Should Flat Owners extend their leases now? If they hold off will the later find themselves driven to do so i.e. as a result of lenders tightening their ground rent requirements or the reforms being considered by the Government?
These are some of the questions facing flat owners where their lease is either shortening or contains a significant ground rent.
Broadly speaking flat owners have the right to claim an extended lease of their flat after two years of legal ownership. In return for the payment of a premium this adds 90 years to the remaining term of their lease and effectively reduces the passing ground rent to zero.
Shortening of the lease term has been the main driver for flat owners to want to make a lease extension claim to date. Often that is only considered at the point of sale which then leaves the flat owner in a weak bargaining position as the statutory lease extension procedure can take 6 months or so to conclude and so often they will end up agreeing terms for a voluntary lease extension that are less good i.e. with a continuing ground rent, an increased premium or both.
More recently ground rent has attracted a lot of press coverage which in turn has affected buyer’s sentiment in this regard when choosing a flat. Lenders have also tightened their requirements in this regard. So flat owners may now be driven to extend their lease under the statutory scheme in preparation for a sale so as to remove the ground rent as a potential issue.
Perversely that may be aggravated if the Government introduces legislation to give effect to its intention to set ground rent at zero in new leases (excluding shared ownership leases) as this may create a two tier market of lease ground rents with second hand properties with the higher rents potentially being seen less attractive so causing the holders of such flats to extend their leases so as to zero the ground rent. This was first announced on 21 December 2017 by Sajid Javid the then Secretary of State for DCLG. In addition to covering rents set in future leases granted on first sale of a flat by developers, the Government wants to see this support extended to all those with “onerous” ground rents including second hand buyers and for customers to be proactively contacted.
Flat owners with existing levels setting relatively high levels of ground rent can also find themselves at greater risk of losing their asset without compensation due to the ground rent level taking their lease within a definition of an assured tenancy and so subject to the risk of a mandatory position order for ground rent arrears. That applies where the ground rent exceeds £1,000 in London or £250 in the rest of England. While the Government has expressed its intention to take action to address this loophole, flat owners are exposed to the risk in the meantime and so on resale of their flat they may find some buyers are put off by this where the issue is spotted. So they may be driven to extend their lease to get rid of the ground rent.
Market values and the effect of these on the premium payable for an extended lease is an issues as ever; the current emergency may well cause a downward effect on valuations that may play into the premium payable for an extended lease but it would need to eclipse the upward effect on the premium of a lease already beneath 80 years getting shorter and it will only be possible in hindsight to know when the best time was to make a claim. Prices may be unaffected or even turn upward unexpectedly in which case flat owners may wish they had taken the opportunity and made a claim at this stage.
Flat owners without the pressure of a sale may prefer to wait and see what decisions the Government makes further to the Law Commission’s report on options to reduce the price payable for a lease extension. Of course the risk is the Government doesn’t make any changes or that the changes they do make don’t make a significant difference sufficient to compensate for the upward effect on a premium payable of the lease getting shorter in the meantime for leases that are or fall beneath 80 years remaining in the meantime.
From the perspective of a flat owner, the best case scenario is that the Government removes the obligation to pay marriage value, so benefiting those holding leases with less than 80 years left to run, and prescribes rates in their favour that are used to calculate the premium i.e. the capitalisation rate used to calculate the value in today’s money of the future income stream the landlord benefits from.
That would bring with it the possibility of an online calculator so reducing the cost of exercising the right to a new lease. Those with onerous ground rents might benefit from reform that only takes into account ground rent up to a level of 0.1% of the freehold value of the property when calculating that element of the enfranchisement premium so avoiding compensating the landlord for the balance of the ground rent income it otherwise be entitled to under the lease term. These are significant potential benefits.
Lenders’ requirements may operate as a push factor as well; the standing requirement for lenders who are members of UK Finance is that they will tolerate a periodic increase in the ground rent provided the amount is fixed or can be readily established and is reasonable. Where the buyer’s conveyancer has a concern that a potential increase in the ground rent might materially affect the value of the property then they have to refer that to the lender for approval which they would then pass on to the valuer for comment, all of which will incur additional time and may mean the buyer can’t proceed.
In addition, individual lenders have their own requirements as to the level of ground rent they will accept both in respect of new and second-hand properties (different requirements for each). For example, Barclays Bank currently require ground rent on a second-hand property to be within 0.2% of property value, they accept RPI linked ground rents as long as the review isn’t more frequent then once every 5 years and doubling ground rents as long as their doubling no more often then every 20 years and don’t continue to do so after 125 years. They don’t accept price linked escalations in the ground rent. Britannia want to be consulted if the ground rent exceeds 0.1% of market value and might accept it up to Barclays’ level. In addition they aren’t happy with ground rent levels that cause the lease to be an assured tenancy and so require the lease to be varied (which may not be achievable) or a suitable indemnity policy to be put in place.
In conclusion there are many factors to consider and so it can be a difficult balancing act for flat owners to decide whether it is best to extend now or roll the dice on where the market may go from here and what the Government may do with the Law Commission’s options as to reducing the premium payable in future.
If the market is potentially going to become thin again and flat owners consider they may be under some pressure to sell, then it may be best to extend their lease now so as to remove this as a potential issue that may put off buyers who will become pickier in that market. They should certainly extend before their lease drops below 80 years remaining.
We appreciate that cost is a concern for flat owners and so we have teamed up with certain valuers to provide all the support they need to extend their lease for a fixed fee.