In relation to lease extensions and freehold purchases, the objective of the Leasehold and Freehold Reform Bill can be summarised as making it “cheaper and easier” for leaseholders.
For those advising clients about how much “cheaper and easier” it might become in practice it would be nice to have a crystal ball. Instead, we have a herculean task of trying to assess the contents of the bill – and the extensive discussion within the parliamentary process – to understand what the impact will be.
The bill is whipping along at a great rate of knots and has recently made it through the Committee Stage in the House of Commons. Having watched much of the discussion (or read the transcript) and the written submissions, the only thing which is clear is just how controversial this bill is.
This article explains some of the changes to the regime around lease extensions and freehold purchases and the impact on leaseholders and the practitioners who advise them.
Abolition of Marriage Value
When you do a lease extension, the flat will jump up in value. Where the lease is below 80 years, the leaseholder must pay a share of their hypothetical profit to the freeholder. This makes premiums very expensive.
Under the new law, they won’t have to. This doesn’t seem unfair to me: marriage value is a share of the profit that the leaseholder makes and does not represent a loss to the freeholder. Equally, the freeholder would have no way of realising this value if the leaseholder didn’t extend their lease.
However, unsurprisingly my view isn’t shared by all – some see it as a wholly unjustified windfall from freeholders to leaseholders worth £1.9bn, and they won’t take such a loss lightly.
Capping Ground Rent
While not actually included in the bill itself, there has been an extensive consultation on whether it would be possible to cap ground rent – although the level of the cap is not yet clear.
The Government have stated that they would like to cap ground rent at a peppercorn, i.e. nothing. However, various other options have been proposed in the consultation, including capping ground rent either at 0.1% of property value or £250.
Clearly a cap would be extremely desirable for leaseholders who see ground rent as money for nothing. It would also benefit practitioners involved in transactions kiboshed by a ground rent schedule that isn’t acceptable to either the buyer or their lender.
However, the community of freeholders are as vehemently against such a cap as leaseholders are for it, arguing that it would infringe upon their human rights. Dr Maxwell, an expert on Human Rights who gave evidence to the Public Bill Committee, thought the chance a challenge on human rights grounds was “very high”.
I wonder whether another option, capping it at £250, would be more workable. This would reduce ground rent significantly for those most badly affected, while making properties mortgageable and sellable. For freeholders it would mean that their income might be reduced, but not extinguished completely.
When a leaseholder completes a lease extension, they must pay both their own legal and valuation fees and those of their freeholder.
Freeholders argue that this is not unfair. If the leaseholder is essentially claiming a “compulsory purchase” of the freehold or extra years on the lease, why shouldn’t they pay the costs of the transaction?
What we have seen working on lease extension transactions is that costs where one party chooses the provider (and their fees) and the other pays is rarely leads to a fair price. This is shown by the fact that sometimes the freeholder’s fees are twice those we charge to the leaseholder.
So, in theory this also seems like a very good idea. However, the only worse than a freeholder who has overpriced representation is one who isn’t represented at all. We are concerned making freeholders pay for their own representation will lead to many claims which are frustrated by the freeholder not seeking advice of professionals who will on one hand counsel them to be reasonable and on the other facilitate getting the deal over the line.
Standard Valuation Model
In addition to abolishing marriage value, the bill also proposes a new approach to valuation -the Standard Valuation Model.
This should illicit a sigh of relief from anyone who has negotiated a lease extension premium. However, this model is still half-baked. The obvious omission is that the discount rates which are used by the model have not been set.
This is akin to giving us a calculator and asking us for “the answer” but not telling us what numbers to plug into it. For those of you who are fans of Douglas Adams, the numbers 42 come to mind.
Finally, any practitioner who has been involved in transactions impacted by the Building Safety Act will know the impact legislative change can have on our transactions. An example of this being that some poor wording in that act meant that doing a lease extension would prejudice the position of a leaseholder who would otherwise qualify.
We wait with bated breath about how well the Leasehold and Freehold Reform Bill works in practice when it becomes an act, and the impact it has on freehold purchases and lease extensions and the sales and purchase transactions which depend on them.