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With continued media interest in the unfair leasehold practices of some freeholders and ever-increasing queries from clients surrounding this point, I wanted to address this again.
In the past, property developers have built properties with a view of selling off the freehold for a substantial profit. This is how a considerable number of developers have made their profit from a development after selling the properties off at close to build cost. In order to achieve the high prices from a freehold purchaser that they needed in order to make this profit, the ground rent charges would be set with a multiplier that allowed them to sky-rocket over the period of the lease. In some cases this could be as significant as doubling every 5 years. The new owners of the properties have bought into these leases with little mention of the damaging effect this could have to the property price purely because it was common practice and solicitors wouldn't see this as out of the ordinary.
However, a number of years down the line and the ground rent is now at such a level that it puts off prospective purchasers and the leaseholders of these properties are stuck in a home that they can no longer afford to pay the bills of.
For example, let’s look at a situation whereby the ground rent started off at £250 a year doubling every 5 years. This means that after year 5 it becomes £500, then £1,000 after year 10, £2,000 after year 15 and £4,000 after year 20. This means that in the twenty years you have owned the property, the ground rent is now 1,600% higher than what it started off at. We can be fairly confident that inflation, or incomes, over the next 20 years won't increase 1,600% meaning that the ground rents become wholly unaffordable.
What is happening at the moment?
With increasing pressure from lenders, as we discussed in our blog on the 19th July, government are starting to intervene in what has become known as the "leasehold scandal". There are approximately 4.2 million properties which fall under leasehold in the UK and it is likely that a lot of these built-in the last few years will be directly affected by unfair ground rent multipliers. What is worse, however, is that this doesn't just affect flats but some houses were also sold off as leasehold including by some of the country's leading developers. The idea of leasehold houses makes sense in that it can protect the overall look of a whole site and stop one person ruining property prices throughout by not looking after their house. However, developers have sold off the freeholds and the new owners of these have implemented ever increasing ground rents. As such, the government are planning on banning the sale of leasehold houses completely and instead replacing it with a common hold. This includes an infinite freehold but with obligation to look after the common shared areas of either a development or a block of flats. If this is implemented in full then it would spell the end of freehold sales for large profits.
So what could happen if this is implemented?
In theory, if developers are unable to make their profits from selling the freehold of a development, either flats or houses, then there is a chance that they could pass this on to the purchaser and put house prices up. That being said, it is common knowledge through property agents and the media that the demand for properties at present has dropped considerably. Admittedly you could consider that this is down to the usual seasonal changes of the property market but it does appear that there has been a slowdown in the sale of properties throughout 2017. I would say, therefore, that the likelihood of this causing house prices to rise are somewhat limited but it has to be something to consider.
The other alternative is that some smaller developers will just not be able to make developments work and could end up going out of business. I do not like to see this happen but we have seen a number of developers over the years who are first time property developers and the product they produce is not at the standard you would expect. I would also suggest that it is some of these developers that have been the greatest exploiters of the unfair leasehold practices that we have seen.
Written by - Tom Stedman, Head of Property Sourcing at Choices Investments
