I recently took a telephone call from a local agent who had been asked by a potential buyer of a leasehold flat to explain residential leasehold property. The buyer knew very little about leases, which is not uncommon because most people have only ever owned freehold houses. In the current economic conditions buyers are being very cautious about where they spend their money and are far less willing to take on the risk of substantial borrowing.
It is safe to say that this new cautiousness has meant that buyers are steering away from leasehold property partly because they are being prudent and partly because they do not understand why we have long residential leases. What exactly is meant by a lease? This question triggers the usual scratching of heads because leases are to some extent a bit like elephants. You would recognise one if you saw it, but it would be very hard to describe it. Of course, you find far more variety in leases than you do in elephants and solicitors have yet to find a way to charge for time dealing with an elephant.
Why do we need leases?
Many people equate the notion of a lease with social housing or private rentals on a six month tenancy. Pictures of Rigsby in Rising Damp or Ian Beale in Eastenders may come to mind. This notion may sit uncomfortably with someone thinking of spending the best part half a million pounds on a penthouse in Woolacombe with sea views. The fact is that people sometimes see leasehold property as a poor relation to freehold property.
From a legal perspective a lease of 999 years with a ground rent of a peppercorn (technically a leaseholder may be required to open their pepper grinder once a year and hand over a peppercorn to the freeholder) is far more akin to freehold ownership than a tenancy agreement where a leaseholder pays over £500 a month under an assured shorthold tenancy. The first point to appreciate is that the only absolute owner of land in England and Wales is the Crown. The rest of us only get an interest in land. This goes for everyone, including Prince Charles. Since 1925 there have only really been two types of legal interest in land, these are commonly called leasehold and freehold. Freehold lasts for ever and leasehold is limited to a specified time, for example 99 or 999 years. You are never completely king of your castle in either system.
On freehold land we all have to obey the law and restrictions are placed on our use of land by town planners and the building regulations department, and covenants are often imposed on freehold land to restrict what the owners can do. For example you may not be able to keep a caravan or boat on the driveway or you may not be able to build an extension or put up a shed without getting consent from the original developer.
Most of these obligations are designed to help us rub along nicely with our neighbours and the law allows these obligations on freehold land as long as they only prohibit owners from doing something rather than actively requiring them to do something positive, namely something that costs them money. This is essentially why any group of properties that need their respective owners to all pay into a common fund cannot easily be freehold. This would include a block of flats or group of maisonettes where someone must look after communal gardens or put in place a single insurance policy. For there to be enforceable obligations between neighbours to put money in a shared hat the neighbours must all own their properties on leases. A mortgage lender will generally not advance a mortgage on a flat if it is freehold. When it comes to flats and maisonettes, freehold is in fact the poor relation to leasehold.
Good Leases and Bad Leases
The basic principle with a leasehold flat is that each individual owner is responsible for the upkeep of the interior of his flat whilst the freeholder is responsible for insuring the block and maintaining the main structure and common areas. All the expenses incurred by the freeholder are then apportioned each year between the various individual leaseholders, the freeholder therefore generally not incurring any personal liability. Normal residential leases vary hugely. They tend to vary in the length of time from 99 years to 999 and may or may not charge a ground rent.
In terms of how attractive they are to buyers and how readily mortgage finance is available, they can be categorised as follows:
Good Leases – These are the ones that lawyers, estate agents and buyers like to see. They would normally run for 999 years and have a very low or nominal ground rent. These are generally the most favoured and effectively give you the property for ever as it is fairly safe to assume that the chances of the property still being here when the lease finishes in nine-hundred-plus years are very slim. From a valuation point of view the leasehold property would be worth the same as the equivalent freehold property. The value of a freehold interest of property divided into flats with long leases is usually very low.
In-between Leases – It is also safe to say that shorter leases, say for 125 years or 99 years with a ground rent of £129 per year, which still have at least 80 years to run should not cause buyers or sellers too many sleepless nights either. Some buyers would be put off by this, but generally speaking a mortgage lender would be happy to lend to fund the purchase of a lease in these circumstances. For these types of leases the freehold does have a value which is worked out by a very complicated formula which takes into account the level of ground rent and time left on all the leases together with the additional value you may receive by ‘marrying’ the leasehold interest and the freehold interest. This rather dry calculation is a surveyor’s job but, depending on the lease, the freehold value may run to thousands of pounds.
Bad Leases – Less attractive to buyers and lenders are leases that only have a short time left to run. As a rule of thumb a mortgage lender would only lend on a property where the term left to run was for the length of the mortgage (often 25 years) plus another 25 years. This does vary between mortgage lenders and, as property prices have increased, the length of the term of a mortgage has risen. It is now not uncommon to see mortgages for 35 years. This means that unless the lease has at least 60 years left to run, you may not be able to get a mortgage. If you are thinking about buying a property with a shorter lease you should also bear in mind that were you to sell the property in, say, 5 years it may be impossible or difficult for a buyer to get a mortgage on it. Generally speaking a leasehold property with 60 years left to run on the lease would be worth less than the equivalent freehold property. This value would decrease dramatically as the lease nears its end.
