Earlier this year, the UK Government reconfirmed its intention to bring forward residential leasehold reforms following the Law Commission's recommendations last year. The proposed changes are expected to benefit up to 4.5 million leaseholders.
The news will no doubt be welcomed by leasehold homeowners who have been campaigning for changes to what they perceive to be unfair ground rent laws. However, the impact on developers, house builders and landlords, is less clear, but it is likely to affect the legal structuring of both the ownership and the ongoing management of new residential developments.
In this article, we consider what the proposed reforms are, when they are expected to come into effect and some of the potential implications on developer landlords or investors.
What are the proposed reforms?
The key points of the reforms are:
- To give leaseholders of flats and houses the right to extend their leases up to 990 years without needing to pay a ground rent to their landlord. Currently, leaseholders of houses can only extend their lease term once for 50 years with a ground rent, whereas leaseholders of flats can extend multiple times for 90 years for nil rent.
- "Marriage value" (reflecting the increase in value of the property following a lease extension) is to be abolished.
- An online calculator is to be introduced making it simpler for leaseholders to find out how much it will cost them to buy their freehold or extend their lease.
- Changes will be introduced to ensure that leasehold owners of retirement properties have the same rights as other homeowners.
When do the changes come into effect?
The short answer: we don't know yet. At this stage, the proposed legislation is only at consultation stage and we do not yet have details of the legislative timescale. Even if the legislation is brought forward, it will take some time to go through the Parliamentary process, so the changes will not take effect immediately.
What is the position on ground rents in leases that have already been granted?
The prohibition on ground rents is expected to be forward looking and apply to future leases only. Therefore leases that have already been granted remain unaffected. If a developer is already in the process of constructing a build-for-sale residential scheme and has granted some leases which reserve a ground rent then the ground rent will continue to be payable under these leases.
What about contracts that are exchanged before the legislation is implemented?
The position is less clear in relation to contracts that are exchanged but not completed before the legislation is implemented (i.e. where the price has been agreed on the basis of a ground rent being paid but the lease has yet to be granted). There is very little detail in the Government's announcement and so it is hard to assess the full impact until the draft legislation is published. The key, as always, will be in the detail but for now, developers should consider doing everything they can to get the relevant phases of the development completed and the leases granted before the prohibition comes into effect.
How will landlords be compensated if "marriage value" is abolished?
The current proposals deal with the rights to extend leases but do not deal with payments to landlords. Therefore it is not currently clear how the loss of value to the landlord of the ground rent income will be compensated. Currently, when extending their leases, leaseholders pay a premium to reflect the benefit to them of replacement of a ground rent with a peppercorn rent. There is then a valuation process that deals with how "marriage value" is calculated and shared with the landlord.
Will there be a replacement of this element to fully compensate landlords? It remains to be seen. In the absence of any compensation built into the calculation, for developer landlords or investors who might be relying on the income generated from ground rents there may be an argument that this effectively is a compulsory acquisition of the landlord's property without compensation. In reality, we expect that, this will instead mean that the sale price increases to reflect the fact that the purchaser does not have to pay an annual ground rent, but it remains to be seen whether the market will be sufficiently buoyant at the point of sale to follow economic logic in this way.
Clearly the detail of the legislation will need to be scrutinised when the draft legislation is tabled and debated. However, given that the proposals recommended by the Law Commission in July 2020 purported to move the law in favour of leaseholders, it will be interesting to see what steps (if any) are taken to protect the interests of landlords and developers.
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