"One of the longest-term challenges that the country faces: fairness in the housing market."
In January 2023 Michael Gove indicated that the Government had plans to abolish the "feudal" leasehold system. This has been on the Government's agenda for a while, following a White Paper published in February 2017 "Fixing our broken housing market". In England and Wales almost all flats and many houses are owned through leasehold structures (for reasons discussed below). It is reported that there are around 4.98m leasehold homes in England and Wales, of which 70% are flats and that the proportion of new-build houses sold by way of a leasehold transaction increased by 8% between 1995 and 2016. Accordingly, the property industry has been waiting for further details of Gove's proposals with some apprehension.
In his first King's Speech earlier this month, King Charles III announced a new Leasehold and Freehold Bill that will, according to the Government's briefing notes, "reform the housing market" and make "the long-term and necessary changes to improve home ownership for millions of leaseholders in England and Wales".
We have created a summary of the key takeaways from the King's Speech from a real estate and construction perspective. Most of the proposed changes are designed to empower leaseholders and improve their existing rights. However, these proposals appear to be far more modest than suggested by Gove's comments to date. One of the most significant changes is the proposed ban on the creation and sale of new houses by way of lease.
It is worth noting that the current proposals would not prevent new flats being sold as leasehold properties, despite Gove's original proposal to abolish the creation of new residential leases entirely. Some Tory MPs have indicated that they would challenge any failure by the Government to apply the "ban" to the sale of flats as well. A wide-ranging proposal to ban all residential leases would be incredibly challenging and require wholescale property law reform, which seems unlikely to be achievable before a general election. However, achieving a ban on residential leases for new houses may pave the way for the eventual end of residential leases.
Whilst we wait to see the detailed contents of the Bill and whether the ban on leasehold continues to apply only to new houses, at first sight, it appears that the proposals will grab headlines without fundamentally reforming the property landscape.
Why has the leasehold structure of residential properties come under scrutiny ?
In recent years media coverage has described the leasehold system as a "shambles" and "crumbling". There can be a perception of "punitive service charges", regardless of the legislative protection for leaseholders. In addition, ground rent charges in certain leases have been structured to increase disproportionately throughout the term, which has made some residential leasehold properties unsaleable and unattractive security for mortgage providers.
There has been piecemeal reform to address specific issues. For example, in June 2022 significant reforms were implemented through the Leasehold Reform (Ground Rent) Act 2022, limiting ground rent charges in new leases (subject to certain exceptions) to a peppercorn (i.e. effectively nil). The announcement of a consultation (which has now been launched) into capping existing ground rents in the King's Speech may further improve the situation for existing leaseholders going forward. The consultation includes five proposals for reform of existing ground rents from the Government:
- capping the ground rent at a peppercorn;
- capping the ground rent at a maximum value to which ground rent could rise;
- capping the ground rents at a percentage of the property value (which was put forward by consultees following a 2017 consultation on "Tackling unfair practices in the leasehold market";
- capping the ground rent at the original amount it was when the lease was granted; and
- freezing the ground rent at current levels.
However, this is only part of the story. In 2020, the Law Commission published a report on potential reforms to reinvigorate commonhold as an alternative to leasehold ownership alongside reports with recommended reforms to rights to manage and leasehold enfranchisement (which we discuss in more detail below). The Law Commission argued that structure of leases themselves (i.e. the time limited nature of leaseholds and a landlord's retained control over the property) are the root causes of many criticisms of leaseholds as a form of home ownership.
Why are leasehold structures used for the sale of residential houses?
From a technical legal perspective, leasehold title is a mechanism that ensures that both positive and negative covenants "run with" or bind the land, i.e. leases can impose obligations on future owners of the property. In contrast, positive freehold title covenants cannot automatically bind incoming purchasers. The simplest example is that an obligation to pay service charge contained in a long lease will bind all future owners of the leasehold property, but it would not bind future owners of a freehold property unless further steps are taken (as discussed below).
In addition, the current landlord and tenant structure gives the landlord or management company (as a third party joined to the lease) responsibility for enforcing breaches of the lease. If there is no lease in place and no landlord, then the developer will need to consider how covenants could be enforced between the various homeowners in a development. For example, obligations not to make alterations to a property without consent would normally be enforced by the landlord. In the absence of a landlord, thought will need to be given to how and whether such covenant can be meaningfully imposed.
These principles of property law are some of the reasons that encourage developers to structure the sale of new houses, as well as flats which are invariably sold as leaseholds, on new developments as leasehold interests. Where developers have a mix of housing stock, i.e. houses and flats on the same estate, a uniform approach of selling all residential properties by long leasehold interest would have provided both developers and purchasers with consistency in terms of covenants, enforcement of such covenants and the mechanism to ensure future purchasers would continue to be bound by those covenants. Any change to houses only will necessarily complicate ongoing estate management for developers and homeowners.
What alternative structure could be used?
In its 2020 report, the Law Commission suggested that commonhold (which was introduced as an alternative to leasehold in 2022) offers a number of advantages in comparison to leasehold ownership. However, the Law Commission recognises that a move towards commonhold would require a culture change in our mindsets and, as mentioned above, an overhaul of existing property law. We previously discussed the Government's proposal to establish a Commonhold Council and the Law Commission's proposals for reform to pave the way for commonhold as a form of tenure in the housing market.
What do the proposed changes mean for developers going forward?
