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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 an investment vehicle for large ground rent investment companies.

The value of ground rent is a multiple of the current amount and depends on the following:

  1. How many years are left unexpired on the lease;
  2. Any future increases in the level of ground rent, (either fixed or geared through the rent review clauses);
  3. Market interest rates;
  4. 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’.

SALE OR TRANSFER OF THE INTEREST

The sale or transfer by the landlord of his interest is termed a disposal which can take the following forms:

  1. A simple sale of the interest (which is the lease);
  2. The sale of the freehold;
  3. The creation and sale of an intermediate lease (a new interest) by the superior landlord to someone else known as a  head-lease. This head lessee will also be able to make a profit from ground rent if the ground rent collected from all the other leaseholders in the block exceeds the ground rent payable by him to the freeholder. A head lessee can also hold a reversionary interest (the right to get the lease back once the term expires) if he is granted a longer lease term than the other leaseholders, for example 125 years against 99 years. So with a 26 year longer lease than the others, the head lessee has the right to all those flats before they would have to be returned to the freeholder.

Where the disposal is a relevant disposal and the conditions relating to the building, the landlord and the leaseholders are met then the right of first refusal exists and the disposal must first be offered to the leaseholders.

EXEMPTIONS OR LOOPHOLES TO THE RIGHT OF FIRST REFUSAL?

The majority of such disposals will trigger the right of first refusal, which is provided to leaseholders under s5 of the Landlord and Tenant Act 1987 (Part 1)  The right is not a means of forcing a landlord to sell the freehold because leaseholders who want to do that can do so through the collective enfranchisement provisions of Part 1 Chapter 1 of the Leasehold Reform, Housing and Urban Development Act 1993. RFR simply enables leaseholders to purchase the interest before it is offered on the open market or by auction.

On the other hand there are some exemptions where it will not be triggered.

Developers want to maximise their profits so they often sell ground rents (pre-packaged in bulk) to ground rent investors before construction starts. The investors pay a large deposit up front which will be used to fund building costs. The sale and exchange of contracts is agreed upon very early in the process because one of the conditions will usually be that completion takes place on a notice served by the developers at a fixed period after the sale of the last flat.

So, on new-builds where developers are selling to ground rent investors and neither parties want to be slowed down by having to issue a Section V notices to leaseholders, as long as the sale of the ground rents occurs before half of the flats are sold, there is no need to do so. It’s not actually illegal because legislation requires there to be a majority of leaseholders willing to accept the right so if less than half of the leases have been granted then such a majority simply does not exist!

Another area when the right of first refusal is exempt is where a developer may keep the freehold and register it in a limited (associated) company. On completion of the development, and the sale of all the leases, after a period of 2 years, the developer then sells all of the shares in the company (the freehold) to another party such as a ground rent investor. There is no change of ownership, because in effect the freehold has simply changed hands and it is the company that has new owners. So under this arrangement, they are not obliged to offer leaseholders the Right of First Refusal.

Transfers within a family or trust are also exempt as are the following:

  1. Grant Of Single Tenancies: The disposal (sale) must apply to the whole building. The landlord is free to grant tenancies of individual flats;
  2. Grant Of A Mortgage: This is where the landlord obtains a mortgage or a loan on the security of his interest;
  3. Disposal Is In The Hands Of A Receiver Or Trustee In Bankruptcy: This means that if the disposal was transferred to the receiver, liquidator or trustee first it makes it an exempt disposal. However, any subsequent disposal by the receiver,liquidator or trustee will not be exempt and the leaseholders will need to receive notice of their rights;
  4. The Disposal To An Associated Company: This is where the interest is transferred as an asset to another company, which has been associated with the parent company for at least 2 years. Therefore, for example, a landlord which is a company may transfer its freehold of a block of flats to an associated company. Leaseholders are not able to exercise the RFR in this case, but should investigate, (through the Registrar of Companies), that the associated company has been associated for the requisite 2 years prior to the transfer as per the Landlord and Tenant Act 1987.

SUMMARY

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!

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