Ground rent is a regular amount of money paid to the freeholder by leaseholders. On the surface it is exactly what it says on the tin but it is far more complex than that. It is a key component in freehold valuations in both collective enfranchisement and lease extensions and it’s value (freehold interest) is comprised of the following elements:
- A multiple of the current ground rent which in turn depends on 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 chance of default by the leaseholder as a ground rent owner will have precedence over all other creditors, including mortgage lenders and HMRC.
Paragraph 5.14.19 of the Council of Mortgage Lenders Handbook (CML) states that ‘we have no objection to a lease which contains provision for a periodic increase of the ground rent provided that the amount of the 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’.
Ground rent has also been a low risk, long-term investment vehicle for a number of years. When developers draw up leases the most common method they use to increase ground rent 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.
Developers also often sell ground rents (pre-packaged and in bulk) to ground rent investors before starting construction. These investors will 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. If developers don’t want the building of the development slowed down by having to issue Section V notices to the leaseholders under the Right of First Refusal, as long as the sale of the ground rents occurs before half of the flats are sold, the need for serving such a notice is avoided. It’s not actually illegal because legislation requires there to be a majority of leaseholders willing to accept the right. If less than half of the leases have been granted then such a majority simply does not exist!
Many leaseholders however don’t see why they have to pay ground rent as they do not see how such a payment is of any benefit to them and a scandal of “doubling” ground rents on freehold houses has seen the building of freehold houses now banned. This came about because the freeholds of these properties were sold on to another party without the knowledge of the new leaseholders. They only became aware of this when they saw their ground rent demands (with another company name on them) doubling every 10 or 25 years, rendering the properties un-sellable.
An interesting article on the subject of Government intervention in this area comes from Paul Winstanley, FRICS entitled ‘Be Careful What You Wish For: The Unintended Consequences of Political Intervention in the Ground Rent Market’ who holds the opinion that for such a responsibility taken on by freeholders, the existence of a ground rent payment by leaseholders to a reasonable upper limit is justified. The key words here are ‘existence’ and ‘reasonable’ but so far there is no indication as to how banning the build of freehold houses and therefore that of ground rent will impact on lease extensions, which use ground rent as part of the valuation of the premium to be paid!
GROUND RENT DEMANDS
It is s166(1) of the Commonhold and Leasehold Reform Act 2002 (requirement to notify leaseholders that rent is due) that provides that a leaseholder is not liable to pay any rent due unless they receive a formal demand from their landlord. This is limited to 6 years if not collected but must be properly demanded.
In order to be valid, the demand must include the following:
- The name of the leaseholder;
- The period the demand covers;
- How much the leaseholder has to pay;
- The name and address of the freeholder and/or managing agent;
- The date on which the ground rent is due or fell due.
The only control leaseholder have over ground rent is that of a statutory lease extension (90 years added to the unexpired term) which reduces the ground to a peppercorn (nil).