‘A Collective Blindspot’: On The Ground Rent Scandal

The need-to-know for all buyers of leasehold properties...

There’s been some real horror stories involving leasehold properties in the headlines recently, with talk of hidden clauses rendering many recently-bought properties impossible to sell on. Alan Edwards talks us through the ground rent ‘scandal’ and flags us the key issues and pitfalls all buyers should be aware of…

There has been a great deal of publicity over the past six months concerning the practice by some major house builders of selling houses on a long leasehold interest instead of freehold at what appears to be a modest initial ground rent (Say £250 per annum) but doubling over comparatively short periods, such as 10, 15, or 20 years. In the most extreme examples this has resulted in a ground rent in the last years of the term being £8 million per annum. The same practice occurs in developments of blocks of flats and also on voluntary lease extensions outside the provisions of the Leasehold Reform Housing and Urban Development Act 1993 (under the statutory process a lease extension is granted at a peppercorn rent). The Rent Charges Act 1977 broadly prohibited the creation of new rent charges on freehold property. The creation of a long leasehold interest (typically 999 years) on sale enables a developer to impose a ground rent. This has become a lucrative industry resulting in £26 billion of freehold houses subject to a ground rent being sold in 2016 and it is estimated that developers make £300 million-£500 million per annum out of ground rent sales.

We therefore have the bizarre position where the industry builds and sells homes as an asset class but upon terms which render it impossible for a purchaser to realise the full value of the asset unless remedial steps are subsequently taken

The publicity, however, has not been a celebration of this burgeoning industry but a criticism of it, because a rent review resulting in the kind of figures referred to above renders the house or flat virtually unsaleable.

The adverse publicity has been generated by cases where lessees have been unaware of the adverse provisions of the rent review clause until they placed their property on the market and found that they were unable to secure a sale. We therefore have the bizarre position where the industry builds and sells homes as an asset class but upon terms which render it impossible for a purchaser to realise the full value of the asset unless remedial steps are subsequently taken.

How has this position arisen?

When the purchaser of a leasehold house or flat purchases, they will almost invariably be represented by a professional conveyancer, whether a solicitor or licensed conveyancer. It is for that professional to advise the purchaser on the terms of the lease to include the impact of a rent review clause on the future marketability of the property. The Council of Mortgage Lenders’ Handbook says that “if ground rent may materially affect the value of the Property” it must be reported to the Lender. There is no doubt that an escalating ground rent of the nature described above does adversely affect value. Lessees have complained that whilst they were advised on various aspects of the lease they were not advised on the impact of the rent review clause and failed to address it themselves as they relied upon their professional advisers. Lessees made comments that they were advised on the provisions in the lease in relation to the prohibition on pets, noise nuisance, and alterations and other provisions but not on what figures would be produced by the doubling of the rent over the periods prescribed by the lease or what those resulting figures would mean for future marketability. The addressing of this last issue appears to have been something of a collective blindspot.

What can be done to remedy the position?

The key is to dispose of the offending provision for the rent review. Consumer law is underdeveloped to deal with this problem. The lease is a contract between the freeholder and the lessee and can only be varied by the consent of both parties. The Court takes the view that because a contractual arrangement lacks foresight is not a reason for departing from the terms that have been agreed by the parties. The Supreme Court recently ruled in Arnold v Britton (2015) UK SC 36 that a formula in a lease resulting in the lessee having to pay a service charge of “millions,” where the service charges expended could be a fraction of that, should stand. An application to the Court to rectify the position therefore appears to be closed.

The following practical steps are, however, available:

1. In the case of a house after two years ownership have expired, an application can be made to the Freeholder to “enfranchise” the freehold under the terms of the Leasehold Reform Act 1967. The loss of the ground rent to the Freeholder will be an element of compensation.

2. In the case of a flat an application can be made after two years ownership have expired for a 90 year extension lease at a peppercorn rent under the Leasehold Reform Housing and Urban Development Act 1993 where again the loss of the rent will be an element of compensation.

3. An alternative way forward in the case of a flat would be a collective enfranchisement of the Freehold again under the Leasehold Reform Housing And Urban Development Act 1993 provided that the building qualifies under the legislation and that 50% of the qualifying tenants in the building as defined by the Act join in the enfranchisement. Again the loss of the rental income will be a ground of compensation to the Freeholder.

Professional negligence

If it is the case that a professional adviser failed to advise a lessee of the wording of the rent review clause and its implications then the lessee will have a cause of action for damages in negligence against the adviser. The possibility of an increasing number of negligence cases based upon these facts has been the subject of some discussion in the legal press.

Future policy

The existence of the problems outlined in this article have had the attention of Parliament and there was a comprehensive debate upon the issues by the All Party Parliamentary Group On Leasehold Reform on 14 December 2016. The Government White Paper on housing identifies ground rents as an area for reform. The writing is therefore on the wall, and Taylor Wimpey has already indicated that they will discontinue the practice.

Alan Edwards, Partner at Russell-Cooke