What is Ground Rent?
Ground rent is the annual amount payable to the freeholder (known as the freeholder interest) in return for the granting of a long lease. It is also a freeholder investment vehicle.
The value of ground rent is a multiple of the current amount and depends on the following:
- How many years are left unexpired on the lease;
- Any future increases in the level of ground rent, (either fixed or geared through the rent review clauses);
- Market interest rates;
- The possibility of default by the leaseholder as the owner of the ground rent will have precedence over all other creditors, including mortgage lenders and HMRC.
The most prevalent method of increasing the ground rent used by house builders when they draw up the leases is that of fixed uplifts with increments varying greatly in range. Another is a regular rise according to the corresponding Retail Price Index which allows the rent to track inflation, the House Price Index, or as a percentage of the capital value of the property.
Leaseholder Rights v Investment Risk
The income stream derived from ground rent is known as ‘hard income’ but interestingly the rights granted to leaseholders such as lease extensions and collective enfranchisement (a group of qualifying leaseholders buying the freehold and becoming the new freeholders) put this investment at risk because they both reduce the ground rent to a peppercorn. This why the freeholder has to be ‘compensated’ for this loss of income and why a premium is paid by the leaseholder to offset this loss. This (and the placing of buildings insurance) is known as ‘soft income’.
Since the 28th February 2005 any demand for ground rent by a freeholder, (or their managing agents), must be made in a ‘prescribed form’ as set out in s166 of the Commonhold & Leasehold Reform Act 2002 (requirement to notify long leaseholders that rent is due) and which ‘may’ be sent by post to the address on which the ground rent is payable. If the leaseholder has notified the landlord in writing of a different address in England & Wales at which he wishes to be given notices, then they must be sent there.
If this is not adhered to then the leaseholder is not liable to make payment until it is. Again, under s166, whilst the ability to demand ground rent has not been lost if the the freeholder attempts to add legal or administrative charges for non payment based on incorrect demand notices, then these charges will not be payable.
The payment date in the notice cannot be earlier than 30 days from the date notice is given, nor can it be more than 60 days after that date. What will override this however is that the date for payment cannot be earlier than the date set out in the lease itself.
Under s167 of the 2002 Act (failure to pay amount for a short period) a landlord cannot use the forfeiture procedure under the lease unless the amount owed for ground rent, service charge or administration charges (or a combination of them) is more than £350. However, the forfeiture procedure can be used even if the amount is less than £350, if it has been outstanding for more than 3 years. Ground rent can be recovered for up to 6 years in arrears.
All collected ground rent should be held and accounted for in a separate bank account to that of service charges. It is important to be aware that if ground rent is not collected then there will be no money in the company account to pay for the annual return (now the Persons with Significant Control) directors and officers liability insurance and other charges that do not come out of the service charge account.
There is currently a great deal of outrage from leaseholders and interest from both the press and government regarding the building of leasehold houses with extortionate amounts of increasing ground rent over differing periods. This has left a number of properties becoming unsellable. There are calls for no more leasehold houses to be built and the Nationwide Building Society have stipulated that ground rent must be reasonable at all times during the lease term, with unreasonable multipliers such as doubling every five, ten or fifteen years not allowed. If the valuer believes the marketability of the property will be severely affected by unreasonable lease terms, they may decline the property, or reflect those terms in the valuation figure they provide to the lender. Other lenders are expected to follow.
Where will all this leave the ground rent investor market? Only time will tell!