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Leasehold: a Mortgage Strategy investigation

As the current government and Labour have both announced plans to tackle the on-going leasehold issue in recent weeks, a Mortgage Strategy investigation, headed by Emma Lunn, has revealed the need for urgent reform.

Companies such as Taylor Wimpey, Morris Homes, Bellway, E&J Estates, Ground Rents Income Fund plc and Wallace Partnership Group have signed a pledge. They have committed to amending leases where the ground rent doubles more frequently than every 20 years to contracts where the ground rent rises in line with RPI inflation.

However, leasehold campaigners think the pledge does not go far enough. They say it will still leave many leaseholders with properties difficult to mortgage due to other ground rent clauses unacceptable to many mortgage lenders.

Clive Betts MP chaired a HCLG select committee which investigated the leasehold sector. In a letter to the secretary of state he said: “This is not about doubling ground rent alone, and there are plenty of examples of RPI-based mechanisms having the same effect, particularly where ground rents increase above 0.1 per cent of the value of a property.”

Issues with informal lease extensions

The 0.1 per cent figure has become a benchmark of what is generally viewed as an ‘onerous’ ground rent, after Nationwide publicly stated it would not lend on new build properties if the ground rent was more than 0.1 per cent of the purchase price.

The Leasehold Knowledge Partnership estimates there are around 12,000 leasehold properties with doubling ground rents, but a further 88,000 where the ground rents are above 0.1 per cent of the property value.

Many of these will not be new builds, but older properties where the leaseholder has extended their lease. Lease extensions are necessary as mortgage lenders generally are not keen on lending where a lease has less than 80 years to run.

Leaseholders can extend their lease in one of two ways: the statutory route or via an informal agreement with the freeholder.

The statutory route under the 1993 Leasehold Reform Act extends a lease by 90 years and reduces the ground rent to zero. However, premiums can be expensive, and the leaseholder is obliged to pay not just their own surveying and legal costs, but the freeholder’s too.

Informal lease extensions can often be completed more quickly and can appear cheaper. However, these deals offer none of the protection awarded by the 1993 Act.

The freeholder sets the terms of the lease – and this can include higher ground rent, rather than reducing it to zero. The lease will not necessarily be extended by 90 years either, often just up to 90 or 100 years instead.

Simarc Property Management provides a freehold sales service. Its director Mick Platt says: “When we quote, we offer three alternatives – the ‘statutory’ option under which the ground rent is reduced to a peppercorn in exchange for a premium, a second option where no premium is payable but the ground rent is increased, and a third option, which combines a reduced premium and a lesser increase in the rent.

“The second and third options are calculated by reference to the first and effectively mean we receive the equivalent premium over a 20-year period.”

An example

In one case, Sam (not his real name) bought a two-bedroom flat in Sunderland in 2012 for £85,000. The previous owner had completed an informal lease extension with a property management company. The deal saw the lease extended from below 80 years to 100 years and the ground rent increased from £15 a year to £450 a year, rising every 10 years in line with RPI.

The flat is currently worth around £60,000, making the £450 ground rent about 0.75 per cent of the property’s value. The leaseholder says the ground rent level makes the property difficult to remortgage or sell. His only realistic option is to pay to extend the lease again, either formally or informally, resulting in more favourable ground rent terms.

The Leasehold Group of Companies managing director Louie Burns says: “Freeholders are experts at making informal deals look like an attractive option to leaseholders, when they are anything but. The simple reason for making informal deals look so tempting is because they are a great way for freeholders to stitch up leaseholders and make extra profit, and this is a prime example of why nobody should touch an informal lease extension.”

Simarc says it completes about 400 lease extensions a year, with most completed outside of the Act. It says this makes the process cheaper and easier for leaseholders.

The company blames mortgage lenders for refusing to lend on leases where the ground rent exceeds a certain level.

Platt says: “This is a change of policy, no doubt in response to erroneous claims that current levels of ground rent are excessive (in fact, ground rents are at their lowest levels for years relative to wages and house prices).

“It might also be driven by the recently published select committee opinion that ground rent should be an arbitrary 0.1 per cent of the property value and not exceed £250. This has instantly rendered some properties unsellable as potential purchasers cannot obtain mortgage finance, even though these are not new build properties. In our example, mortgage finance can no longer be raised, even though none of the lease terms have altered since the purchase.

“It does not strike us as reasonable that mortgage lenders should put leaseholders in this position by suddenly amending lending criteria which have been in place for years.”

Lenders’ criteria

Although ground rent at no more than 0.1 per cent of the property value has become a regularly stated figure, lenders differ in their approach. Most consider leasehold properties on a case-by-case basis.

SPF Private Clients chief executive Mark Harris says: “Lenders are uncomfortable in this area and there are a number of policy points where they insulate themselves.

Typically, these could be insisting on maximum ground rent or property value ratio of 0.1 to 0.25 per cent; maximum initial ground rent values; and time period restrictions during which time rents cannot double.”

For example, Yorkshire Building Society requires ground rent reviews to be a minimum of 21 years from the start of the lease. It says issues with informal lease extensions vary but escalating ground rents can impact affordability, the property’s value and sometimes limit the ability to sell, which all impacts the society’s approach.

Barclays will not lend on leasehold properties “with onerous terms, including unreasonably and escalating ground rents” and relies on an independent valuer’s professional opinion as to the impact of lease terms on the value and future saleability of a property.

Santander generally accepts properties where ground rent increases with RPI, but adds: “If a property has an onerous ground rent which is out of step with similar property in the locality then this will affect its value and marketability.”

John Charcol senior technical manager Ray Boulger says lenders’ criteria are designed to be simple and help prevent future abuse by developers – but are often not fit for purpose.

“Most lenders have copied Nationwide’s lead, and this has created a new class of mortgage prisoner, in respect of some leasehold terms, such as this case study.

“The problem has been caused by lenders defining ground rents as being ‘onerous’ simply because they exceed 0.1 per cent of the property value. Had the ground rent of this £60,000 flat been only £60, i.e. 0.1 per cent of its value, the flat would have ceased to be mortgageable if its value fell to £55,000, which is madness.”

Ground rents

Ground rent is a regular payment from a leaseholder to the freeholder or landlord. Historically, ground rent was a token or very low payment, often referred to as a ‘peppercorn’.

However, the past decade or so has seen developers identify ground rent as a potential income stream. Housebuilders started to sell properties with high initial ground rent and lease clauses, allowing for the ground rent to increase at periodic intervals. Some ground rents were set to double every 10 years, while others rose in line with RPI inflation.

These clauses made ground rents and freeholds attractive to institutional investors and pension funds, keen on the steady income stream.

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