Leasehold Reform

Residential property ownership is typically held on a freehold or leasehold basis. Freehold ownership cannot be applied to flats, as leasehold is the only way that properties in multi-occupancy buildings can be sub-divided, because freehold property law requires a separate land boundary which can be identified on a location map.

If leases expire, properties revert to the superior landlord. Initially enfranchisement rights (being a form of compulsory purchase) were granted to leaseholders of houses to acquire their freeholds in 1967. This was expanded to include leaseholders of flats in 1993, which was amended in 2002 to include Commonhold as a different form of ownership. However, it was not popular, and it is understood there are less than 20 registered Commonholds in England and Wales.

The reason further reform is being considered now can be firmly placed on the doorstep of the ground rent scandal, that dates back to the early 2000’s, when some developers started including doubling ground rents in leases, with reviews every say 10 years. For example, an initial ground rent of £250 per annum reviewed every 10 years exceeds £1,000,000 per annum 120 years after the grant of the lease.

After this practice fully came to light, in 2017 there was a Government white paper and a consultation on reforming the leasehold sector. Since then there has been a myriad of reviews, further consultations, Law Commission reports, and publications. After nearly seven years, the Government has now published the long awaited Leasehold and Freehold Reform Bill, as well as a new consultation on ground rents that is ongoing.

In 2020 the Law Commission published various reports that amounted to a total of 2,276 pages covering leasehold enfranchisement, Right to Manage and Commonhold. For leaseholders, the proposals in this draft Bill will be welcome, as who would not want to pay less to acquire a lease extension or their freehold. From the Freeholder’s perspective, the proposals go a lot further than might have been anticipated.  Although the proposals in the draft Bill were covered by the Law Commission reports, there are property owners’ rights to consider.

The terms of reference given by the Government to the Law Commission, when asked to provide advice on making the enfranchisement process easier, quicker and cheaper, included “examine the options to reduce the premium (price) payable by existing and future leaseholders to enfranchise, whilst ensuring sufficient compensation is paid to landlords to reflect their legitimate property interests.” This was to ensure the legislation is compatible with the Human Rights law known as A1P1 (Article 1 Protocol 1, the protection of property), as a reduction in premiums which is not compatible with human rights law would be liable to be struck down. This applies to individuals and companies alike.

For this, an opinion was obtained from a Barrister who reported the findings below to the Law Commission. The ones referenced here are done so as they are included in the draft Bill, with others not repeated here as they are not relevant, although the final detail of the Bill is to be decided.

1. Some of the valuation variables for calculating the premium payable maybe set by the Government. Prescription of the variables at the market rate is likely to be compatible with A1P1, with the risk of a successful A1P1 challenge to this aspect of the scheme being Medium Low to Low. The further away from a market rate that is prescribed, the higher the risk of a finding that the scheme does not strike a fair balance and imposes a disproportionate burden on landlords.
2. The proposal to cap the ground rent at 0.1% of the property’s value represents a fair balance between the landlord’s contractual entitlement to receive some income and the rights of leaseholders and is likely to be compatible with A1P1. The risk of a successful challenge to such a cap is likely to be Medium Low.  This would become a Medium High risk if the price originally paid for the leasehold property reflected the rent payable. This element may be affected by the outcome of the ongoing ground rent consultation, which goes further by proposing no compensation is payable to freeholders for altering the ground rents they receive, which has not been proposed before.
3. The proposal to abolish Marriage Value (which is only applicable for leases with less than 80 years unexpired and can be a significant element when calculating the premium payable) produces the greatest reduction in premiums for leaseholders, with the risk of challenge being slightly less than a 50% chance.

For now, there is no mention of reinvigorating commonhold as an alternative ownership structure, which is expected to be reformed at some point.

If the removal of marriage value alone accounts for almost a 50% chance of breaching Human Rights legislation, when the reduction of ground rent and prescription of rates is layered on, gives the freeholders a much greater chance of proving their Human Rights have been breached. From this they would have grounds to successfully challenge the legislation.

Although many will take the view that freeholders can afford to suffer a loss in income and for their assets to be devalued, it is not only large corporations that will be hit financially, but also individual investors, pension funds, and those leaseholders who have participated in collective enfranchisement (freehold) claims on blocks of flats, by acquiring superior interests over non participating flats, without which they could not have acquired their own building.

The effect of this legislation is a one-off transfer of wealth from freeholders to leaseholders, which will cause short leases to be sold at higher prices. For those people looking to acquire a cheaper short lease in a particular neighbourhood they otherwise would not buy in, this will remove choice from the market.

The overriding theme in the press at the moment is the exploitation of leaseholders by unscrupulous freeholders. The reality of course is that there are good and bad freeholders and leaseholders alike. As we have seen with the Renters (Reform) Bill, the continued delays to bring in proposals to reform the rental sector, making it less profitable to rent out properties, have caused various landlords to exit the market and for increases in market rents being payable, resulting in a worse situation for those trying to rent a home.

The property market, like any market, does not respond well to uncertainty. No doubt we will see the same with the enfranchisement sector. With these proposed reforms looming, leaseholders will be left trying to work out if they should be extending or buy their freeholds now, or if they should wait for the reforms to become law. A decision may need to be made without knowing what the final version of the reforms will be, particularly in light of the risk of legal challenge by freeholders. The government has indicated they want to bring this in before the next election, which is expected to take place next year. It remains to be seen what the timing is on delivery and what amendments make it into law.