HOW TO SOLVE A PROBLEM LIKE GROUND RENTS – A REAL ESTATE LAWYER’S PERSPECTIVE
With thanks to Rob Denman, Head of Real Estate, JB Leitch Solicitors www.jbleitch.co.uk.
ARE GROUND RENTS THAT ARE MORE THAN A PEPPERCORN A PROBLEM?
The short answer is no. Abolishing ground rents altogether is not going to solve the perceived problem. There can be no argument that onerous ground rents that increase exponentially over a short period of time are not wanted by leaseholders or mortgage lenders who have lent against leasehold properties. Particularly in those instances where they have not been correctly advised regarding the ground rent provisions.
Lenders are a key stakeholder in this argument whose perspective on this issue is often overlooked. Their outlook on ground rent is very important as when it is reported in such stories as “I cannot sell my property because of the lease” or “I am a prisoner in my own home” (and similar stories) it is usually because any potential buyer cannot get a mortgage on that property because of the lease terms. Mortgage lenders are the gatekeepers to most people buying and selling leasehold properties.
The UK Finance Mortgage Lenders’ Handbook (previously known as the Council of Mortgage Lenders (or ‘CML’) Handbook) provides comprehensive instructions for conveyancers acting on behalf of its 300 lender members (including almost all high street banks) in residential conveyancing transactions. The standard answer for all CML lenders regarding ground rents can be found at 5.14.9 of Part 1 of the Handbook and states the following:
5.14.9 We have no objection to a lease which contains provision for a periodic increase of the ground rent provided that the amount of the increased ground rent is fixed or can be readily established and is reasonable. If you consider any increase in the ground rent may materially affect the value of the property, you must report this to us.
You can see then that ground rents in general and even increasing ground rents are not necessarily an issue for mortgage lenders providing the increase can be readily established and reasonable. It is certainty that they require regarding the amount of ground rent and not a peppercorn ground rent. This is an argument for a different day, but it is highly likely that a lot of escalating ground rent clauses were not correctly reported by conveyancers to their clients or mortgage lenders which has contributed to the current issues. If such clauses had been reported on correctly then perhaps the mortgages would not have been completed and this perceived problem would have been nipped in the bud much earlier.
The income that the selling of freehold titles with ground rents income provides for developers is a key income stream which allows them to secure funding for future building as well as enabling them to comply with s106 planning agreement requirements. In a time when the dearth of house building is a severe problem for the population as a whole anything that restricts development and potentially adds to this is a serious issue.
Like it or not, most people are invested in ground rents income in one way or another through their pensions. Ground rent investments have proved very popular for pension funds as they offer steady returns with a low risk profile. If this asset class ceased to exist through reform it would likely have a significant impact on the value of such investments and pension funds would have to source an alternative asset class that mirrored these current low risk returns.
Some leaseholders might not agree but good Freeholders act as stewards or custodians of buildings and developments as they have a vested interest in them. This is for the benefit of all stakeholders in a building/development. Without the ground rent income which supports the administration of such stewarding such activity would cease to be viable and the burden would fall on the leaseholders themselves through another form of ownership such as commonhold. Although commonhold is perceived as a viable alternative to the current leasehold structure it is yet to be properly tested and would need a significant commitment from leaseholders all of which would need to be in agreement with one another. In our experience this is rarely the case, particularly on larger developments.
A two-tiered system
If all new leasehold properties have their ground rent set to a peppercorn that will create a two-tiered system overnight. Those leasehold properties with a ground rent attached and those without. There is an obvious threat then that a lease with a ground rent attached could be perceived as a ‘second class’ lease with the obvious potential impact being a reduction in value. This is an issue that leaseholders and lenders could not have considered or envisaged when purchasing or financing these properties. This could lead to costly variations of existing leases which were seen up until this point as good security but now might not be or not perceived to be. This lack of certainty is precisely what all stakeholders in leasehold property do not want.
A POSSIBLE WAY FORWARD
As detailed above ground rents per se are not viewed as a problem by mortgage lenders. It is certainty regarding ground rents that both leaseholders and lenders require. Developers, freeholders, leaseholders and the general population through pension fund investment, all, to some extent, can benefit from the existence of fair ground rents.
Would it not make sense then that all stakeholders agree on a fair ground rent or escalating ground rent going forward through the current leasehold consultations? Most modern service contracts such as mobile phone contracts are linked to RPI which the population as a whole are used to, so would that not be a fair indexation to which ground rent increases could be linked to on a 10/20-year basis?
This standard ground rent/increased ground rent could then be enshrined as a standard clause through statute to appear in all residential leases. From 19th June 2006 all new leases for residential property that are registrable at HM Land Registry have to have standard ‘Prescribed Clauses’ at the beginning of every lease. This was HM Land Registry’s attempt to try and standardise (as much as they could) residential leases and the prescribed clauses include: Title Number, Parties, Property, Term etc. It would make sense then that once a fair ground rent or escalating ground rent clause were determined that this clause would appear in all new leases as a prescribed clause, so it would be easily identifiable to all parties reviewing the lease. Furthermore, the new lease could not be registered at HM Land Registry unless this standard clause appeared.
Standardising this clause would remove the need for conveyancers to report on the ground rent provisions on new leases to mortgage lenders thus eradicating this action which may or may not have been followed correctly by them previously which has added to the current perceived problem. This would also help speed up the conveyancing process.
Standardising this clause could also help to make the purchasing of leasehold properties easier from the outset as all potential buyers would know what ground rent would be payable on a property prior to making an offer. This level of ground rent could also be factored in more easily to budgeting for buyers, mortgage underwriters when determining affordability for potential buyers and mortgage valuers when determining the valuation. At present I doubt that mortgage underwriters and valuers have the necessary information to factor this cost in and the system works backwards in that respect. Certainty would now exist for all stakeholders.
Fair ground rents can work for the benefit of all interested stakeholders in leasehold property provided there is certainty as to what they are and where they are detailed.