Leasehold issues for lenders mini-series 2: Ground rent ‘scandal’ and unfair practices updatePrint publication
Walker Morris’ Sandip Singh explains the ground rent issue that has resulted in many leasehold owners feeling trapped in a home where they are forced to pay higher ground rents than anticipated; cannot afford to buy-out the freehold owner; and cannot sell the property on. Sandip also explains related unfair practices within the leasehold market, reviews the UK Government’s response and comments on the potential for legal claims, and on the implications for mortgage lenders.
“the PPI of the housebuilding industry” and “legalised extortion”…
… is how Justin Madders MP and the chief executive of the Chartered Institute of Building respectively have referred to the issue of leasehold ground rent clauses in many new-build properties sold in recent years. The issue concerns leasehold houses and flats which have been sold by housebuilders to consumers where the lease includes clauses which provide for ground rent payable by the homeowner to increase at a significant and, crucially, an unexpected rate.
Diversity in Low Cost Home Ownership options, coupled with economic pressures facing borrowers of all ages and across all socio-economic groups today, has resulted in mortgages increasingly being offered on leasehold flats, retirement housing, shared ownership arrangements, and so on. While leasehold has traditionally been the appropriate form of land ownership for properties within communal buildings and estates, a trend has emerged for developers to sell new-build houses as leasehold properties.
There is nothing inherently wrong with leasehold houses, or flats for that matter. As far as lenders or purchasers are concerned, so long as the lease is properly drafted and attempts are not made to take advantage of the freeholder/leaseholder relationship.
Last year the BBC announced that: “Almost half of all newly built properties in the UK are sold as leasehold rather than freehold properties. Some homeowners have found they are then tied into paying a ground rent that increases every year.” In some of the cases we have seen, the ground rent doubles every 5 to 10 years so that by the end of the lease term it runs into the £millions.
The reason for this is commercially motivated and the problem is compounded where developers have then sold the freehold interest in the property to another party, who collects those rents and refuses to sell the freehold to the homeowner except in return for a large premium. In many cases, customers had been told outright, or had at least led to believe by sales staff, that they would be able to purchase the freehold themselves, shortly after their purchase, for a much lower sum only to find that such promises are not upheld by the new freeholder who has purchased from the developer.
This problem is further exacerbated because the Housing Act 1988 (the HA) deems leases of 21+ years with ground rents exceeding £1,000 per annum in London and £250 elsewhere (that is, a very large number of properties indeed) to be assured or assured shorthold tenancies; and provides that arrears of rent, including ground rent, are a mandatory ground for recovery of possession. This is an issue that affects not only new properties but also traditional, older leases where parties have failed to recognise the significance of the ground rent exceeding the maximum level set out in the HA.
An immediate problem for lenders of such assured or assured shorthold tenancies is that they are easily terminable under the HA and, unlike long leases, in the event of a default by the tenant the landlord/freeholder can bring statutory possession proceedings and obtain possession without the need to deal with a forfeiture process that would allow a lender to seek relief. With an assured or assured shorthold tenancy the landlord could obtain possession following a default before the lender was even aware that there was such an issue and without the lender being able to resolve the problem post-default.
Some retail lenders are also refusing to provide mortgages on properties containing onerous ground rent clauses. Such leases are at greater risk of forfeiture due to the high and unaffordable ground rents that will be payable year on year, as well as the risk that such leases are no longer long leases but assured tenancies with significantly less value.
So far as lease owners are concerned, many now feel trapped in a home where they are forced to pay higher ground rents than anticipated, cannot afford to buy-out the freehold owner and cannot sell the property on because the issue has come to light and is adversely affecting saleability
Housebuilders are facing a variety of complaints, including: the allegation that the leasehold structure is unnecessary and has been put in place merely to extract value via ground rent obligations and sale of the freehold to investors; the detail and significance of the ground rent clauses were not sufficiently brought to the attention of customers prior to and at the point of sale; customers were misled about the potential for them to purchase the freehold and/or the freehold was then sold out from under them to private investment companies; customers felt under pressure to appoint solicitors recommended by the developer (and those solicitors did not then properly advise their client); and that excessive administration fees are charged by developers each time a query or complaint is made by disgruntled homeowners. All of this has led to the issue being debated in Parliament and to housebuilders being denigrated by the all-party parliamentary group on leasehold reform and in the press.
In an attempt to address these, and related, issues, the Government consulted on various matters, including the following, in its consultation paper ‘Tackling unfair practices in the leasehold market’:
- Whether and how the Government should limit the sale of new leasehold houses.
- What reasons are there for houses to be sold with leasehold (as opposed to freehold) tenure.
- Whether and how the Government should limit the reservation and increase of ground rent on new residential leases.
- What effect the restriction of ground rents would have on the supply of new build homes.
