How will the Government's crackdown on residential leasehold impact developers?

10 minute read
12 January 2018

On 21 December 2017, the Government published an eagerly awaited response to its July 2017 consultation on tackling unfair practices in the residential leasehold market. The key announcements, billed by the Government in a strongly worded press release as a "crackdown" on "abusive" and "feudal" practices, are considered below.

The latest announcement forms part of the Government's commitment, set out in its 2017 white paper, to "fix the broken housing market". Much is still uncertain at this stage; legislation will be needed to implement the majority of the measures, which relate to England only.

No new long leases of houses

This is the flagship announcement and had been widely anticipated. It will apply to existing houses (e.g. those undergoing refurbishment) as well as new-builds. Like many of the Government's proposals, the ban will require legislation in order to be implemented. It is therefore not in force yet. While some developers had already taken the decision to move away from selling leasehold houses, other developers face difficult decisions on existing part-sold sites. We are seeing a mixture of approaches from buyers, with some pushing back against leasehold acquisitions and others still happy to proceed. Where a plot is sold freehold rather than leasehold, some developers might propose a small increase in the sale price to reflect this. Inevitably buyers will start to push back given the Government's stated position.

There will be limited exceptions to the ban. Where houses are built on land which is already leasehold, then sale off on sub-leases may be permitted - but this only applies to land which was subject to a lease as at 21 December 2017. Other "limited" exemptions may be permitted following discussion with the industry. The press release refers to houses with shared services as a possible exception - the Government wants to ensure that any changes made do not have an adverse impact on the long-term sustainability of shared facilities, structures and open spaces. More detail is needed, as many developments could otherwise potentially fall into this category, which presumably cannot be the Government's intention. Shared ownership properties will also be exempt from the ban, along with (potentially) Community Land Trusts.

In the meantime, the Communities Secretary (now the Secretary of State for Housing, Communities and Local Government) has written to developers to "strongly discourage" the use of Help to Buy equity loans for the purchase of leasehold houses in advance of legislation.

Ground rent on new long leases of houses or flats to be limited to a peppercorn

Of equal prominence is the announcement that ground rent in new leases for a term of more than 21 years will have to be set at "zero financial value" (traditionally a peppercorn or equivalent). Again, this will require legislation in order to be implemented.

Part 1 of the CML Handbook contains no objection to a periodic increase of ground rent "provided that the amount of the increased ground rent is fixed or can be readily established and is reasonable". However, residential lenders had already started to alter their approach to ground rents on new-build properties. While the Handbook currently remains unchanged, it is possible that we may start to see individual lenders adopting the Government's stated position, even in advance of legislation.

The consultation response states that "Government will also work with UK Finance to address misunderstanding of lending criteria with regards to leasehold properties."

It is clear that the effective abolition of ground rent on new properties will significantly impact on the value of reversions, and so on the business model currently adopted by a number of housing developers. Whether this will result in an increased sales price for new plots remains to be seen, although the Government has acknowledged it as a possibility.

As with leasehold houses, developers on part-sold sites are faced with whether to take the plunge and remove the ground rent on unsold plots now, or whether to wait to see how things play out during the course of the year. There is no easy answer (there is no indication that there will be any transitional provisions for existing sites), although the Government's stated intention to also tackle onerous ground rent terms in existing leases (see below) may have a bearing on the decision. Where developers decide to continue imposing ground rent in new leases pending legislation, it would be sensible to future-proof those provisions as far as possible.

Support for those currently suffering from onerous ground rent terms

The proposed ban on ground rents does not apply to leases which have already been granted. However, the Secretary of State will write to developers to ask those who have customers with onerous ground rent terms to provide "necessary redress". The Government is also to work with redress schemes and Trading Standards to provide tenants with information on routes to redress open to them, including, in appropriate circumstances, a claim for mis-selling, or a possible negligence claim against the conveyancer who acted for them on the purchase.

Many developers have already been proactive in seeking to replace onerous rents, such as those which double periodically, with those based on (for example) an RPI increase. The Government has recognised that a number of developers have introduced schemes to compensate individuals, but has said that these must "go further and faster", with existing tenants (including second hand buyers) being proactively contacted. It is unclear how the Government will proceed in relation to existing leases and it is very much a case of watch this space.

Housing developers with a ground rent portfolio, ground rent investors, and their lenders, will all need to consider what strategy to pursue - not an easy task when the goalposts may shift. Doing nothing, however, would not appear to be an option.

Making it easier to extend a residential lease or acquire the freehold reversion

According to the press release, there were 4.2 million leasehold dwellings in the private sector across England in 2015-16 (of which 1.4 million were leasehold houses). The Government is to work with the Law Commission (an independent body tasked with law reform) to consider how the process for tenants to buy their freehold could be made easier, faster and cheaper, with particular priority being given to tenants of houses. A consultation will be issued on the introduction of a prescribed formula "that provides fair compensation to the landlord, whilst also helping leaseholders avoid incurring additional court costs". The consultation response states that the Government will "work with UK Finance to encourage lenders to assist consumers wanting to purchase their freehold".

The Government will consider introducing a right of first refusal for tenants of houses on the disposal of the freehold (currently such a right is only available to tenants of flats).

The Government will also consult on proposals to enable tenants to exercise their existing right to extend their lease "on more favourable terms". In particular, it notes that some tenants may become subject to very high "modern ground rents" when extending their lease. The Government also wants to introduce a minimum lease term for new long leases of flats, designed to give the leaseholder greater security, and protect them from incurring costs on a lease extension.

There is, in this part of the response paper, some indication of timing - the Government aims to bring forward solutions by the summer recess - but legislation will be "when Parliamentary time allows".

Giving residential freeholders equivalent service charge rights to leaseholders

Residential tenants currently have certain statutory protections in relation to service charges, including a right to challenge the reasonableness of the charge. The government proposes to extend these protections to freeholders who pay a service charge for the maintenance of communal areas and facilities on a private or mixed use estate.

Other things included in the announcement

The 32 page response to the consultation paper includes a number of other proposed measures, including:

  • Protecting long leaseholders with ground rents against the risk of a mandatory possession order in the event that they fall into arrears with the rent. This is due to a legal loophole whereby a lease becomes an assured tenancy (more commonly used in short term lettings) if ground rent exceeds £250 per year outside London or £1,000 in London.
  • Preventing a rentcharge owner from exercising its right to take possession of the property, in circumstances where the rent under the rentcharge is unpaid by the property owner for a short period of time. Estate rentcharges are used in some developments where plots are sold freehold, in order to ensure that provisions relating to the maintenance and upkeep of communal areas on the estate can be enforced.
  • Proposals to reinvigorate commonhold. Commonhold is a method of setting up ownership of units on an estate that does not rely on the use of leasehold. Each unit owner owns their unit freehold, and also owns a share in a management company which owns the common parts. Legislation facilitating the use of commonhold has been on the statute books since 2002, but it has never taken off. The Government believes that one of the reasons for this is the financial incentives for developers in building leasehold, but it also acknowledges that access to finance and consumer awareness have both played a part. The Government will work with the Law Commission to re-visit commonhold, looking at both what reforms might be needed to the law, and also how Government can support commonhold to get off the ground. Buy-in from lenders will be a critical part of this process.

Next steps

There is, as yet, no indication of when the necessary legislation will be brought forward (the response simply stating that it will be "as soon as Parliamentary time allows"). However, given the recent re-naming of the former Department for Communities and Local Government, the Government has left us in no doubt that housing is front and centre of its policy objectives. The message has been received loud and clear; the devil will be in the detail.

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