28th June 2022
On the 9th February, the Leasehold Reform Bill (LRB) received Royal Assent. This eliminates financial ground rent on newly created long residential leases. The Government has confirmed that this law will be implemented on 30th June 2022. After this date developers will still be able to sell their units leasehold, however they will be restricted to peppercorn ground rents, with fines up to £30,000 for those that charge ground rent in contravention of the Bill. This legislation is not retrospective and ground rents already in existence will be preserved.
The ground rent industry has largely been expecting the announcement, many developers and their advisors have been caught off guard with many still unaware. The effects of this change are myriad, posing significant and challenging considerations for valuers, lenders, lawyers and purchasers.
Loss of expected ground rent leading to margin and viability erosion
It is accepted that margin and viability erosion is coming from many different angles – be it materials, labour, interest rates or what is now perceived to be a softening market. We can also add the loss of the capital receipt from a ground rent sale to this list.
Ground rent can often be overlooked as a contributor to margin and viability as the relatively low rents do not seem to matter in the grand scheme of things. However, once aggregated up with a competitive multiple applied they can easily hit £10,000 per unit. Again, whilst this figure is hardly life changing it is almost all profit – save for legal costs – and would make up a fifth of development profit on £250k unit working to a 20% margin. The removal of this highly reliable capital receipt combined with the other downward pressures will seriously undermine viability and therefore valuation.
Who is going to be responsible for these complex and specialist liabilities going forward?
Professional freeholders are highly specialised entities with high level skillsets across insurance, facilities management, health & safety, fire risks to name a few. On top of this there is a daily stream of legal, financial and administrative items to attend to. This can range from somebody simply selling their house to complex legal issues. It ranges from petty disputes amongst neighbours to anti-social, sometimes criminal, behaviour. It is never ending and perpetually evolving – if you sat in our office for a day you would be amazed at what can happen across a large portfolio.
We are content to take on these responsibilities and shoulder the internal resourcing costs as we have an income stream and asset to protect. We are perfectly aligned with the apartment owners as we both have a vested interest in the long term success of the building. On the basis we are effectively perpetual investors our horizons are far longer than that of a buy to let investor who maybe looking to work an asset for cashflow and a quick exit. It is our responsibility to do what is best for the building and collective, not the individuals. It is also common that our investment into a building is many magnitudes more than that of any individual owner meaning we have the biggest financial interest and the longest horizons.
The removal of financial ground rent will simply mean professional freeholders cease to participate in acquiring these assets post completion. The developer, who is specialised in an entirely separate field, will be left holding a worthless asset that is laden with responsibility and liability.
It has been suggested that they can simply sign these assets over to the layperson leaseholders who would then be expected to take on the role of a professional freeholder. There is a further suggestion that these leaseholders would then appoint third party managing agents, harmony would be restored and asset values protected.
Unfortunately, and speaking from vast experience, this is a flawed – even naïve – perspective. Managing agents can be fair-weather friends, happy to take on easy jobs and the fees yet quick to resign when the inevitable issues and disputes arise. We saw this post-Grenfell, when many simply resigned, and have seen similar exits from roles in light of the Building Safety Bill becoming law. To date these situations have been solved by professional freeholders stepping in to take on the responsibility.
We know from experience that managing agents who benefit from large volumes of business from professional freeholders accept that it will not all be plain sailing and will work hard to resolve issues to protect their wider business relationship. This will cease to be the case when all future buildings have fragmented ownership at site level.
It has been suggested that managing agents could acquire the freeholds to future buildings as despite there being no ground rent they would still benefit from the management. This is a dangerous position as the managing agent would then become entrenched and lose all incentive to perform, whilst the leaseholders would be unable to remove. The oversight and experience of a professional freeholder ensures performance as well as a backstop in the event of issues. The largest managing agents, who can be looking after 100,000+ units, have balance sheets that are a fraction of those of a professional freeholder investor, especially the multi-billion pound institutions and estates.
Additionally, which is another article in itself, the insurance market has become increasingly difficult. We are directly FCA authorised insurance brokers and have an insurance portfolio approaching £3.5bn and yet we still have to battle on a daily basis to ensure workable terms and premiums. Individual buildings will not benefit from this economy of scale, experience or knowledge. We are often approached by leaseholders with far more attractive quotes than the ones we have procured only to highlight that the building would not be covered under a whole host of scenarios. It is easy to reduce the cost of insurance by removing important elements of cover yet that is not what insurance is there for, nor will mortgage lenders accept unreliable policies.
What happens next?
On the basis that development finance rests on the developer being able to sell the units, which relies on valuations and legal reporting stating that the asset is good security there is a major issue developing. If the success of an individual unit is inherently correlated to that of the building within which it sits then the ownership and management of that building is a key component of the valuation. If there is going to be no professional oversight of a building and no reliance upon the long term success of it’s management then it is increasingly difficult to provide a reliable opinion.
We may see completed sites where unit sales are hard to achieve due to the uncertainty of future management and values, therefore undermining mortgage access and sales. Alternatively, lenders may become more proactive and see that there is a major risk in backing a development if the exit is unreliable and simply not participate. This is something Government have been warned about over the last few years, yet as laypeople themselves have failed to understand or acknowledge.
If the lending market starts to overlook new build apartment schemes or the completed units then we fear Government may have to step in with some sort of underwrite scheme. As with any Government project, irrespective of success, the cost of this would be horrendous. This could all have been avoided with some sensible parameters put around ground rent levels and terms.
Ironically, we may well see a two tier market where ground rent paying leaseholds with professional freeholders are sought out by lenders and buyers. Our average ground rent is around £3 per week, a small price to pay for the benefits and value protection we provide.
If you have any questions about how these changes may affect your work and clients, or if you are aware of any ground rents for sale, please drop Ben an email – firstname.lastname@example.org
Landmark Investments, established 2000, are reputable ground rent investors who have been operating in this niche sector since the mid 2000s. Their portfolio exceeds over 26,000 units and they regularly work with, and acquire from the PLC housebuilders.
Ben Ogunby joined the Landmark team in 2008 as Acquisition Director. Over the years his department has overseen well over 1,000 ground rent transactions, with a collective value in excess of £600m.
By using this form you agree with the storage and handling of your data by this website.