One of the biggest legal changes on the horizon for real estate in England has to be the government's proposals for the reform of residential leasehold law. Given the rising institutional interest in residential schemes and the growth in the number of mixed use developments, these proposals are going to be felt far and wide.
While there are numerous suggestions for reform, there are a few key proposals that stand out:
- a cap on ground rents for new long residential leases (that is, leases in excess of 21 years) at a maximum sum of £10 (though a peppercorn has also been suggested);
- a suggestion that it should be possible to legislate to remove or reduce ground rents in existing long residential leases. The proposal is that existing ground rents should be limited to 0.1% of current value capped to a maximum of £250 per annum with no ability to upwardly review; and
- a ban on the sale of new leasehold houses.
At the present time there is no draft legislation nor any clear timetable for implementation. However, these proposals have widespread political support across parties and are still prompting clients to question now how best to structure their future developments. The following are three of the most common questions that we are being asked.
How likely is it that these changes will be implemented?
Highly likely. Although there is currently plenty of political turmoil, these proposals for reform have received a lot of media and public attention and are sure to be popular with voters. Accordingly, even if we see more political upheaval, it is likely that whoever is leading government at the relevant time will continue to press on with the changes.
What is harder to predict is the timetable for implementation. At present we still do not have any draft legislation although the 2018 consultation1 on this subject indicated that draft legislation would be forthcoming this year. This makes it difficult for developers and investors to plan ahead.
The prudent approach would be to assume that there will be a cap on ground rents at a peppercorn (we think this is more likely than a £10 cap) and a ban on the sale of leasehold houses, and for stakeholders to plan accordingly. Even with established ground rents, a degree of caution is advisable given that the Select Committee report indicated it would be possible to legislate to cap existing ground rents (for more information, please see our previous update).
Can you reserve a "rent" out of a freehold property?
Some may be wondering whether, if there is a ban on selling new houses on a leasehold basis and a ground rent cap, it might be possible to achieve an income stream by extracting a sum equivalent to rent out of a freehold.
Historically, it was possible to extract an annual payment from a freehold for the benefit of a third party by way of a rentcharge. However, subject to limited exceptions, it is no longer possible to create rentcharges2.
Even if you avoid using a rentcharge, a similar scheme for extracting an annual sum out of a freeholder after the property has been sold (other than by way of service/estate charge payments) would be contrary to the policy behind these proposed reforms. This was summed up in the 2018 consultation which stated "when someone buys a house, it should feel truly their own. House buyers should not be faced with a depreciating lease or a ground rent charge for any other purpose than to pay for the privilege of living in the house they have already bought". As such, while it may be possible to devise ways of extracting further payments following the sale of a freehold (for example, by overage or charge) this is unlikely to go unnoticed by the legislators. Further attempts to circumvent the reforms may also run the risk of reputational damage for the party seeking to extract that extra value.
If the ban on the sale of leasehold houses is enacted how will it affect existing leasehold development sites?
If the government follows through on its current proposals, any leasehold development site acquired on or before 21 December 2017 will be exempt from the ban. So, for example, if you bought a leasehold site on 1 December 2017 and intend to redevelop it as houses, the ban on the sale of new leasehold houses should not apply. However, if you bought a leasehold development site on or after 22 December 2017 and the ban comes into effect as suggested, then, after the ban you will be precluded from selling any new houses on that site on a leasehold basis. That might mean having to reconsider the scheme and develop flats instead. For a handy guide on how this ban is likely to apply, please see our previous alert.
There are lots of questions about how these reforms are going to affect developments and investments going forward. Given the central role of residential within the property industry, it would be helpful if some of the answers were forthcoming sooner rather than later. What the market likes least is uncertainty, and there is certainly plenty of that around at the moment