Planning to buy a luxury new build? Watch out for the leasehold…

In this guest piece, Hugh Wigzell, senior associate at Farrer & Co, lists three issues that property buyers and investors should watch out for when purchasing a new build in London.

In June last year, Fenton Whelan unveiled Park Modern, a £500 million development overlooking Hyde Park and Kensington Gardens. Having been due to top out at the end of 2021, the development is bringing 57 luxury apartments to the London market. With prices ranging from £2 million to £60 million, Fenton Whelan’s Co-Founder James Whelan said the development aims to “create something special, a legacy really for that location on the park”.

Opulent developments such as this have piqued interest in London’s luxury new-build market over the last year. With additional developments in the pipeline – such as Marble Arch Place and Twenty Grosvenor Square – there are plenty of opportunities for both domestic and international buyers seeking a dream newly-constructed London pad.

However, with such a purchase naturally comes legal considerations. In particular, leasehold issues can throw up some significant and time-consuming challenges further down the line, which are certainly not part of the idyllic picture conjured up when buying a luxury new build.

Identifying and rectifying these problems at the point of purchase will always be the best remedy, particularly for those looking to quickly bag a prime London new-build in this year’s competitive market. You will be pleased to hear that I do not propose to cover all of my favourite lease issues in this article. However, three doozies do spring to mind. 

AST trap

First up is the AST trap. Where ground rent exceeds £1,000 in greater London, or £250 outside of London, the residential long lease falls within the definition of an Assured Shorthold Tenancy under the Housing Act 1988. Ground 8 of Schedule 2 of the Housing Act 1988 stipulates that non-payment of rent is a mandatory ground for forfeiture, meaning that the Court cannot exercise any discretion should an action for forfeiture be brought by a landlord under this ground.

What this means is, theoretically at least, if a tenant does not pay their rent, the Court would have to forfeit the lease, whereas a Court traditionally will almost always grant relief from an action of forfeiture provided any breach is remedied. This is particularly problematic for lenders who do not control payment of the ground rent. If a borrower fails to pay ground rent and the lease is forfeited, the lender could lose their security. 

There are several ways to resolve this. My preference is to push for a peppercorn (i.e., nothing) ground rent. As leasehold reform is overdue, the received wisdom is that ground rents are on their last legs, so it is hard to justify a rent in a long lease.

You can also insert a mortgagee protection clause which, if well drafted, will require a landlord to serve any notice of forfeiture proceedings on the bank; give the bank the opportunity to remedy the lease breach (i.e., pay the rent); require the landlord to accept payment of rent, and allow the bank to enforce that specific provision.

The final remedy is indemnity insurance which is usually available at a reasonable price, but will protect the bank only as no insurer is going to provide indemnity for an individual not paying their rent.

It is also worth mentioning that there are other requirements to be an AST other than the level of ground rent, namely that the tenant is an individual and the property is used as a primary or main residence. Often not all of these requirements will be met on a transaction, so it is tempting to park this issue, particularly if your negotiations are trying. This would be a mistake, however, as the objective of a good solicitor in a property transaction is to future-proof the title so that you can sell or mortgage in the future without any legal title issues getting in the way. 

Multiplying ground rents

My second favourite lease issue is ground rents that multiply. You sometimes encounter ground rents that double every 10 or 15 years throughout the lease term meaning that the rents escalate to disproportionate sums. 

Not surprisingly, this poses issues of valuation and affordability. You troubleshoot this one by reading the ground rent provisions and escalation clauses carefully and negotiating like a tiger where the ground rent increases exponentially.

Termination on frustration of reinstatement

My third and final favourite lease issue is a bit technical. One of the functions of a long lease is to allocate responsibility for insuring the building, and the lease will also deal with what happens where damage to the building by an insured risk incurs. Where damage is incurred, the lease should require the landlord to apply insurance proceeds to reinstating the building. Conceivably there will be situations where the reinstatement of the building is not possible, like if planning permission is not granted for example.

Most long residential leases will go on to set out what happens should this transpire and the usual position is that the insurance proceeds are held on trust for the landlord and tenant and allocated in proportion to their respective interests in the building, disagreements are settled by reference to an expert. 

Not infrequently new residential leases also contain a provision for the lease to be terminated in the event that reinstatement is frustrated. This is a big ‘no no’, as a lender with a charge over the lease will lose their security if the lease is terminated.

There are two potential solutions to this issue. The first, and most practicable, is to remove the wording that allows for termination of the lease. The backstop solution is to obtain a policy of contingent liability buildings insurance which will effectively reimburse the lender for the loss of their security in the event that the lease is terminated under this defective provision: these policies don’t always come cheap. 

London is England’s prime leasehold location and if you are buying a luxury new build apartment then the best thing you can do to avoid these issues is to instruct a solicitor who is familiar with the prime new-build London market and well versed in spotting and solving these issues.

The risk of not picking up on these problems is that when you come to refinance or sell your apartment the process is delayed and made more expensive, and that’s in the best case. The worst case is you lose your apartment. You have got to love leases. 

*Hugh Wigzell is the senior associate at independent law firm Farrer & Co