The issue of leasehold and the impact it has on the lives of many home owners was something of ‘hidden scandal’ within the UK property market and despite growing numbers affected, it never quite broke into wider public consciousness.
In June of last year however, an investigation into the use of leaseholds was launched by the Competition and Markets Authority (CMA).
In simple terms, a buyer who purchases a house leasehold, rather than freehold, is basically in a position of being a tenant with extremely long rental terms, having to pay an annual ‘ground rent’ and ask for permission for actions such as replacing windows or building a conservatory.
Home owners being exploited
The scandal centred on the ground rents, which had typically been symbolic amounts such as £1 per year, but were increasingly being exploited by developers.
This exploitation would take the form of a clause in a contract stating that the initial ground rent would be something like £200-£400 per year, and that this would double each decade. In this way a ground rent of £400 in 2010 would have ballooned to £12,800 by 2060.
On top of this, freeholders were also making money through tactics such as charging £2,500 for permission to build a conservatory.
The Law Commission reports
In response to growing pressure for change, the government asked the Law Commission to consider ways of dealing with the issue and in particular of easing the path toward ‘enfranchisement’ – the term given to the act of purchasing a freehold outright or extending the lease.
The recently published report sets out possible reforms which will simultaneously reduce the price of purchasing a freehold, whilst clarifying and simplifying what is often a complex and opaque legal process.
The Law Commission sought to deal with the issue of valuation and suggest options that would reduce the price paid by current and future leaseholders wishing to enfranchise their homes, at the same time as maintaining fairness in terms of the compensation paid to landlords.
One complication recognises the landlord’s interest in any property is currently protected by UK human rights legislation and likely to impact on any change to the way the value of a landlord’s interest is calculated.
The Law Commission devised three options, each of which is designed to make enfranchisement cheaper, with a different proposed method for calculating the cost of that enfranchisement.
Alongside the cost, each method also suggests further reforms to the process, intended to embed simplicity and clarity within the system.
The Law Commission consulted widely with interested parties from all sides of the argument, when compiling their report. They were keen to balance the demands for reform by leaseholders with the concerns expressed by various bodies, including charities and pension funds, that feared reform might impact negatively on the value of their interests.
The levels of interest in the topic were reflected in the fact that a consultation paper published in 2018 drew more than 1,100 responses, while an online survey into leaseholder’s experiences pulled in more than 1,500.
As easy as one, two, three
The three options for calculating the premium to be paid for enfranchisement put forward by the Law Commission can be summarised as follows:
Option 1 – This premium assumes the leaseholder isn’t selling the property at the time of the calculation or in the future. Any extra value added by the leaseholder being in the market at the time of calculation is known as ‘marriage value’, while that added by the expectation of the property being in the market in the future is known as ‘hope value’.
This first option reflects what a landlord would receive if the leaseholder chose not to extend or acquire the leasehold, in which case the landlord would receive the ground rent for the rest of the unextended term, and then obtain vacant possession when the leasehold expires.
Option 2 – This premium assumes the leaseholder is not in the market at the time of the calculation, but may be in the future, so it includes the ‘hope value’ mentioned above. This option has been designed to reflect what a landlord would receive if their interest was purchased by a third-party.
Option 3 – This option adheres most closely to the current system and includes the ‘marriage value’ mentioned above, assuming the leaseholder is in the market at the time of the calculation. On its own, this option would not definitely cut costs for leaseholders, but the Law Commission assumes it would be combined with other change, which taken as a whole could still reduce the price paid.
In addition to these three possible schemes, the Law Commission made the following suggestions for options intended to simplify the process of enfranchisement and reduce the cost:
The Law Commission states it is now for the government to choose which, if any, of these options to enact, but also that they will be publishing further reform suggestions in the next few months, including a report into the possibility of establishing ‘commonhold’ as a viable alternative to leasehold.
If you are considering buying a new home, whether freehold or leasehold and want to discuss your options with an experienced residential property team, please contact Julie Tomasik, our Head of Residential Conveyancing on 0121 716 3732 or email email@example.com