The Ground Rent Consultation

On 9 November 2023 the Department for Levelling Up, Housing and Communities (DLUHC) opened a public consultation to seek views on options to restrict ground rents for existing leaseholders, alongside the Leasehold and Freehold Reform Bill. The deadline for responses to the Ground Rent Consultation closed on the extended date of 17 January 2024, with responses expected from different parties including freeholders, investors, pension funds, property managers, surveyors, leaseholders etc.

The Leasehold and Freehold Reform Bill 2023-24, which applies to England and Wales, was introduced to the House of Commons on 27 November 2023. The Bill’s 2^nd reading took place on 11 December 2023 and it entered the Committee stage on 16 January 2024. The Committee has reported to the House and the Report Stage and 3^rd Reading are scheduled to take place on 27 February 2024. No definite decision date has been given and the Government has stated that it will carefully consider the responses before responding. Any reforms are to be introduced through the Leasehold and Freehold Bill. It implements commitments in the Conservative Party Manifesto 2017 to “crack down on unfair practices in leasehold” and in the 2017 housing white paper to “improve consumer choice and fairness in leasehold” and takes into account leasehold reform recommendations made by the Law Commission in their 2020 reports.

The Bill’s main provisions include:

• Making it cheaper and easier for leaseholders in houses and flats to extend their lease and buy the freehold.
• Increasing the standard lease extension term to 990 years, with ground rent reduced to a peppercorn (zero financial value), upon payment of a premium.
• Changing the qualifying criteria to give more leaseholders the right to extend their lease, buy the freehold and take over the management of their building.
• Improving the transparency of service charges and ensure leaseholders receive key information on a regular basis.
• Giving leaseholders a new right to request information about service charges and the management of their building.
• Improving the transparency of administration charges and building insurance commissions.
• Ensuring leaseholders are not subject to any unjustified legal costs and can claim their own legal costs from their freeholder.
• Giving freehold homeowners who pay charges for the maintenance of communal areas and facilities in a private or mixed-tenure estate the right to challenge the reasonableness of charges and the standard of services provided.
• Improving the transparency of estate charges and ensure freehold homeowners receive key information on a regular basis.
• Ensuring a rentcharge owner is not able to take possession or grant a lease on a freehold property where the rentcharge remains unpaid for a short period of time.

The Government has said that it will also reinvigorate the commonhold tenure, regulate all property managing agents,  and establish a redress scheme and a housing complaints resolution service.

The stages of Leasehold reform

The Bill follows on from the Leasehold Reform (Ground Rent) Act 2022, that came into force on 30 June 2022, which restricted ground rent to a peppercorn for most new residential leases granted after 1 July 2022, including deemed surrenders and re-grants.  Existing leases were excluded from the Act.

The other changes that have already taken place include in 2019 numerous freeholders signed a Public Pledge for Leaseholders to assist leaseholders and agreed steps in existing and future leaseholds.

The Consultation

The Consultation asked for views on the following:

• the full range of problems that existing ground rents can cause for leaseholders, and the scale of these problems
• which option to cap ground rents respondents believe is the right one to deliver the Government’s aim of giving leaseholders a fairer deal
• whether there should be a period of delay before implementing any cap, and
• the types of leases which need to be exempted from any cap to ground rents.

The Consultation outlined the following 5 options proposed by the Government to existing leases that contain a ground rent, which are considered in further detail below:-

1. Capping ground rent at a peppercorn;
2. Capping ground rent at maximum financial value;
3. Capping ground rent at a percentage of the property value;
4. Capping ground rent to the original amount when the lease was granted;
5. Freezing ground rent at current levels.

Capping ground rent at a peppercorn

This is in effect a NIL or Zero value.  With a NIL/Zero ground rent, there is no incentive for an investor to bid and purchase a ground rent property.  For those investors already committed to ground rent properties, the lack of ground rent income would affect the obligations they would usually carry out, as a freeholder, for the benefit of the leaseholders and any contractual obligations would no longer be able to be met. This would cause investors to leave the ground rent market, if they do not, in the interim, become bankrupt.  This would leave many ground rent properties without management and expertise, and requiring the leaseholders to step-in and carry out the lease obligations. We are aware that it is not always the case that leaseholders have any interest in managing the building of which their flat forms part.

Capping ground rent at maximum financial value

If ground rent is to be capped at a fixed level, and a figure of £250.00 has been mentioned, those flats with a higher ground rent would benefit from a lower ground rent, but those flats with a lower ground rent could be affected by a higher ground rent than what they are currently paying.