If the Government's proposals to ban the use of leases for new build houses comes into effect, we anticipate that this will have several implications.
- Restrictive covenants on use and estate
regulations
As part of any new development, the developer will typically look to protect the overall aesthetic and amenity value of the development through estate regulations. These would typically include restrictions on alterations to the property, the permitted use and neighbourly behaviours, e.g. noise. Where sales are structured by way of a lease, the developer typically includes such regulations as part of the lease. Developers will likely want to retain these controls in order to maintain estate conformity and prevent damage to shared services or infrastructure. It will therefore become crucial that these restrictive covenants are incorporated on the title to the property. Restrictive covenants may also used by developers to ensure that certain ongoing planning conditions required to keep the development compliant are complied with by the homeowners.
In practice these covenants may not always be enforced or expressed to be enforceable following a developer's exit from a development. If this is the case it will be important to express such covenants to be for the benefit of and enforceable by neighbouring homeowners on the estate in the transfer documentation to enable them to enforce and manage issues with non-compliance and avoid potential legacy issues for the development.
Restrictive covenants will only provide protection in respect of prohibitions and not positive obligations or "positive covenants". To the extent that any regulations are positive in nature, such as payment into an estate service charge or rent charge, developers will need to use an alternative approach. It is most likely that developers will choose to add a title restriction to the title of each house, requiring purchasing homeowners to enter a deed of covenant on future sales. The deed of covenant would require the purchasing homeowner to commit to comply with positive covenants and such obligation would then be released on disposal.
- Management companies and service
charge
We would normally expect that new build houses that form part of a larger estate will benefit from common parts, such as private access roads, communal parking and electric charging points. The developer would normally transfer ownership of these common parts to an estate management company, which will be required to provide maintenance services at the expense of the various homeowners across the estate. Accordingly, in order to avoid a service charge shortfall homeowners will need to pay their share of the costs in respect of such estate services, whether or not their house is owned leasehold or freehold. Historically this was not a long-term concern because the estate common parts would typically be transferred to the local authority or other relevant authority which would then become responsible for the cost of their maintenance, which would be recovered through council tax. However, adoption is not always sought or achieved as readily now. The Competition and Markets Authority (CMA) recently identified a number of barriers to adoption of public amenities which include the costs to both housebuilders and local authorities and the discretionary nature of the framework for the adoption of certain amenities. These barriers were identified by the CMA following its the launch of a housebuilding market study earlier this year which looked into (amongst other things) the private management of public amenities. Earlier this month the CMA published for consultation a working paper on private management companies managing public amenities which includes possible measures that could be taken to address the CMA's "emerging concerns" regarding the private management of public amenities on housing estates. We will wait to see the outcome of the CMA's consultation in 2024.
If a positive obligation on the homeowner to pay a service charge cannot be included in a lease, then homeowners should expect that restrictions will be placed on title preventing any disposition (which may exempt the grant of a charge) without a deed of covenant being provided by the purchaser to the management company to pay an estate rent charge or freehold service charge. In practice, this is akin to a sale of a lease which would likely require the consent of the landlord to an assignment and any such consent would be conditional on the incoming purchaser covenanting directly with the landlord to comply with the terms of the lease.
As such, there is very little practical difference between a sale as a leaseholder or of a freehold title as homeowners will always need to covenant to pay their share of communal costs. In fact, a move away from leaseholds may be worse (at least in the short term) as the rent charge and freehold service charge system do not have the same level of protection for the paying party as the service charge regime for long residential leases (for example the consultation requirements contained within s20 Landlord and Tenant Act 1985). The Government has been indicating since 2018 that it considers that freehold maintenance charges should be reasonably incurred and ensure that freehold homeowners who pay estate rent charges have the right to challenge their reasonableness. The background notes to the King's Speech indicate that these reforms will find their way into the Leasehold and Freehold Bill which would be helpful. However, the extent of such changes and whether they fully put freeholds and leaseholds on an equal footing in respect of any such protections remains to be seen.
- Mixed tenure
As we have indicated above, a move away from leasehold houses will add to the disparity between leaseholders and freeholders on the same estate. These mixed residential tenures will arise on developments with a mixture of houses and flats, as well as phased developments that may be ongoing when the ban commences, assuming that there will be no carve-out for such developments.
Freeholders will, until the Government's proposed changes to freehold service charges or estate rent charges, be less well protected by existing legislation designed to provide some protection to leaseholders.
Conversely, if new estates are made up of a mix of long leasehold interests and freehold interests there will be disparity between how the homeowners are treated not only in terms of service charge as outlined above but also on sales of their respective interests.
- Forfeiture
To the extent that covenants are included as a covenant in a lease, there is normally a theoretical right for the landlord to re-enter or forfeit the lease in the event of non-compliance. In reality, it is very challenging for a landlord to forfeit a residential leasehold interest. However, this remedy is unique to leasehold title and will be totally unavailable in relation to property covenants that are attached to a freehold residential property. This may make it harder for property covenants (including the collection of service charge) to be enforced.
- Existing leasehold houses
If a ban comes into effect, this would only prevent the creation of new residential leasehold houses, which would leave large numbers of houses structured as leasehold properties on the market. We will need to wait to see whether these leasehold interests are enfranchised as part of the enfranchisement reforms and whether there are any further knock-on impacts on these types of houses.
The quote at the beginning of this article has been sourced from the background briefing notes to the King's Speech.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
