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Leasehold Reform – the potential impact on landlords, developers and investors

On 21 July 2020, the Law Commission published its latest proposals to reform the law of leasehold. It was asked to make recommendations to improve the process of extending a lease or acquiring the freehold of residential buildings, making it simpler and cheaper for leaseholders and each of 102 reforms go some way to achieving that.

The July reports follow on from the report published in January 2020 which set out options for reform to reduce the price payable by tenants in an enfranchisement claim, although the Law Commission did not make any recommendations in this report, leaving it to Government to decide what to adopt.

While the recent recommendations are receiving positive commentary for taking a step in re-addressing the imbalance between leaseholders and landlords, some of the proposed reforms will have a significant impact on landlords, developers or investors who have, to date, been structuring their portfolio to protect them from the risk of an enfranchisement claim. If the proposals are adopted, landlords will face an increased risk of having their asset purchased but will have less control as to what will be acquired.

This article sets out some of the relevant recommendations.

Collective freehold acquisition of buildings

  • Raising the limit of permitted non-residential use from 25% to 50%, drastically increasing the number of buildings which will qualify for collective acquisition. This will have particular ramifications for landlords of mixed-use premises as their previously exempt premises will now qualify. The Law Commission felt that a building with at least 50% residential use was a residential building so the legislation should apply.

  • Introduction of a new ‘multi-building’ regime permitting leaseholders of more than one building to make a claim together (with one claim notice and one nominee purchaser) provided each building would qualify for the acquisition of its own accord. There would be no need for these buildings to be structurally attached to each other, as currently required, and could include blocks of flats and houses, provided each building qualifies for acquisition under its respective regime. Landlords of estates are most likely to be impacted by this reform. 

  • Permitting leaseholders to elect which leasehold interests they acquire and requiring landlords to take a leaseback of units within the premises which are not let to participating tenants, including commercial units and non-participating flats. Leaseholders will also be able to elect whether or not to acquire intermediate leases (or any part of them), or leases of common parts, such as a development lease of a roof and airspace. This will allow the leaseholders to take control of what interests they acquire and what price they pay.  Landlords will have the ability to require leaseholders to acquire land which is of no useful benefit to the landlord if it is severed from the building.

Lease extensions

  • A lease extension, whether for a house or a flat, will be for an additional 990 years instead of a 90-year extension under the current regime. This lease length has been recommended to preserve the landlord’s ability to take back the property on the grounds of re-development in the last 12 months of the original term, or the last 5 years of each 90-year period, subject to the landlord meeting certain requirements. It will, however, eliminate any repeat claims by tenants who have already extended.

  • Leaseholders will also be able to elect to extend their lease, without buying out the ground rent if the lease has onerous rent provisions. Conversely, leaseholders can elect to buy out their rent in a very long lease without having to extend the term. This will create uncertainty in what landlords, and in particular ground-rent investment portfolios, can expect to receive in lease extension premiums.

Costs of enfranchisement claims

  • Alternative proposals as to the recoverability of costs have been set out and which should be adopted will depend on which valuation method the Government favour having considered the Law Commission’s valuation report published in January 2020.

  • If the valuation method adopted largely results in a market value being paid, the leaseholder will not be required to contribute to the landlord’s non-litigation costs of dealing with the claim. If the valuation method does not reflect a market value being paid, the leaseholder will have to pay a contribution to the landlord’s non-litigation costs, subject to a fixed-costs regime.

  • Landlords may find they are on the receiving end of a less than straightforward claim, with a number of nuances at the leaseholders’ request, but are unable to recover the costs for properly considering them and responding to the claim.

Right to Manage claims

  • As with the collective acquisition of buildings, leaseholders of buildings will be able to make a Right to Manage (‘RTM’) claim (to take over the management of the residential parts of their building without having to acquire the freehold of it) of buildings with up to 50% non-residential use. The leaseholders will no longer be required to pay any contribution to the landlord’s costs of responding to such a claim. 

Conclusion

The reforms will certainly increase the number of leaseholders who can take advantage of the regime, and the number of buildings which qualify for freehold acquisition. This will mean that landlords may see an increase in the number of claims they receive although, if the valuation proposals which make the process significantly cheaper are implemented, income streams will be damaged, and we may see investors ultimately choosing to invest in other asset classes.

Buildings which were previously exempt from the regime will now fall within it and landlords who actively want to avoid the risk of enfranchisement may now be exposed to having their assets acquired by their residential leaseholders. The proposed regime will likely deter landlords from granting leases which carry development potential, as leaseholders can now elect whether or not to acquire such an interest when making a freehold acquisition claim.

The Law Commission’s reports are now with the Government to consider and decide what, if any, of the Law Commission’s proposals they are going to enact into law. The timeframe for this is unknown but, given what they currently have on their plate, it may be a number of years before we seen any change to the current enfranchisement regime.

*Amy Jackson is the managing associate in the residential estates team at law firm Cripps Pemberton Greenish.

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