In his speech on 7 November 2023 the King stated:
"My ministers will bring forward a bill to reform the housing market by making it cheaper and easier for leaseholders to purchase their freehold and tackling the exploitation of millions of homeowners through punitive service charges."
One way the new bill will do this is to tackle the issue of ground rents in long residential leases.
This is not news. The Government has been talking about tackling "onerous ground rents" since at least 2016. The difficulty has been in defining an onerous rent. This issue was neatly sidestepped in the Leasehold Reform (Ground Rent) Act 2022 which, since June 2022, has limited all ground rents in most new long residential leases to a peppercorn (i.e. £0). However, the issue of ground rents in existing leases remains.
Once a token sum paid annually to the landlord, over recent decades, developers have often factored higher and escalating ground rents into the financial viability of developments. This relatively low-level but reliable income stream has created an attractive asset class for institutional investors such as pension schemes. Despite having taken legal advice before entering into or purchasing a lease, some tenants only become aware of the consequences of rent review provisions when they have difficulty in selling or remortgaging the property.
There is still no agreement about what constitutes an onerous ground rent. However, ground rents which double more frequently than every 20 years are generally considered onerous as are any other rent terms which seem disproportionate to the value of the property and / or affect the tenant's ability to sell.
The Government has opened a consultation "Modern Leasehold: restricting ground rent for existing leases" to consider how to deal with the issue of existing ground rents. Its initial concern to protect tenants from onerous ground rents has extended to include a desire to provide transparency for leaseholders; asking the question "what return or value do they receive for the ground rent?"
Owning a freehold and managing a residential block is not without risk. It requires adherence to a raft of statutory provisions, breach of which can, in many cases, result in criminal prosecution. Rather than asking what the tenant is receiving in return for paying the ground rent, the question should perhaps be "what is the landlord receiving in return for taking on this liability?"
In any event, the current consultation seeks to understand which approach to capping rent is the right one to achieve the aim of giving leaseholders a fairer deal:
- Reduce it to a peppercorn
- Cap it at a maximum value
- Cap it at a percentage of property value
- Cap it at the original ground rent charged under the lease
- Freeze it at current rates
- Other,
and whether there should be any provision for review.
Given the choices proposed in the consultation, it appears that the Government has changed tack from targeting onerous ground rents and instead seems to be suggesting that all ground rents should be treated in the same way. Although easier than trying to define an onerous rent, it is hard to imagine the massive impact that this approach is likely to have on the market.
Applying legislation to ground rents retrospectively will have the effect of re-writing the contract made between the landlord and the tenant on the grant of the lease. What message would this send about the English legal system? How might this influence decisions toward inward investment?
The Government has stated that:
"Regardless of the option taken forward we would not expect to compensate freeholder for lost revenue, nor do we expect freeholders would be able to capitalise this lost income stream through other means."
It argues that restricting rent agreed under a lease is a form of rent control rather than depriving the landlord of proprietary rights and that so long as the restriction is lawful, in the general interest and proportionate it can be justified on human rights grounds. There appear to be several institutional investors who are keen to challenge this view.
Although taking action such as reducing all ground rents to a peppercorn may sound like good news for tenants, we know from our institutional investor clients that asset values have already been impacted in anticipation of impending changes. The management of large ground rent portfolios requires efficient management of blocks, promoting economies of scale and professional management standards. If institutional investors are forced to leave the market, will tenants suffer higher costs and worse management standards? What will be the impact on investment returns?
With various political crises unfolding, the Government must see this as a vote winner. Even if measures are not put in place before the general election, whichever party wins is likely to seek to continue with this programme of reform. This could be a case of jam today …. but not tomorrow for tenants.
The consultation closes on 17 January 2024. You will find the consultation here. We encourage you to respond.