Buying Leasehold Flats
Leasehold properties continue to be built unabated and whilst many prospective purchasers are becoming more savvy in some areas, yet more still have no idea what they are actually buying into. This is because they usually only get to see the property, rather than the lease which is what they are actually buying, not the the bricks and mortar.
The lease allows the purchasers to stay in the property for a pre-determined amount of time, dictated by the number of unexpired years left on it. It’s fundamental function is to allow the freeholder to collect payment from the leaseholders for the maintenance and repair of common areas – areas that they do not directly own. Because there is no legal definition of the common areas, what they actually cover depends on the wording of the lease. Both parties (freeholder and leaseholder) agree to enter into a series of covenants (promises) to do and not to do certain things, with leaseholders entering into a series of express covenant that are specifically written. There will also be few such covenants which oblige freeholders to carry out certain functions. There are also implied covenants which are not specifically written into the lease but implied by common law.
Note: leaseholders are actually ‘owner occupiers’ because they actually fall between being a freeholder and a renting tenant.
Although leases may be the same (or similiar) throughout a block of flats, another block will have entirely different leases. This is because it is up to the developer/freeholder as to how they are written. There have been attempts to make them more uniform by the introduction of prescribed lease clauses, and the Leasehold Properties Enquiries Form LPE1 was introduced to capture information about a property held by the freeholder landlord, the RMC, the managing agent, the residents association or a representative acting on behalf of any of them. The second edition of this form was released in October 2015 (LPE2) and how to download both editions can be found here.
But who are all these different parties?
Right at the top is the freeholder who can be an individual, a finance company, a ground rent investment company, a company which owns commercial and residential property or a local authority. Leaseholder can also be freeholders and they can also manage a block of flats without owning the freehold.
It is the freeholder who holds the greatest power when leaseholders breach the terms of the lease, that of forfeiture. This is the taking back of the lease (and the property) before its natural expiry.
More about forfeiture can be read here.
There are however a number of problems that can be created if the freeholder is termed ‘absent’. Reasons are varied but include death, bankruptcy, being criminals (convicted or not) or they have simply disappeared and do not want to be found.
Whilst flats can be sold when the freeholder is absent, (and this is where the use of indemnity insurance comes in) key covenants on the part of the freeholder cannot be met such as service charge and ground rent collection, common area maintenance and repairs and the placing of block buildings insurance. This will in turn lead to significant disrepair and flats that can’t be mortgaged, not to mention issues with the title!
SHARE OF THE FREEHOLD (leaseholders are also the freeholders)
This is where developers draw up two-party lease which has a mechanism compelling the transfer of the freehold to a leaseholder-comprised Resident Management Company once the last flat is sold. The selling of this type of lease is known as ‘share of the freehold’. This is usually at a minimal cost (or may be at no cost at all) with shares being issued on completion of each lease. Each leaseholder then becomes a shareholder of this new company and a group of interested leaseholders (as the new board) take responsibility for complying with the management covenants set out in the lease. In this situation the developer walks away with the profits and with no future interest in the block.
Sometimes the RMC is already established by the developer for this purpose but if it isn’t it will be necessary for the leaseholders themselves to form a company to enable the transfer of the freehold to them once the last flat is sold. The management responsibilities are transferred into the name of the RMC, often via a head-lease.
The advantages of ‘share of the freehold’ are that longer leases can be granted at a reduced premium, terms of the lease can be varied and agreement can be reached on who provides the service, with self-management reducing the costs of the service charges.
These advantages are however reliant on all the leaseholders/shareholders being in agreement with all proposals.
A freehold company owned in this way by the leaseholders is also under no obligation to sell a share in the freehold to other leaseholders who don’t own a share. It is however sometimes possible for those leaseholders to ‘buy into’ the freehold company for which there will be a payable premium.
If, however a flat is sold on, then the share will automatically transfer to the new buyer.
More on share of the freehold can be read here.
TRI-PARTY LEASES (leaseholders don’t own the freehold)
Developers can also draw up a tri-party lease which consists of the freeholder, the leaseholder and the RMC which has the right to manage the building. These leases were created by developers and freeholders in the 1980’s when the granting of a number of leaseholder rights resulted in making the idea of being a freeholder much less attractive to investors.
This type of RMC doesn’t own the freehold because this is retained by the developer who farms out management to the RMC under the guise of giving leaseholders more power. The RMC (or the managing agent if the lease states that this is what is required) acts as a management trustee to deal with the unprofitable ‘grunt’ work i.e. collecting service charges and chasing bad debts. They will also instruct contractors to carry out repairs and services. This leaves the freeholder with very few obligations other than the profitable areas of collecting ground rent and placing building insurance. If the RMC is party to the original lease then it’s obligations will be set out as per the lease terms, rendering a contract between itself and the landlord unnecessary. The RMC will have contractual rights directly with the leaseholders so it can sue them if they don’t pay their service charges
COMPANIES CREATED VIA COLLECTIVE ENFRANCHISEMENT (leaseholders are also the freeholder)
The Leasehold Reform, Housing & Urban Development Act 1993 gave leaseholders of flats the right to collectively buy their freehold and become the new freeholders themselves.
It’s a process of several months (sometimes years) depending on the building and its residential makeup as both have to meet certain criteria.
It is also equally important to be aware that a building might be subject to several forms of lease so if possible, the terms of the new lease should be agreed before commencing the claim.
More on the process of collective enfranchisement can be read here.
COMPANIES CREATED VIA RIGHT TO MANAGE (leaseholders don’t own the freehold)
Right to Manage was introduced in s71 (Part 2 Chapter 1) of the Commonhold and Leasehold Reform Act 2002 in September 2003 and hailed as a great right for leaseholders because they can replace current managing agents with one of their own choosing, with no premium payable and without needing to go to court to prove ‘fault’ on the part of the freeholder. Smaller developments can choose to self manage.
There are certain criteria that both the building and the leaseholders have to meet to exercise the right.
More on the process of right to manage can be read here.
Under the Landlord and Tenant Act 1985 a group of leaseholders who hold houses or flats on tenancies/leases from the same landlord upon similar terms have the right to set up a recognised tenants association. The RPTS (Residential Property Tribunal Service) defines a tenants/residents association as ‘a group of leaseholders that pay variable service charges – service charges that the landlord can vary from year to year, depending on running costs in the building’.
It is only when it has been officially recognised by the freeholder landlord that it has the full legal rights to be consulted by the landlord on major repairs and other works, and to get certain information from the landlord.
More on establishing a recognised residents association can be read here.