For nearly two years now the once rock–steady ground rent market has been functioning under the shadow of growing political sensitivity and impending reform. For some time, more and more developers have been adding increasingly higher ground rent payments in the leases of new build flats and houses.
Payments have been subject to more frequent review structures, often doubling or linked to inflation. Whilst very attractive to long-term investors, leasehold homes have become more difficult to sell or finance. Add to this, criticism from pressure groups of high service charges, opaque or one-off billing, permission charges and high enfranchisement/lease extension payments and it is no surprise that something has had to give. Although trade in ground rents in and outside the auction room has continued, caution and uncertainty surrounding future legislation has impacted investment values.
Finally, the Government’s stance on ground rents and leasehold reform is becoming clearer. Following two consultation periods (which started in December 2017), a Law Commission review and a House of Commons Select Committee, last month the British Government clarified its position on potential legislative changes with plans to ban future leases on new build houses, a legal clamp down on unjustified costs, provide rights for leaseholders to challenge payments and implement regulation to review charges faced by leaseholders and freeholders. The government has also outlined plans to create a compulsory new homes ombudsman which will include a code of practice in dealing with leaseholds, service charges and mixed tenure estates.
There has been much speculation about whether legislation will be brought in to affect existing leases retrospectively, especially those with ‘onerous ground rents’. It looks as though this will be unlikely. However there are some points to note.
Many lenders now have a ground rent lending policy for individual flats. Nationwide is one of the toughest. They will not lend on a dwelling where the ground rent is more than 0.1% of the value.
About 60 developers, freeholders and managing agents have already signed up to a voluntary code of practice whereby they will offer leaseholders who have an ‘onerous’ review clause a replacement clause linked to inflation.
Despite the impending changes, yields of long dated ground rent investments sold at auction across the UK over the past three years have not been significantly impacted. With the help of the Essential Information Group (EIG), we have analysed yields of ground rents with over 90 years unexpired for the 36 months to June 2019. Average yields in year one (12 months to June 2017) were 4.24%. Although this figure rose to 4.98% over the following 12 months, average yields in year three (to June 2019) fell to 4.29%.
There will be relief amongst investors that rent caps are unlikely to be retrospective. Indeed, we may see the older style investments become the more valuable collectibles of the future if left unaffected by reform.
The future value of reversionary ground rents however has become particularly uncertain. The opportunity to derive capital payments for lease extensions has long been sought after. Indeed, several years ago we saw investors attributing reversionary value to leases having up to 90 years unexpired — despite the statutory formula for calculating enfranchisement prices prescribing 80 years. The language of the House of Commons Report is likely to be of concern to those in this market. There is support for a process that makes enfranchisement ‘substantially cheaper’ and effects ‘a transfer of power from one party to another’ (landlord to tenant). Quite sensibly though, it appears less likely that a new pricing system will be based solely upon a multiple of ground rent.
These reforms are likely to be implemented when the government finds legislative time in parliament. Although the timing is still vague, there is no doubt that this is an area which is seen as a priority. Only when proposed reforms have or have not become law will investment values become established once again. Until then, all eyes will be on auction results.
