By Joanna King, Legal and Compliance Analyst
There has been a lot of publicity shared in recent months around the topic of ‘toxic leaseholds’. Just before Christmas last year the government published its response to the recent call for evidence on “Tackling unfair practices in the leasehold market”. One of the issues considered as part of this consultation was the matter of onerous ground rents in residential leases.
There is no precise definition of what exactly constitutes an onerous ground rent, as opinions vary substantially across the property industry.
Some lenders offer an indication that ground rents which exceed 0.1% of the property value or those which double (or more) at set intervals would fall into this category. This approach is shown in Part 2 instructions to 5.14.9 of the Lenders’ Handbook, as first announced by Nationwide Building Society.
Others maintain that ground rents falling outside the definition of ‘low rents’ under the Housing Act 1988, and thereby creating an assured tenancy (subject to other criteria being met), are considered onerous. This is because of the risk of mandatory possession, should the tenant default on their rent payments.
As the consultation response has shown, over 40% respondents were in favour of peppercorn rents (zero financial value). Others argued that ground rents provide valuable income to the landlords in return for maintained quality of services, supporting the affordability and viability of schemes (especially in retirement housing) and generally ensuring that landlords retain an interest in their investments.
Whatever your personal perception of what makes the ground rent onerous, here are some pointers that every conveyancer should consider, and accordingly bring to the attention of their buyer and lender clients, when assisting in a purchase transaction.
Acting for the buyer
As briefly mentioned above, under the provisions of the Housing Act 1988, leases where the annual rent exceeds £250 per annum (or £1000 per annum in Greater London) may be considered an assured tenancy (subject to other criteria being met). This provision can be evident at the start of the tenancy or it may take effect further into the lease term.
In assured tenancies, if the rent remains unpaid for a sum and a period prescribed by Ground 8 in Part I of the Schedule 2 to the 1988 Act, the landlord may be entitled to seek mandatory possession of the property through a court order.
The court will need to be satisfied that both at the date of the service of the notice under section 8 of the 1988 Act and at the date of the hearing:
• at least eight weeks’ rent is unpaid, if the rent is payable weekly or fortnightly;
• at least two months’ rent is unpaid, if the rent is payable monthly;
• at least one quarter’s rent is more than three months in arrears, if the rent is payable quarterly; or
• at least three months’ rent is more than three months in arrears, if the rent is payable yearly.
In such circumstances, if the rent remains unpaid, the tenant will not be able to rely on any settlements or statutory protections, for example relief from forfeiture, and the lease would be brought to an end.
If the clients happen to face financial difficulties in the future, they may perhaps look to prioritise settlements of other debts instead. If they are not advised at the outset of the real risk of losing their home associated with these provisions, this may have catastrophic consequences.
Let’s also look at escalating ground rents. Long leases will typically include provisions for periodical rent reviews. These may refer to increases by a fixed amount, they may be linked to Retail Price Index or in some cases may provide for ground rent multipliers, for example doubling every set number of years.
In a lot of the cases, the initial ground rent may sound reasonable enough on completion, even when contrasted with the increase provisions dictated by the lease. For example, an annual ground rent of £250, increasing by £100 every 20 years would bring the amount to £650 per annum (pa) after 80 years. That should be manageable enough. But what about some recent examples of leases with clauses allowing the ground rent to double every 10 years? If the starting rent was £250 pa, after 30 years the leaseholder will be asked to pay £2,000 pa. But the 80 years’ mark will attract an eye-watering bill for £64,000 pa!
A buyer rushing to complete the purchase of their new home may not necessary appreciate the financial implications of such rent review clauses, especially if they do not intend to hold onto the property for too long. But, with time, the affected property will become less attractive to a prospective buyer and in some cases the leaseholders may find themselves struggling to sell the property on without bearing a loss in value as a result. The consequences may also be felt much sooner, as we have already seen multiple lenders restricting their lending on properties with adverse ground rent provisions.
Acting for the lender
Conveyancers acting in the purchase subject to a mortgage loan are also required to consider whether the ground rent payable now and the lease provisions for its future increase are compliant with Part 1 and the specific lender’s requirements under Part 2 of the UK Finance Lenders’ Handbook.
Last year, the Council of Mortgage Lenders also published a guidance sheet for new build leasehold properties. Whilst the guidance does not replace or override any individual lending policies or provisions under the Lenders’ Handbook, the document does offer some direction into a selection of leasehold related matters, which may have implications on the value of the property as well as the affordability of the mortgage loan. Consequently, the lenders may expect to be advised on these matters accordingly.
Part 1 instructions of the Lenders’ Handbook state: “We have no objection to a lease which contains provision for a periodic increase of the ground rent provided that the amount of the increased ground rent is fixed or can be readily established and is reasonable. If you consider any increase in the ground rent may materially affect the value of the property, you must report this to us.”
Whether the rent increase will be fixed or can be readily established will of course depend on the wording of the relevant clause in the lease. But the assessment of what level of ground rent is reasonable poses a number of challenges. Conveyancers have a difficult task of balancing their obligations towards the lender clients as well as acting in their buyer clients’ best interests. A report to the lender will no doubt prompt a further referral to the valuer and this in turn may delay the transaction. An overcautious approach may therefore negatively (and unnecessarily) impact the client’s purchase due to an issue which potentially might not have required a referral to the lender.
It is therefore essential to fully recognise the scope of matters that may require a referral as well as the specific lender’s requirements. Seeing how much Part 2 instructions can vary from lender to lender, the need to frequently refer to the Handbook’s provisions is certainly not an easy task during a busy conveyancing day.
Managing the risks now
In its response to the consultation the government has shown commitment to introduce legislative measures to address the risk of unfair mandatory possession orders for leaseholders classed as assured tenants. At the same time, Communities Secretary Sajid Javid also announced plans for future ground rents to be set to peppercorn on all new long leases in houses and flats.
But before any changes take effect, conveyancers need to manage the existing risks in line with the current legislation and industry practice. A lawyer also has a duty to draw the client’s attention to any unusual and/or onerous clauses in leases (County Personnel (Employment Agency) Ltd v Alan R Pulver & Co  1 WLR 916).
Intelliworks case management system from Ochresoft takes away the burden of regular workflow and precedents management, allowing conveyancers to focus their valuable resources on delivering great service to their customers. As a provider of specialised residential conveyancing software, Ochresoft helps conveyancers manage the risks at every step of their client’s transaction.
Lawyers can enjoy the benefit of a responsive and intelligent leasehold report on title, which seamlessly tailors the key details of the subject lease with comprehensive advice on all legal aspects of the client’s transaction.
Users can also easily refer to specific lender’s instructions under the Lenders’ Handbook, right from the case. This allows you to immediately view just the right paragraphs that are relevant to the information you are dealing with, at that stage, without the need to leave the case to search online for relevant provisions of the Lenders’ Handbook. The information is sourced in real time so you can be sure the Handbook content is always up to date.
Should you need to contact the lender to seek their instructions on any of the Handbook matters, you can easily do so with our comprehensive Report to Lender wizard, which will readily insert the relevant paragraphs into your correspondence as well as will help you keep track of the lender’s response to each issue raised.
With specialised workflows in place, you can be sure that the transaction risks are managed effectively and that clients are always well informed.