Leaseholders, Freeholders and Buyer Beware!
The onus of finding out about everything concerning a leasehold flat is down to the buyer. In turn, the buyer relies on the solicitor or the conveyancer applying the principle of ‘Caveat Emptor’ (buyer beware) on their behalf.
The most important thing a prospective leaseholder needs to be aware of is that when they buy their flat they will NEVER own it, regardless of whether they buy through a mortgage or outright in cash. Why? Because the closest that anyone can get to owning property outright in English common law is that of owning freehold. So, in blocks of flats it is the freeholders who own the structure, the roof, the land the building stands on, foundations, load bearing walls, gardens, landings, paths, gates, fences, drives, stairways, and any other outbuildings. Inside they own things such as the plant rooms, lift motor rooms, and meter cupboards and any other areas that are not owned by each leaseholder. All of these areas are known collectively as the common areas.
Freeholders can take many forms so can be people, finance companies, mixed use companies (owning both commercial and residential properties in the same development) ground rent investors, or leasehold resident management companies. A block of flats can also have more than one freeholder if the freeholder who owns the ‘superior’ lease sells what is known as an ‘intermediate’ lease to another party. That party becomes the ‘head lessor’ who can then grant ‘under leases’ to the leaseholders of each flat, making the head lessor their landlord.
This then results in 3 different levels of ownership in the building:
- The freeholder who has the highest level of overall ownership;
- The head lessor (also called the head lessee) who is directly responsible to the leaseholders;
- The leaseholder.
Some freeholders self-manage their blocks but most use the services of a managing agent.
Note: Freeholders are also known as landlords in common law but this is not to be confused by a landlord subletting a property.
So what are leaseholders purchasing?
Essentially they are purchasing an ‘interest’ cut from the dominant estate of freehold in the form of a long lease, a contract between themselves and the freeholder. This document allows the leaseholders to live in the property as an owner-occupier for a pre-determined amount of years (where historically the tenancy falls between being a freeholder and a renting tenant), or to sublet it.
New-build properties usually have lease terms of either 99 or 125 years, other leases have 999 years (more on that later) and others can be very short, depending on how many unexpired years the lease has remaining. Some lenders might not lend on a very short lease although it is possible to assign the right to an extension during the conveyancing process. The school of thought here though that it is always preferable for sellers to have obtained a lease extension before they sell, thereby allowing them to ask a higher price for the property. On the other hand they might not want to do this because the time taken to secure the benefit of a lease extension may add several months to the conveyancing process. Not only that but the buyer will not know what the cost will be until it’s agreed with the freeholder. Some freeholders take so long to agree terms that the situation ends up having to be referred to the First Tier Tribunal for a determination.
It is the lease that governs the relationship between the freeholder and the leaseholders. Both parties have rights and obligations to each other and these are laid out in the covenants (promises). There are two types: positive (to do something) and restrictive (to not to do something).
The main positive covenant entered into by the freeholder is carry out the repairs and maintenance of the building structure and common areas (see above).
The main positive covenants that the leaseholders enter into are to pay service charges, (so that the freeholder can meet its repairing obligations), ground rent (which is not exactly what it says on the tin but is a financial asset for the freeholder) and buildings insurance and keep the interior of the flat well maintained.
Leaseholders also have a number of restrictive covenants such as not to play loud music, keep pets or install laminate flooring.
Covenants are either going to expressly written into the lease or implied and its important to be aware that implied covenants have just as much force in law as express covenants do.
Deed of Direct Covenant
Many older leases (written before 1996) have a need for the new leaseholder to give their details to the freeholder/managing agent in the form of a Deed of Direct Covenant meaning that they agree to abide by all the original lease terms before completion and through the duration of ownership. It will be provided by the solicitor acting for the selling leaseholder in a draft form to the buyers conveyancing solicitor, and the latter will then produce the final deed for the buyer to confirm that they will comply with the existing lease terms.
Understanding the relationship between the seller and freeholder/managing agents is key to understanding leasehold because whilst the lease states the responsibilities and obligations of the buyer and the freeholder, it a) won’t tell you if either party are currently complying with them and b) nor will the tell you what the state of the relationship is between the freeholder and/or managing agent with the rest of the development.
There are a number of documents that the buyer will need to get from the seller which are as follows:
- The lease;
- Office copies of the leasehold title;
- The plan of the property filed with the Land Registry;
- A copy of the buildings insurance and the current year’s schedule;
- The last 3 years service charge demands for the particular flat being purchased;
- Copies of the recent town planning decisions showing the conditions upon which the planning decision permitting the development have been made;
- A copy receipt (or a written confirmation) showing that the seller has paid the service charge for the current period;
- A copy receipt from the landlord showing that the seller has paid the ground rent if the ground rent is paid to the landlord separately to service charges paid to managing agents.
Note: Some lenders require that receipt(s) for rent and service charges be sent to them following completion, so part 2 instructions of the CML Handbook will need to be checked.
