GROUND RENT THEFT

The Government is presently consulting to radically alter all leases to reduce ground rents – potentially to zero – and to extend the leases to 990 years.  This windfall to the leaseholders would represent theft of an asset from the freeholders.  Not only is this unfair, un-Conservative and un-British, but it will have undesirable unintended consequences.

For hundreds of years, the prosperity of this country has been based on the sanctity of property and possessions.  Early industrialists could invest knowing that the fruits of their labour and money would not be arbitrarily confiscated by the Government.  On this foundation, Britain was the leader in the industrial revolution and has continued to improve productivity and overall living standards decade after decade.  Yet this same Government, heir to all that is good in growing productivity, is proposing to expropriate all ground rent investments without compensation and give them to leaseholders.  This is interference in literally millions of private contracts for nothing more than cheap headlines. By destroying assets, they reduce the incentive for future investment and so remove growth of living standards.

THE “UNFAIRNESS” OF GROUND RENTS

For several years, campaigners have been agitating about the “unfairness” of ground rents due as part of leasehold contracts, claiming that freeholders do nothing to “earn” these payments.  This is to completely misunderstand how the leasehold market works.  Even the Daily Telegraph gushingly exclaimed how leasehold reform could enrich leaseholders by £50,000.  The assumptions behind that £50,000 are hugely unusual, but even if the gain is only £5,000 per property, that still represents a £5,000 loss for the freeholder.  It is a zero-sum game: whatever is given to the leaseholders is stolen from the freeholders.  The article in question does not explain why it is fair for the freeholder to have their asset confiscated to create a windfall for the leaseholders.

Any estate agent will confirm that flats where the leaseholders have bought the freehold are more valuable that the equivalent flats that pay ground rent.  This is only natural, as an asset without an annual payment is better that one which requires ground rent to be paid.  All the campaigners against ground rent are in reality trying to achieve is a share-of-freehold flat without paying for the capital uplift.  This situation is exactly the same as a car-buyer entering into a PCP scheme, but then complaining that people who buy cars outright do not have to pay monthly premiums, so why should they?  The answer is that people who bought their car for cash put up more money in the first place!

Campaigners for Leasehold Reform rarely mention the freeholders.  Typically, the owners of the land are investment funds, pensions and local authorities.  They have invested their money in low-risk and low-return assets with foreseeable income streams to match their liabilities.  Ultimately, all the freeholds are owned by real people who will have a possession taken from them if these reforms go through.

SCANDALS

The leasehold arena has suffered two scandals in the last few years, neither of which justify replacement of the whole system.

Some leases were written with ground rents which doubled every 10 years.  Primary school children know that if you double something repeatedly, then after only 10 doubles, it is 1024 times larger.  The lawyers drafting these leases should have realised such clauses would cause trouble. The lawyers acting for the buyers were guilty of professional negligence in not warning their clients of the toxic nature of the leases they were acquiring.  Clearly, none of these solicitors understood simple maths.  This event alone justifies Rishi Sunak’s plan to make maths teaching compulsory to the age of 18!

The other claimed scandal is the opaque nature of some service charges.  These are not relevant to the ground rent debate, but are being used as extra mud to sling by proponents of leasehold reform.  Already there is Right To Manage (RTM) legislation where leaseholders can take over the management of their block if they are unhappy with the operation. RICS have guidance in how service charge records should be presented.  We support these recommendations.

Neither of these two crises justify the wholesale removal of ground rents.  Like all other professions, leasehold property has some bad apples.  These operators should be addressed individually rather than punishing the whole asset class.  After all, Parliament has had more than its share of criminals – rapists, conmen, frauds and many other bad actors.  Nobody campaigns for the House of Commons to be abolished because of them!

UNINTENDED CONSEQUENCES

To put it bluntly, the proposal to reduce ground rents to a peppercorn – aka zero – will destroy the leasehold system.  Leasehold is an idiosyncratic British system which has developed over hundreds of years and actually works pretty well. Wrinkles have been ironed out by many years of case law.  All of the practitioners know where they stand.

Freeholds are sold on the open market.  There are already laws in place such that leaseholders have to be offered first refusal on these asset sales.  In more than 50% of cases, the leaseholders do not take up these rights.  This demonstrates that not all leaseholders want the hassle and responsibility of managing their own freehold.  Freeholds usually sell for 15 to 20 times the annual ground rent income.  It is interesting to note that prices are not affected by whether management of the property is included or not. This illustrates that the value of managing service charges is set by the market at zero!  Many property owners consider that the fees to be received for providing this service are not worth the responsibility and overall hassle.

One has to wonder what will happen to these freeholds if ground rent is abolished.  Bearing in mind the lack of attractiveness of managing service charges, suddenly there is a link in the chain with no interest in the future of the building.  Most freeholders will confirm that ground rent is what keeps their interest in ensuring that the property is maintained and insured.

The next unintended consequence is that without an interested and motivated freeholder, some of the leaseholders will have to pick up the reigns to manage the property.  Sebastian O’Kelly of the Leasehold Knowledge Partnership, the property campaigners, is quoted as saying: “You will own the property with your neighbours but you’re going to be responsible for it as well. You’ve got to sort things out yourselves. That will mean people have to take proper decisions about their block.”

Our members have reported several instances where the right to manage and indeed the freehold have been offered to leaseholders for free and turned down.  Not everyone wants to spend their spare time managing a large block of flats, and most rational people do not want to be chasing their neighbours for money every year.  This is especially difficult if some of those leaseholders cannot or will not pay.  If the service charge kitty is empty when the insurance needs to be paid, what will happen?  A motivated and engaged freeholder is almost certain to loan the money to the service charge kitty.  A disengaged or absent freeholder with no ground rent income to protect will not do so. Suddenly, there is no backstop should the leaseholders struggle to manage the property.

990 YEAR LEASE WORRIES

The extra plan of Mr Gove to extend all leases to 990 seems to create more problems than it solves. Yet again, it removes an asset from the freeholder without compensation.  A freehold with no reversion for 990 years and no ground rent is effectively worthless.  This means it will not be managed or treasured.  It is likely to be lost or just allowed to be sit in a dormant company.

The other idiocy of 990 year leases without ground rent is that it is an incredibly long time.  All of the buildings currently standing will be obsolete or derelict long before then.  One only has to look around for structures constructed 990 years ago – in 1033AD, before even the Battle of Hastings – to comprehend that the leases will last much longer than the building.  When the building is no longer relevant in a couple of hundred years, who will organise the leaseholders with 790 years left on their leases?  Who will be able to redevelop the land when perhaps 50 or more leaseholders are involved?  When politicians struggle to plan for issues extending beyond the next election, perhaps it is overoptimistic to hope they might consider problems they are creating 200 years into the future?

SUMMARY

The Leasehold System has developed over hundreds of years and actually works pretty well.  Freeholders have accepted lower sales prices for dwellings on the basis that they will receive an annual payment and reversion of ownership some generations into the future. It would be outrageous for any Government to interfere with millions of private contracts, giving a windfall gain to one class of investor, but only at the expense of a different class of long-term owner. Making these changes is likely to create as many problems as it solves.