Capping ground rent at a percentage of the property value

There are indications that the ground rent would be based on 0.1% of the property value, to coincide with the majority of mortgage lenders’ lending requirements.  There are likely to be issues and costs in the event that the valuation is disputed and in dealing with the continued valuations. Numerous factors will apply each time the property value needs to be ascertained, which would also have a cost implication, e.g.  the current seller and buyer interest, interest rates, housing quality, differing values of different types of properties and in different parts of the UK etc.   Those flats that are not within the proposed percentage cap would have their ground rent adjusted to either increase or decrease.

Capping ground rent to the original amount when the lease was granted

The original rent could be difficult to determine, particularly if there was an initial discounted period before any ground rent applied, or incentives were originally offered to leaseholders resulting in a rent reduction, or in the case of older leases where it is difficult to ascertain the original rent.

Freezing ground rent at current levels

This would not deal with those leases with higher rents, although the rent increases would no longer apply.

In all of the above options, and as confirmed by the DLUHC in most cases, a change in the rent would increase the amount of the service charge being payable, in the event that the freeholder’s obligations which would normally be funded through the ground rent would need to be provided via the service charge, as per the examples below. For those freeholder’s statutory and other obligations that do not fall within the service charge, and the costs of which are also likely to increase, these would not be recoverable by the freeholder. This could result in the freeholder’s insolvency,  or in the freeholder defaulting on its contractual obligations if the capped ground rent fails to meet superior and contractual obligations, culminating in forfeiture of its interest,  and even a reluctance to invest in ground rent properties in the first place. There would be Court and administrative costs in potential redress, lease variations and valuations.  Pension funds and insurance companies would also be affected by losing their reliability on ground rent income to meet their liabilities, particularly if they cannot find alternative investments and it is not known if such alternative investments would remain in the UK.

The view that leaseholders receive nothing in return for paying ground rent is not correct.  A freeholder is often required to provide additional services outside of the service charge. Some examples of this are in complying with the Building Safety Act and pursuing leaseholders to comply with building safety, dealing with neighbouring disputes, dealing with enquiries from the Council and/or the Police, ensuring resident and right to manage management companies are aware and comply with their obligations, being responsible for areas of land that fall outside of the lease demise.

There are also occasions where a freeholder may need to obtain a service charge loan, for example, to pay for insurance premiums or for ongoing section 20 applications, and where there are insufficient service charge funds.  It is not uncommon for some leaseholders to delay the payment of rent and/or service charge, which places additional responsibilities on a freeholder to comply with obligations in order for the ground rent property to be managed efficiently.

Consideration needs to be given as to what impacts the removal of ground rent will have beyond the leaseholders’ leasehold interest. There are some leaseholders who would prefer that ground rent in leases is removed in its entirety, quoting that the terms of the ground rent were not made clear to them at the outset or that they do not understand the ground rent increases.  However, such matters would have been made clear at the stage where a leaseholder was in the process of purchasing a leasehold property, so that it could decide whether or not to proceed with the purchase of the leasehold property.

The ground rent in leases allows the freeholder to offer a price for the purchase of the ground rent property, and the receipt of the ground rent by a freeholder is part of its investment in the ground rent property as an asset. If there is no ground rent, there is no incentive for freeholders to acquire ground rent properties and offer its services for the benefit of the ground rent property and the leaseholders.

If freeholders no longer invest in ground rent properties, it would be for the leaseholders to manage and the management of a ground rent property could fall upon overseas leaseholders, who could be absent freeholders. It is often the case that many leaseholders have no interest in managing their ground rent building and many refuse to become directors or secretaries in their management companies either because they lack the expertise, the time or any interest. With the lack of interest and expense, ground rent properties could ultimately fall into disrepair and become neglected, resulting in flats losing their value.

It has been quoted that Douglas Maxwell, a Barrister from Henderson Chambers was invited to advise the Government on the human rights issues arising from the consultation on restricting ground rent for existing leases and on the compatibility provisions in the Bill with Article 1 of the Protocol No.1 to the European Convention on Human Rights (“AIPI”).  The Government’s impact assessment indicates that the potential impact of limiting or capping ground rent would be £27.3bn.  Mr Maxwell set out to the Government that: the capping of ground rent in existing leases to a peppercorn would more likely than not constitute a breach of the right to property in A1P1.

Conclusion

The consultation raises many questions. What will investors do with their current ground rent properties? With transactions on hold, the uncertainty is affecting both sellers and buyers. Most transactions are likely to become abortive, if it is no longer economically viable for buyers to buy and the sellers can no longer achieve the price they were expecting. Will the investors be tempted to sell their ground rent properties to leaseholders, subject of course to complying with Section 5 of the Landlord & Tenant Act 1987, but what will happen if the leaseholders are not interested in buying. There is also the ongoing question of whether the Government will compensate investors if ground rents cease for existing properties but until the final Bill receives Royal Assent, many questions remain unanswered.