What is a Leashold Property and Why does it Matter? For Landlords and Homeowners
You’ve probably heard of properties being described as ‘freehold’ or ‘leasehold’ but what do these terms actually mean? Today, we look at what do you will need to know if you are thinking about buying a leasehold property and also at lease extensions and the Ground Rent Scandal.
With a freehold purchase the buyer owns the home and the land it is built on.
With a leasehold purchase, the buyer is effectively buying the right to occupy the home, for a specified number of years, from the freeholder. After that period ends, ownership reverts back to the freeholder.
How Long do Leases Last?
How long a lease will last will depend on several factors. Primarily, it will depend on what was agreed when the property was first sold but also the type of property it is, and where in the country it is located, can also have an impact.
Historically, leases have tended to be for 99 years but there are a lot of exceptions to this rule. For example, in Greater Manchester and Merseyside, terraced houses with 999-year leases and peppercorn ground rents are common. This is because the houses were built on old, large estates, where the respective landowners were unwilling to sell their land for the purpose of freehold housebuilding.
The leashold system should really be understood as a relic of the colonial days and while almost all of the former British Empire has abandoned it for other systems, it is still very much in-play in England, Wales and (with some differences and ideosynchranies) Northern Ireland. Scotland, however, has it's own ownership system, where properties are either freehold or, effectively speaking, shared freehold.
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When can a Property be Leasehold?
Flats and apartments, whether they are new builds, in converted buildings or above offices and shops, almost always are and have generally always been leasehold. In other words, if you are buying a flat, in all likelihood, you will be entering into a leasehold arrangement.
This is much less likely if you are buying a house, although, as per our example above (the terraces in Greater Manchester and Merseyside), it is far from impossible.
The Ground Rent Scandal
Unfortunately, over the last 15-20 years, we have seen some unscrupulous homebuilders and developers, exploit the system, in what has become known as the Ground Rent Scandal.
As we have seen above, houses are typically sold as freehold and flats as leasehold. This means that flat owners can have to pay ground rent to the landowner which in most cases is a very affordable charge and in some, is what is known as a peppercorn or peppercorn rent. (Peppercorn rent is a very small, nominal charge, that exists, historically, only to enforce the terms of the lease and keep it legally binding.)
So, what happened in the scandal is that some homebuilders and developers decided to flip the switch on these norms and started to sell houses as leaseholds while writing into those agreements, ground rents of, for example, £400 per year and as this wasn't bad enough, they were including provisions in their agreements that this amount would increase over time, say, doubling every 10 years.
There is a lot that could be said about this story (not least of all the efforts that were made to make sure home buyers didn't understand the detail of what they were signing are jaw-dropping) and I recommend this article from the Guardian if you want to get up to speed on it all but the cliff notes version is this: at least 100,000 people ended up trapped in properties, with spiralling ground rents, that they couldn't sell, exactly because of those spiralling ground rents.
The end result of all this? The government banned ground rents from applying to almost all new build properties, as of the 30th June 2022 so while you should always get independent legal advice on any property you buy, homeowners are now largely safe from this kind of practice.
Advantages and Disadvantages for an Investor
As an investor, buying a leasehold can yield a couple of key advantages over a freehold.
The first is that buying a flat (especially in an apartment block) will generally be a more convenient, hands-off investment when compared to buying a house. This is because, while every block is different' they often come with facilities management, cleaning, gardening, maintenance and security.
While it is true that these services fall under a service agreement and are not covered by ground rent (which does not imply the provision of any services at all), you are unlikely to buy a property that comes with such services, without it being a leasehold.
The second concerns lease extension opportunities, which we shall go into more detail about in the next section of this article. In short, a lease that is coming to the end of its term can make a property unmortgageable, presenting cash-ready investors, who have knowledge of the lease extension process, with the opportunity to buy at a discount and sell at a profit.
However, there are a few disadvantages to leasehold properties as well and would-be investors should take note and always consult with a solicitor before purchasing.
The first is ground rent. The Ground Rent Scandal notwithstanding, ground rent is normally low, often peppercorn and is no longer allowed on new developments. But it does still exist, it needs to be paid and you don't want any nasty surprises.
Secondly, there can be extra conditions, connected to the lease. Pet ownership or rules around noise are two possible examples of this. Again, it is a case of knowing what you are agreeing to.
Thirdly, your rights to refurbish your apartment might be restricted by the terms of the lease, meaning that you would require a license to alter to engage in any refurbishment works.
And finally, you don't want to run into any trouble regarding the length of the lease. Whilst investors may actively be on the lookout for short leases if the lease runs out without being extended, the property can be lost and trying to sell with a short lease can be difficult. It's not a situation anyone would want to find themselves in by accident.
Extending a Lease
Owners of leasehold properties have a legal right to extend those leases, through a process known as enfranchisement.
A lease can be extended by up to 50 years for a house and up to 90 for a flat although to apply, the homeowner needs to have owned the home for at least 2 years. However, if a homeowner buys a property after the lease extension process has begun, then the extension can still go ahead.
On top of the 'security of ownership' a lease extension can bring, it can also enhance the value of a property by making it easier to get a mortgage on and an extension may also mean that ground rent is cancelled, bringing down costs.
As mentioned already some property investors will buy short-leasehold properties with a view to extending the lease, meaning they can sell at profit but this is not a strategy for beginners in this market.
The Leasehold Extension Process, Explained
The Leasehold Advisory Service or LEASE should be the first place to go to when considering extending a lease. They are an official public body who provides free initial advice to residential leaseholders.
You’ll need a solicitor who specialises in leasehold extension. The Law Society’s Find a Solicitor tool can help you find one – search the ‘Houses, Property and Neighbours’ tab. There is no fixed scale of charges, so ask for estimates first.
It is also advisable to obtain a professional valuation to establish a reasonable cost for the extension. You’ll need a surveyor experienced in these kinds of valuations. The RICS Find a Surveyor tool can help here.
There are two ways in which a lease can be extended: The first is by informal negotiation with the freeholder in which case it can be done under any terms you both agree. The second is using a formal legal process. This starts by serving the freeholder with a formal Tenant’s Notice to Extend.
By law, the freeholder is required to extend the lease at its fair market value. This is worked out according to a fairly complex formula. It takes account of factors including the reduction in the value of the freeholder’s interest in the property between the existing lease and the new longer lease, and compensation for loss of ground rent.
You may also have to pay what is known as marriage value if the lease has under 80 years remaining. Marriage value means that as well as the cost of the leasehold extension you will be expected to pay 50% of the adjusted amount or potential profit that the leasehold extension adds to the value of the property.
The Leasehold Reform, Housing and Urban Development Act 1993 stipulates how marriage value should be calculated, and that it should be shared equally between the leaseholder and freeholder. The Leasehold Advisory Service explains how it is calculated according to the law.
It’s clear that buying or investing in a leasehold property involves many more considerations than buying a freehold property. So always be sure to ask your conveyancer or solicitor to explain the terms of the lease to you in detail.
That said, there is no reason why a leasehold property shouldn’t make a perfectly good property investment – as long as you know exactly what conditions and costs the lease involves and that all the numbers still stack up.