Uncapped Ground Rents on homes – the latest trend will need to be capped itself

June 1, 2017

Categories Landlord and TenantReal Estate

For centuries, leaseholds have been sold at a premium (i.e. a full purchase price) subject to a fixed nominal annual ground rent often expressed as “a peppercorn” or ‘£1’ or similar.

About 20% of all private homes in England have long leasehold interests.  Flats or houses can be acquired on long leases.  Over the last 10 years or so, house building developers have created more and more leasehold housing estates.  There is no legal necessity for houses (unlike flats) to be leaseholds as there are successful alternative arrangements for managing the estates of houses. In any event then is no legal reason for any leaseholds to be subject to anything other than the traditional nominal ground rent.

The reason for such an increasing trend for developers to have high or increasing ground rents has nothing to do with the law, but is driven by the developer’s desire to create another source of income.  What is happening is that in long leases of flats and houses, the ground rent is no longer fixed at “a peppercorn” each year for the duration of the term of the lease, but an amount which increases quite considerably over the period of the lease. We are seeing ground rents in long leases of flats or houses which double, say, every 5 years and thereby create an investment asset for the landlord or developer.

The knock-on effect on leaseholders of houses or flats is that when they have sought to extend their leases say 20 years into the term of the lease (which is permitted by legislation), the actual cost of doing so has been prohibitively high because the value of the asset they are buying at that stage has increased as a consequence of the valuable ground rents.

As a consequence, the value of the leasehold property interest they then currently hold (i.e. without the extension) falls and in addition it may not be possible to get a mortgage for the leasehold property interest (as lenders look for a minimum number of years left to run on a lease – it varies from lender to lender as to the exact length they require).

Members of parliament have commented openly on the issue and their opposition to this use of ground rents as another income source.  Also, increasing ground rents have been the subject of media and industry criticism.

The outcry over uncapped ground rents has caused one large developer to apologise to its leaseholders and acknowledge that it will try to rectify the situation.  This is not surprising given that some lenders have added their voices expressing concern.

Nationwide Building Society and fairer lending conditions

Nationwide Building Society has gone further than expressing its distaste. With effect from 11 May 2017, Nationwide has taken steps to protect its mortgage members from escalating ground rents with a new valuation policy for new build leasehold properties.  It is the first major lender to impose fairer lending conditions on these homes.

The maximum acceptable starting ground rent on all new build leasehold properties will be limited to 0.1% of the property’s values.  The ground rent must be reasonable at all times during the lease term, with unreasonable multipliers which double the rent every so many years not being allowed.  Escalation can be linked to a verified index such as the Retail Prices Index but no multipliers.

If the valuer believes that the marketability of the property would be severely affected by unreasonable lease terms, Nationwide may decline the property, or reflect those terms in the valuation figure they provide to the lender. Other banks and building societies will no doubt follow suit.

It is therefore incumbent on developers to avoid uncapped ground rents and advisable for potential purchasers of new build leasehold properties to be fully aware of this issue.

For legal advice about commercial property contact Liz Brady on 01227 763939.