Ground rent - a stumbling block for purchasers of leasehold properties

Ground rent might not seem like a very important part of a property purchase, especially at a time when there are so many other things to think about. But whether you are a first time buyer, taking your first step on the property ladder or a landlord adding to your investment portfolio, if you are buying a leasehold property, take note of what it says about ground rent..

What is ground rent?

Ground rent refers to a recurring payment made by a leaseholder to the freeholder (also known as the landlord) of a property, typically on an annual basis. In essence, ground rent represents the rent paid for the use of the land on which the property is built. The amount of ground rent payable is set out in the lease.

The amount of the annual ground rent can vary from lease to lease. It can be a peppercorn (i.e. nil), hundreds or even thousands of pounds. The ground rent can be a fixed sum for the length of the lease, or the lease can provide for the ground rent to increase over time.

This unique form of tenure has its origins in history, dating back centuries; but throughout its primary purpose has been to maintain the freeholder’s ownership rights over the land. While it may appear a straightforward concept, the legal implications can be far-reaching and multifaceted.

Is ground rent the same as the service charge?

Ground rent is not to be confused with the service charge. They are both common elements in leasehold arrangements; they serve different purposes and cover distinct aspects of the leaseholder’s responsibilities and the freeholder’s obligations. As you can see below, ground rent and service charge cover relate to very different elements of your leasehold property ownership and usage:

Ground rent:

Your ground rent payment will be pre-established and typically follows an annual schedule. It is essential to grasp that ground rent is essentially a reflection of the tenure’s historic foundations; it serves to recognise the landowner’s interest in your property and to pay him or her (or sometimes a company) for the use of the land on which your property is built. It does not include any element of property maintenance or shared service expenses.

Service charge:

In contrast, your service charge is a financial contribution made by you and other leaseholders to the freeholder or a designated management company. The primary purpose of the service charge is to defray the costs associated with the maintenance, upkeep, and management of communal areas and shared amenities.

Unlike ground rent, service charges are not fixed but fluctuate depending on actual expenses incurred throughout the lease period. These expenditures are likely to consist of essential services like repairs and upkeep of the property, landscaping, and general administration of communal facilities.

So why is ground rent important?

Ground rent that exceeds more than £250 per annum is seen as a red flag by conveyancers and mortgage lenders.

If your ground rent is (or will be during the term of the lease) above the £250 threshold (or £1,000 in Greater London) the lease may be considered an ‘assured short hold tenancy’. This means that should you fall into three months of ground rent arrears, your landlord will have the right to repossess your property. Failure to pay ground rent provides the landlord with greater powers to take possession of the property and bring the lease to an end. Your landlord would be able to seek to end your occupancy by a court order, and attempt to evict you under the same law landlords evict tenants of rented property.

But how can my leasehold property be classed as an assured short-hold tenancy?

The Housing Act 1988 can potentially be interpreted as an assured shorthold tenancy if:

1. The ground rent is over the amounts stated above and

2. The property is the only principal residence of the leaseholder.

Essentially, this means that all of the usual rules around forfeiture - in other words, how and when the lease is terminated - as well as relief from forfeiture, do not apply. So, the usual thresholds for rent arrears are irrelevant, as are the rules requiring determination of breach of lease. If you have a long lease, the law says you can pay off any arrears, even after a possession order has been made, and therefore stay in your home. But if you are deemed to have an assured shorthold tenancy, those provisions won’t apply. 

Repossession is therefore the biggest risk for leasehold properties with ground rent that exceeds the threshold. Forfeiture results in the loss of the leaseholder’s rights to the property and although repossession due to ground rent arrears is not common, it remains a potential risk for leaseholders who encounter financial difficulties.

How does this affect my mortgage lender?

Ground rent terms can significantly affect buyers with mortgages, particularly in cases where ground rent increases are structured to escalate over time. Mortgage lenders have become increasingly cautious about lending on properties with onerous ground rent terms. Some may refuse to provide mortgages on properties with high ground rent or rent that increases substantially over the term of the lease. Even if you are a cash buyer and don’t need a mortgage, it could seriously affect the marketability and value of your property when you come to sell.

What does the government say about ground rent?

In response to the growing concerns and issues related to ground rent, the government has implemented reforms to improve leasehold practices and protect leaseholders. These aim to address excessive ground rent terms, promote transparency, and equip leaseholders with greater rights and control over their properties.

As part of the Leasehold Reform (Ground Rent) Act 2022, ground rent has been abolished for new leases of flats and houses in England and Wales. Under the new law, the government states that ground rent for new leases is set at a “peppercorn rent, effectively restricting these ground rents to zero financial value”. That includes a lease on a brand-new property, a new lease signed when you buy an older flat or an extension to your existing lease.

However, many property owners with existing leases will continue to face ever-growing ground rent costs. 

The government is trying to address this. It says: 

“The government is aware that, where ground rents exceed £250 per year or £1,000 per year in London, a leaseholder is classed as an assured tenant. This means, that for even small sums of arrears, leaseholders could be subject to a mandatory possession order if they were to default on payment of ground rent. The government will take action to address this loophole and ensure that leaseholders are not subject to unfair possession orders.” 

However, there is no definitive date as to when this will happen.

Is there anything I can do if I’m faced with excessive ground rent charges?

The good news is that if you want to buy a property that has a ground rent in excess of the threshold, there are things that you can do. 

 

Deed Of Variation

A Deed of Variation is a legal document that allows both the leaseholder and the freeholder to mutually agree on changing certain terms of the lease. Sometimes this will require the approval of a third party, such as a lender, but this will depend on the circumstances.

If your ground rent exceeds the threshold you could consider drawing up a Deed of Variation that will ensure that future increases of ground rent are reasonable or fixed. This will allow you to negotiate more favourable ground rent terms and improve the marketability and value of your property. However, the freeholder’s consent will be essential and you will have to pay all the costs associated with the Deed of Variation - including the landlord’s consent fee, the landlord’s legal costs and your own legal costs!

Indemnity policy

You may therefore consider that an indemnity policy is a better option. An indemnity policy is an insurance policy that provides financial protection against potential future costs or legal disputes related to ground rent issues. The policy only protects the lender and typically costs much less than a Deed of Variation. If the landlord exercises their right to regain possession of the property because the leaseholder falls into ground rent arrears, the lender would be protected by the policy. The policy does not protect you as the individual leaseholder - it will only protect your lender. If you buy a leasehold property for cash and it has a ground rent above the threshold, you should expect to have a request for an indemnity policy when the time comes to sell, because any potential future buyer with a mortgage will need either a Deed of variation or an indemnity policy in order to get a mortgage.

Lease extension

Another alternative is to pursue a lease extension. This is available to leaseholders who have owned the property for two or more years and involves extending the term of the existing lease. By extending the lease, leaseholders can negotiate new ground rent terms as part of the lease extension process.

It is important to note that the effectiveness and suitability of each of these methods will depend on the specific circumstances of the leasehold property and the willingness of the freeholder or seller to engage in negotiations before you purchase the property.

What to do now?

Buyers need to be fully aware of any ground rent obligations and thresholds associated with their purchase, and similarly, the costs associated with taking out an indemnity policy or seeking a Deed of Variation to provide assurance to lenders. Buyers should ask for a copy of the lease at the point they view the property and consult with a solicitor. And for freeholders, the programme of leasehold reform that is currently in motion together with the limits for ground rents on new leases makes it a good time to consider the practicality and viability of variations to their leases.

Should you wish to discuss this subject and its implications, please contact our Real Estate team for further advice. You can contact me on 01206 217328 or email me at [email protected]