
But has it worked?
A few weeks ago I spoke at a conference organised by the Association of Leasehold Enfranchisement Practitioners (ALEP). My subject was How to Value a Section 5. I needed some evidence for my presentation. Value is ultimately the product of buyer sentiment. So I asked our top 50 ground rent investors what influenced their purchasing decisions. If the lessees had nominated a buyer under s.5B, would they bid less? If so, how much less? Or would they not bother at all and turn the page in the auction catalogue in favour of an unencumbered investment?
The responses to my survey were full and frank. 68% of our investors simply wouldn’t bid. The reason most gave was the inconvenience of having to pay and then recover their deposits. Others said that, even if the sale did not go ahead to the lessees, there was an enhanced risk that they would have to sell subsequently to an organised group of tenants under the collective enfranchisement procedure offered to them by s.13 of the Leasehold Reform (Housing and Urban Development) Act 1993. 16% of investors said that their bidding would be unaffected. And 16% said they would buy but only at a price that reflected the risk of having their purchase confiscated. But by how much? How has this thinner competition impacted value?
We sell a lot of ground rents. In fact, we have 27% of the auction market by value in the sector*. So I analysed our results to see how the disclosure of a nominated purchaser affected auction prices.
I looked at a total of 225 ground rent transactions with 80+ years’ income sold under the Allsop hammer over three years. Of these 151 (67%) were sold with no nominated purchaser in the wings. On average, the YP (years’ purchase) multiple for unencumbered investments was 23.4. For affected sales (33%) it was 12.6 – a reduction of 46%. It seems that the smaller investments are more likely to attract a nomination – partly because there are fewer tenants to agree and to organise a purchase – and partly due to the lower value lot sizes being more affordable.
I’ll be advising landlords to consider accepting a reduced deposit for affected disposals. The research shows that many bidders will be encouraged by that. An alternative would be to withdraw from auction in the event of a nomination and to serve s.5A notices on the lessees at a higher YP multiple. But then you may be back to the original 1987 Act issues and locked in for a year if the tenants don’t bite. An auction in that period may have to be subject to a high and uninspiring guide/reserve price.
So it seems that this cloud has a silver lining for some. Investors who pass over the purchaser nominated ground rents should rethink their strategy. These lots are clearly where the buying opportunities lie. True, it’s inconvenient to have your money out for a few months, but you could be creating a chance to buy at a significant discount. And look out for reduced deposits in the special conditions of sale in the future.
Don’t let Macbeth’s ghost scare you away!
* Essential Information Group