Ground Rent, Collection and What It’s Used For
On the surface, ground rent is a regular amount of money collected by the freeholder from leaseholders as an annual payment for granting a long lease. A freehold interest has no intrinsic value other than the ground rent paid to the freeholder for the ground their property stands on and the reversion (the handing back of the property after the terms of the lease have expired).
Freehold property is therefore normally valued on an investment basis with its value at any given moment based on a calculated present value of the future income. It is the loss of the future income that the freeholder has to be compensated for.
- 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.
Developers often sell ground rents (pre-packaged and in bulk) to ground rent investors before actually starting construction. These investors will pay a large deposit up front which will be used to fund building costs with the sale and exchange of contracts agreed upon very early in the process. When they draw up the new leases they allow these ground rents to increase incrementally over time with greatly varying amounts. This is not new because ground rents have been classed as a long-term investment vehicle with the total returns available seen as being considerably higher tthan those achieved from gilts, fixed income annuities and long-dated bonds.
They are usually traded on a multiplier (years’ purchase, commonly known as YP) or a gross yield applied to the ground rent income. However, unlike both traditional residential and commercial assets, the return generated from the investment does not just come from rental income and capital appreciation (which are known as hard income). Other forms of ancillary income (know as soft income) come from two other provisions within a lease: lease extensions and buildings insurance.
- Portfolio size: the rents payable are relatively low so a large portfolio is needed to be able to maximise all the investment benefits;
- Intensive Management: there is a significant management responsibility and cost involved with responding to leaseholder’s requests and queries often being both time consuming and costly (which is why tri-party leases were created so the resultant RMC’s would deal with this element themselves);
- Index Linked Rent Review Uplifts : a significant proportion of ground rent investment rent review clauses are index linked. Common
index linked provisions include: RPI (Retail Price Index) uplifts, HPI (House Price Inflation), and uplifts based on the average earnings index;
- Political /Legal Risk: Government intervention is an issue because 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.
Regarding Point 4, Government intervention, an interesting point came 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 but trying to balance profits over the cornerstone of leaseholders rights, that of ‘reasonableness’ has gone horribly wrong.
In fact Paragraph 5.14.19 of the Council of Mortgage Lenders Handbook (CML) states that ‘we have no objection to a lease which has 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 COLLECTION
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 per s166 (1) of the Commonhold & Leasehold Reform Act 2002 (requirement to notify long leaseholders that ground rent is due).
Such demands ‘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.
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 which cannot be earlier than 30 days from the date notice is given, and it cannot it be more than 60 days after that date. Overriding this is the provision that the date for payment cannot be earlier than the date set out in the lease itself.
Such demands ‘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. The tenant (leaseholder) is not liable to make payment unless (and until), it is properly demanded. This doesn’t mean that the ability to demand ground rent has been lost, but if any attempt is made to levy legal or administration charges for non-payment based on an incorrect demand notice, those charges will not be payable. If necessary the leaseholder should seek a determination from the First-tier Tribunal (Property Chamber) in England, or the Leasehold Valuation Tribunal in Wales.
The form also contains a reference to s167 of the 2002 Act (failure to pay small amount for short period). This section provides that 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 outstood for more than three years. Ground rent can be recovered for up to six years in arrears under the Limitation Act 1980 if not collected.
The method used to value freeholds, that of the Parthenia method was challenged in 2016 with the case of Sloan Stanley Estate v Mundy because the method used pre-1993 Act facts to show relativity in a “no-Act” world. It apparently produced an impossible result because the open-market value of the leasehold property was shown to be lower than the “no-Act” value. Evidence given by valuers on behalf of the freeholder stated that in their opinion “Act rights” do have a value so that the market value of a property without rights must be less.
The decision by the Upper Tribunal for the Parthenia model not to be used again has been upheld by the Court of Appeal in January of this year, a summary of which can be read here.