- Whether arrears of ground rent should be exempted from ‘Ground 8’ possession orders made pursuant to the Housing Act 1988.
- Whether freeholders occupying shared private estates should be given rights to challenge the reasonableness of estate service charges similar to those enjoyed by leaseholders.
After receiving some 6,000 responses, the majority of which were from private individuals, the Government published its consultation response on 21 December 2017. The key points to note are:
- New legislation will prohibit new long leases being granted on residential houses (whether new-build or existing houses).
- The Government will work with UK Finance to address any misunderstanding of lending criteria in relation to leasehold property.
- The legislation will ensure that ground rents on new leases of houses and flats are set at a peppercorn rate only.
- The Government has written to developers to discourage the use of ‘Help to Buy’ equity loans for the purchase of leasehold houses.
- A number of developers have already introduced schemes to compensate existing leaseholders with onerous ground rents. The Government wants to see such support accelerated and extended to all affected leaseholders (including second-hand buyers) and for all developers to proactively contact customers.
- The Government will work with redress schemes and Trading Standards to provide leaseholders with comprehensive information on the available routes to redress, including where their conveyancer has acted negligently, and the Law Commission will consider whether unfair terms apply when a lease is sold on to a new leaseholder.
- The Law Commission will also consult on introducing a prescribed formula that makes it easier for leaseholders to buy the freehold of their home, while providing fair compensation to the landlord.
- The Government will consider what it can do to get commonhold  off the ground across the property sector, including working with mortgage lenders. (Commonhold was not successful when first introduced because of the financial incentives for developers in building leasehold.)
- The Government has committed to action to ensure that leaseholders are not subject to unfair possession orders as an unintended consequence of the HA’s deemed assured tenancy and mandatory possession for arrears provisions.
- The Government will also ensure that, where a freeholder pays a rentcharge, the rentcharge owner is not able to take possession or grant a lease on the property where the rentcharge remains unpaid for a short period of time.
The response also states that the Government is committed to improving the situation of leaseholders more generally, and the proposals outlined so far are a starting point only.
Practical implications for lenders
If the Government enacts proposals in line with its consultation response, the situation should be significantly improved for homeowners and for mortgage lenders in the future.
Issues are likely to remain, however, for existing leaseholders already affected by escalating ground rents.
Some housebuilders have so far announced voluntary schemes enabling affected leaseholders to receive financial assistance with onerous ground rents, or whereby developers will buy back freehold reversions from third party investors so that ground rent obligations can be rectified. If such schemes work, then lenders will obtain the security that they expected and thus will not be any worse off than they should have been. The same will naturally apply for lease owners too. However, such schemes are currently by no means common across the industry, and even where they do exist they are generally limited, whether in terms of customer-eligibility or because only a finite financial provision has been made available. Such schemes will also not resolve issues relating to historic leases that have static or increasing ground rents that have gone unnoticed.
Lease owners and, if the lender’s mortgage terms allow, lenders may be able to either negotiate for a variation to the ground rent clause with the freeholder or may be eligible to seek a statutory lease extension which would then not only increase the term length but also mean the ground rent becomes a peppercorn. However a word of warning: a statutory lease extension requires a premium to be paid to the freeholder which is calculated with reference to, amongst other things the rent he will lose if the new lease is at a peppercorn. As a result, the premium itself may be prohibitive given the ground rent on an onerous lease will likely be high.
All of this means that affected parties may look elsewhere to try to recoup their losses. Property professionals and indemnity insurers are already receiving large numbers of claim notifications. Conveyancing solicitors who failed to advise upon escalating ground rent clauses or high static ground rents and/or mortgage valuation/Homebuyer surveyors who failed to raise such provisions as a risk in their reports could find themselves facing claims.
In addition, Walker Morris has written previously about consumer protection risks facing the property industry. It is possible that a failure, on the part of estate agents or developer’s sales staff, to flag onerous ground rent clauses to potential customers could amount to an unlawful material omission, giving rise to liability for prosecution under the Consumer Protection from Unfair Trading Regulations 2008.
This leasehold market review and response is likely to result in some significant market and practice changes for housebuilders/developers, mortgage lenders and homeowners alike when it comes to how leases are dealt with in the future, but there is no intention to revise or disapply onerous clauses in leases that already exist. As a result, lenders will need to be alive to the terms of the leases that they lend on. Where appropriate, lenders should also ensure that they act quickly to safeguard as many options as possible, whether by seeking to vary the terms of the lease, agree a statutory lease extension or bring third party claims against solicitors or valuers.
 Commonhold is a type of freehold ownership which is created by a further registration at the Land Registry. Commonhold combines freehold ownership of a single property within a larger development, with membership of a company limited by guarantee that owns and manages the common parts of the development. It allows the owners of each unit within a development to be in control of the development, without a landlord or other party able to make decisions about how the development is run.