Owning a share of the freehold
Whilst a leasehold flat that is sold with a share of the freehold is quite popular on the property market, most prospective buyers do not fully understand what the deal means. Take the example of a leasehold flat with a 999 year lease and a share of the freehold on sale at £250,000. There are 4 flats in the building and they are all on similar leases. A buyer would own two separate interests; the lease and a share of the freehold. The freehold may either be in the joint names of all the owners or in the name of a company in which each owner has a share. The lease of the flat has an open market value of £250,000. The freehold, which will be shared by all four flat owners is worth very little on its own, but makes the leasehold more attractive in some buyers’ eyes. A share of the freehold may make a property more saleable, but it will not make it more valuable. The other key advantage to owning the freehold is that all the owners have greater control over the running of communal matters. Leaseholders, not distant freeholders, all decide when the outside needs painting or whether to shop around for a cheaper insurance quote for the building. There are still some inherent problems though. There is no guarantee that all the freeholders will agree on a course of action. If, as is often the case in North Devon, some of the flats are owned as second homes you may find it difficult to contact the other owners. The day to day management of things can sometimes prove more difficult when everyone shares the freehold than if there is one freeholder, simply because making decisions is more difficult. If the leaseholders set up a company to own the freehold, the company structure can help the decision-making process. However, the company will be subject to the usual requirements at Companies House and if the paperwork is not in order, the company may be struck off the register. If this happens, the freehold may revert to the Crown. The process to recover the freehold is costly and time consuming. Moreover, selling or remortgaging the property could be problematic or in the worst case impossible whilst the Crown owns the freehold, for no other reason than the Queen will not call round to check that the fire extinguishers are full or sort out the buildings insurance policy on renewal day. Owning the freehold can therefore be a bit of a two-edged sword.
Good leasehold management
Regardless of whether a prospective leaseholder would own a share of the freehold or have the freehold belonging to a freeholder, the general advice is the same: if it ain’t broke don’t fix it, and if it is broke do fix it. Flat owners sometimes object to service charges being too high. Others complain if they feel they are too low to provide adequately for the proper maintenance of the building. Bear in mind also that if other owners in the building do not co-operate readily when payments for shared costs are required other owners can have the unpalatable choice of paying more than their fair share of costs in order to try to get work done or face the prospect of trying to make the freeholder take court action against the other owner(s). Note also that the costs of any such court action may in the first instance have to be borne by the owners requiring action and of course there would never be a guarantee that such costs could ultimately be recovered from a defaulting owner. Sometimes freeholders disappear or decline to perform their obligations – all of which can be difficult for owners and off-putting if you are trying to sell. In terms of fixing things the law tends to favour the owners of flats rather than freeholder. It is the owners who have the expensive assets – the lease – and freeholder who has the less expensive asset – the freehold – which is sometimes worth nothing. The recent trend for legislation is leaseholder-friendly and is designed to prevent abuses by freeholders:
- Insurance – Leaseholders have the right to details of the building insurance policy – a right to inspect it and an entitlement to proof of payment of the premium, and a right to have a copy subject to paying any reasonable copying charge Leaseholders have the right to notify the freeholder of a claim up to 6 months after the event: but bear in mind that the policy itself may have different time limits if the lease obliges the freeholder to insure with an insurance office nominated by the freeholder there is a mechanism for the leaseholders to apply to a body called the Leasehold Valuation Tribunal (LVT) or the County Court which both have statutory powers to deal with this if it causes a problem
- Major Repair Work – the leaseholder has a right to be consulted by the freeholder in advance of repairs which will cost £1000 in total or £50 per flat – whichever is the greater. The freeholder must get at least 2 estimates for major works, one of which must be from a contractor wholly unconnected with him a notice accompanied by the estimates should be sent to all leaseholders OR displayed in a prominent place that will bring it to their attention the leaseholder has a month to make comments which the freeholder must take account of – and if the leaseholder is not consulted they have a right to refuse to pay part of any such costs if there is a recognised leaseholders association – as there often is in large blocks – the freeholder has additional duties to consult
- If the freeholder fails to carry out obligations to repair – any leaseholder has a right to ask the LVT or County Court to make an order compelling the freeholder to do so
- Court Costs – a dispute with the freeholder about service charge or the freeholder’s obligations may prevent the freeholder from trying to recharge its legal costs to the leaseholders
- Management Audits – a majority of leaseholders (normally 2/3rds) can require an audit of by a qualified accountant or surveyor of the way the freeholder is managing the building or estate – but note there is no power to recover these costs from the freeholder
Leaseholders’ right to manage
Leaseholders in blocks now have a right to manage the building even if the freeholder is not in breach of any duties under the lease provided that all the following conditions are met: The block must be a self contained building or part of a building, and Contain 2 or more flats held by qualifying leaseholders, and Qualifying leaseholders hold 2/3rds of the flats in the building, and The resident freeholder exemption does not apply The application of the rules is a complex subject. The requisite number of leaseholders must join in the right to manage scheme after all being given the opportunity to do so, and the necessary formalities including formation of a right to manage company must be complied with. Specialist advice will usually be required before embarking on a right to manage scheme.
Leaseholders’ right to acquire the freehold
Subject to some limited exceptions leaseholders in blocks enjoy the right to buy the freehold of the building. This is known as enfranchisement. Where the relevant number of leaseholders wish to exercise the right they must form a Right to Enfranchisement Company – which will be entitled to buy the freehold at a price to be agreed, or determined in accordance with the legislation if agreement cannot be reached. Note that one element taken into account in assessing the price of the freehold is the ‘marriage value’, the added value to the leaseholder of controlling both the freehold and leasehold interests in the building. The freeholder is taken to have a 50% share in the marriage value. But where the unexpired term of the leaseholder’s lease is over 80 years the marriage value is nil.
Therefore if you are considering buying a flat with the possibility of future enfranchisement check the remaining term of the lease – if it is less than 80 years you will have to pay the freeholder considerably more to reflect the marriage value than where there is more than 80 years left to run. This firm deals with leasehold property in all shapes and forms and prides itself on giving the best possible advice. Unlike almost all other firms doing similar all our property lawyers are qualified and specialise in specific areas or law. It is true that sometimes the most technically complex solution is not necessarily the most efficient of cost effective solution. We can give you both options and let you decide on the way forward. If you would like questions about leasehold property, flat management, enfranchisement, right to manage or landlord/tenant disputes answered, please free to contact us.