A seismic shift in the residential leasehold system awaits. Under the draft Commonhold and Leasehold Reform Bill ("the Bill"), commonhold will become the default ownership structure for new apartment blocks, and annual ground rents will be capped.
But what does this mean for existing and prospective owners of freeholds and leaseholds, and should they prepare before the Bill becomes law?
This article is relevant to landlords who own the freehold of buildings subject to long leases, and therefore rely on the ground rent income, as well as landlords who just own the leasehold, i.e. those who buy properties on long leases to rent out to tenants.
Commonhold structures have operated successfully in countries around the world, but they have not become popular since being established in England and Wales in 2004. Under the existing framework, there is limited clarity about how commonhold works in practice, creating nervousness amongst lenders as well as limited incentives for developers to establish such structures.
Under the Bill, a much more beneficial system for property owners in new buildings (whether that be occupiers or investors) will emerge. There will also be greater clarity of how the commonhold system will work, which should encourage lenders, too.
Under a commonhold system, flats are held in a form of freehold ownership. Owners collectively, through a Commonhold Association, take charge of how the building is managed. A Commonhold Community Statement governs their practices. These commonhold structures will give property owners a greater say in how communal areas are managed, safety issues are resolved and the costs of such matters.
Extortionate service charges placed on leaseholders, and poor management of apartment blocks by some unscrupulous freeholders and their residential management companies have dominated headlines in recent years. Equally, the absence of freeholders has caused huge issues for leaseholders. This new Bill will establish a new era, ensuring the new buildings of today do not result in the issues flat owners face today, for generations to come.
For existing leases, there will also be changes regarding the enforcement process when there has been a breach of covenant. Freeholders will lose the right to forfeit (terminate) long residential leases. Instead, they will have a new right to make a ‘lease enforcement claim’ against long leaseholders. Despite there being existing safeguards around forfeiture, it has still proved financially detrimental for many flat owners who have lost leases for minor breaches that could be easily fixed.
Under the Bill, freeholders will have to jump through more legal hoops before sanctions are imposed on defaulting leaseholders, providing further protections for leaseholders. However, freeholders will be provided with powers to take enforcement action against leaseholders who have not remedied breaches, such as seeking an order for sale. This will create a much more proportionate approach to breaches of covenant.
The Bill will also strengthen powers for existing leaseholder structures to convert into commonholds. While this right is already available, the requirement for unanimous consent has hindered its uptake. The Bill will require only half of the leaseholders to agree for a conversion to commonhold to be implemented.
Ground rents will also be capped at £250 per year, cannot be doubled every 10 years, and will be reduced to a peppercorn after 40 years. This creates much more certainty for existing leaseholders and those looking to buy leasehold flats, with a greater ability to assess whether a property is a good investment.
The Bill is good news for long leaseholders. Freeholders, on the other hand, are less likely to welcome the changes. Property investors will receive lower returns from ground rents, and potentially no rent at all after 40 years.
There will also be no opportunity to purchase a freehold for new apartment blocks. As a way of anticipating these changes, property investors in freeholds would be wise to start creating contingency plans for conversion to commonhold requests, as well as considering how their portfolio could be diversified, to weather these changes.
The Bill will provide much-needed clarity to the residential property sector, but it is still in its very early stages. The Bill will be most favourable to landlords who are leaseholders, and minimal preparation may be required from this group. For freeholders, it will be essential to keep a close eye on its progress, to ensure appropriate and timely preparations can be made to respond to this seismic shift.