If confirmation of ground receipts and service charges cannot be obtained then lenders may consent to the transaction providing:
- Absent landlords are common in the area i.e. landlords that can’t be traced. It is however also likely that they may not lend (although some may accept Absent Freehold Indemnity Insurance) because the freeholder covenants can’t be enforced and this makes properties less marketable Additionally if they need to repossess a mortgaged property, the size of the market they can then sell to will be limited and may result in the property having to be sold at auction and at a loss to the lender. It will also not be possible to exercise the right to buy the freehold because a premium needs to be agreed with the freeholder.
- The seller confirms no other breaches of the lease (although the conveyancer should make further checks as the seller is under no legal obligation to divulge anything that could harm the sale);
- A clear qualified title is provided.
There are also a considerable number of questions that must be asked of the managing parties who will usually ask a fee for providing this information. There is however no statutory guidance on what a managing agent can charge the seller and no statutory deadlines by which the information has to be provided by the managing agent.
The following list shows just how many questions surround the tenure but it is not an exhaustive one:
About the Lease
- Are the leases in a similar form throughout the development (which ideally they should be);
- How many flats are there?
- Are all the flats sold on long leases:
- How many unexpired years are there remaining on the lease?
- Can the lease be extended?
- Have there been any breaches of the lease by the freeholder?
- Have any lease breaches been remedied or are they still ongoing?
- Does the lease allow the keeping of pets?
- Does the lease allow you to use a car park or space and allow access to the gardens?
- Are there any other conditions or restrictions in the lease which impacts on how the property is used?
- Is a direct Deed of Covenant required? See above
- Are there any defects in the lease relating to insuring the building?
- Are the buildings insurance payments up to date?
- Are the interests of lessees and their mortgages automatically noted on the buildings insurance Policy?
Freeholders, Managing Agents and Resident Management Companies
- What is the name and address of the freeholder?
- Who are the freeholder’s solicitors?
- Is the freehold owner deemed a ‘absentee landlord’ i.e. are his whereabouts known?
- Has the Landlord ever served a Notice on the seller (or to their knowledge their predecessors in Title) in matters relating to the Lease or the use of the flat?
- Have there been any consents granted for alterations? If so, they should show as part of the Title Document as a Deed of Variation. If there have been structural alterations made without permission then this renders the lease defective and it must be remedied;
- Is there a head lessee?
- What is the name of the resident management company (or a Right to Manage Company)?
- Is the management company registered at Companies House and still in existence?
- Where can the RMC (RTM) Memorandum and Articles be found?
- Is the RMC limited by shares?
- Has confirmation been obtained that the sellers share certificate will be handed over on completion along with a (signed) stock transfer form? Some lenders will need the new share certificate given to them after completion together with a blank stock transfer form signed by the purchaser and a copy of the company’s memorandum and articles of association so the conveyancer will need to check part 2 of the CML Handbook.
- Is the flat ‘share of the freehold’?
- Is the company limited by guarantee?
- Is the purchaser required to become a member of the company?
- What is the name and address of the managing agent?
Health and Safety
- Is there an up to date health and safety risk assessment?
- Is here an up to date fire risk assessment?
- Is there a copy of the asbestos survey for the common parts?
- Has any Notice under Section 5 of the Landlord and Tenant Act 1987 been served? (the right of first refusal)
- Will there be a surplus or deficit in the service charge accounts after the financial year-end?
- Is there a sinking fund to cover large items of expenditure that come as the building ages and are payments up to date?
- Is there a reserve fund to cover day-to-day maintenance and are payments up to date?
- If a sinking/reserve fund is held, how much is being held for this particular property?
- Are there or will there be any major works either ongoing or scheduled for a later date?;
- Does the lease prevent subletting?
- Is the consent of the freeholder required?
- Does the lease allow the subletting of the property tenants on housing benefit?
SPECIAL CONDITIONS OF SALE
Many new leaseholders receive service charge demands long after they have bought the lease, usually because there is a shortage for the service charge accounting year during the time the seller owned the property. Any monies owed (or credited) are not finalised until the accounts for the block are issued some months later.
So, under the Special Conditions of Sale, the basic rule is that the outgoings of the property should be apportioned between the buyer and the seller and both conveyancers’ will work out the apportionment on service charge demands with effect from the completion date. There are two forms apportionment can take: an undertaking, or a retention clause if the lease provides for payments on account (with a balancing payment at the end of the service charge year). The sales contract should a) specify the amount and b) how long it is to be held for.
On the other hand, if no apportionment is made at the time of the completion (or a retention clause agreed), recovery of any arrears relating to the seller’s period of ownership will need to be made directly from the seller.
Note: Freeholders and managing agents will not give consents, provide deeds of covenant or register the sale if any debts are not paid.
More on retentions can be read here.
Despite all the available information about leasehold, many prospective leaseholders still have no idea what they are purchasing because of the sheer size of the information that surrounds the tenure. This is despite the efforts made such information easier to get and more transparent. Since the introduction of prescribed lease clauses there have been two forms: LPE1 for use from 1st October 2015, which has questions asked on behalf of the buyer, and LPE2, the buyers leasehold information summary which was introduced in response to the Competitions and Market’s Authority Market Study on Residential Property Management Services. This study looked to make clearer the ongoing financial obligations leasehold purchasers were committing to making. So what does this mean in practice? Leasehold conveyancing is a specialist area but as many conveyancers are not specialists then the principle of ‘Caveat Emptor’ remains as relevant as ever!!