Ground rents have long been considered one of the lowest risk – and perhaps the dullest – long term investments in the property sector. Despite the vanilla, cries for reform regularly move them firmly into the property spotlight. Last month the Government outlined proposals for “the biggest reforms to English property law for 40 years”. The sector awaits its fate, but will this be any time soon?
Although historically low income producing per unit, ground rent payments are secured upon individual homes with the ultimate, but rarely invoked sanction of forfeiture of lease for non-payment. Additional capital payments over time add to the attraction. As lease terms diminish, extensions are granted at premiums. Freeholders’ permissions for lease variations are dispensed in return for payments. Commissions are earned for insurance and management. And, one hopes, latent development value is released from say rooftops, garage blocks or porters’ flats.
The scale of ground rent collection ranges from a handful of units by small investors to multi-million pound portfolios by property companies, pension funds and landed estates. Despite challenges presented over the years by, for example, lessees’ rights of pre-emption on sale (Landlord and Tenant Act 1987), collective enfranchisement (Leasehold Reform Housing and Urban Development Act 1993) and the right of lessees to manage their own buildings (Commonhold and Leasehold Reform Act 2002), the trade and value of ground rents – and the vehicles that own them – have largely been unaffected.
Over recent years, to maximise the value of their residual freehold interests, developers have granted leases on new build homes which impose hefty payment obligations. These will often start from a higher base level, be subject to more frequent reviews (every ten years being common) and often double at every interval. Lenders have recognised the impact on affordability over time and UK Finance (formerly the Council of Mortgage Lenders) has advised against accepting such leases as mortgage security. As a result, many leaseholders have found that their properties are unsaleable. Much lobbying forced government to announce its intention several years ago to introduce reforms, although these proposals were not detailed at the time.
Indeed, leaseholders have had a fair amount of problems to contend with lately, not least flammable cladding, excessive service charges and management issues. Abolishing aggressive ground rent structures in the future is a good thing, although such measures were never likely to be retrospective. A lease extension at a revised rent has always been the only way out. But the methodology of calculating the enfranchisement price has historically been confusing to the consumer (and some practitioners) and seen as something of a dark art. Simplification is welcome.
Despite this promise of reform, the market for ground rent investments has continued pretty much as before, with little or no perceptible change in pricing. In 2020 the average years’ purchase (YP) multiplier (price to income) for long dated (over 80 years) ground rent investments sold at auction in the UK was 21.4 – an average yield of 4.7%. This breaks down to 26YP (3.85%) for sales within the M25 and 19.4YP (5.1%) for sales elsewhere.*
On 7 January this year the shape of this intended reform was brought further into focus. The Government issued a statement announcing that, in order to make home ownership fairer and more secure, leaseholders will be given the right to extend their lease by a maximum of 990 years at zero ground rent. An online calculator will be introduced to make it simpler for the 4.5 million leaseholders in this country to find out how much it will cost them to buy their freehold or extend their lease. ‘Marriage value’ – presently shared equally between freeholders and lessees on the extension of leases of flats and some houses with less than 80 years to run – will be abolished. A zero ground rent restriction will also apply to retirement leasehold properties. That was it. Not much more to go on.
Freeholders, particularly the London estates, institutions, property companies and others with wide exposure to the sector, will want to make their case strongly. They are likely to accept that a pendulum swing in favour of leaseholders is inevitable but will oppose an outright value grab. Pension funds will point out that many savers invested in ground rent funds – many of whom are leaseholders themselves – will suffer losses unless fair compensation is awarded for the diminution in the value of their investments.
Some lessees will wait until reforms are finalised before extending. Others will not have the option and will pay the statutory price now, or at least reach agreement with their landlords.
If lease extensions become cheaper, then logically the value of short leasehold interests will rise. Impaired mortgageability will remain a barrier to sale though.
So how do owners and practitioners value ground rents today? It won’t be easy. Allsop sells almost half of all London ground rents traded at auction and accurate pricing has always been key. Until the online calculator is unveiled, the market will decide. If auctioneers can persuade sellers to set reserves low enough to reflect the uncertainty, results will establish values over time.
Since January’s announcement, the market remains active. We have however experienced different emerging approaches to bidding. Some prefer to limit bid prices to multiples of ground rent income and ignore marriage value for now. Others are betting against the abolition of marriage value and are prepared to reflect that additional element in their bids.
Before freeholders panic, and new investors smell blood, we have to remember that reforms in this area have been on the cards since 2017. Recent announcements have amounted to little more than a press release. Whilst effective in courting headlines, they have changed nothing for the immediate future. A change in legislation is required before lease extensions become ‘easier and cheaper’, and that could take years. In the meantime, freeholders are likely to hold firm leaving leaseholders to face a choice – pay the going rate or sit this out. The outcome and duration of this process are a long way from clear.
For an in-depth look at what happened in the residential auction market in 2020, property, vendor and yield analysis, as well as an outlook for 2021, read our Residential Auction Annual Review.